Lately the housing bubble and subsequent burst may have exhausted some, but the bulk of homeowners, investors (and the real estate agents that sold them those houses) are convinced that home values improve over the years. What I am about to tell you might surprise you and also sway your opinions on homeownership and single family home investing forever. Be prepared. This information might jolt you a little…
The Tough and Honest Reality
Yale economist Robert Shiller, arguably the leading expert on the subject of home values, made some very intriguing discoveries after cautiously analyzing home values over the course of the last 100 years. He found that on a long term margin, home values remained relatively the same when you take in account inflation. From 1900 to 2000, the national average of the true rate of appreciation on home values was astonishingly only 0.2%.!
But wait, wouldn’t the cost of a home you buy today cost even more 20 years from now? Yes, it probably will, but in most cases, the price increase you’d be seeing would mainly be the result of inflation, not a solid appreciation of the worth of the property. Inflation is the devaluation of your money as time passes. Five dollars today will buy far more than five dollars twenty years from now due to inflation. For example, if a house has a sales price of $325,000 today, in ten years, it may be valued at $375,000, but the $50,000 increase is simply a devaluation of the dollar. What costs you $325,000 today, in this example, would cost you $375,000 ten years from now.
For Homeowners This Means
A lot of people are in complete shock over Shiller’s findings. However, his findings may provide a different approach on the purpose of owning of a home. A house is a place to live, a place to make your own, a home to raise your family in. It’s not an investment. It may be considered a forced long term savings plan because each mortgage payment may include a portion of principal pay down and the actual worth of the home will usually keep up with inflation. The goal is for your mortgage gets paid off sometime in the future, so that your total monthly payment is far lower than the cost to rent a similar house. Being a homeowner has many benefits, but sadly, one of them is not your home being a good investment.
For Investors This Means
For those who buy single family homes for investment purposes, understanding the real rate of return of houses is very crucial. Too many venturers in the mid 2000s bought properties with the belief that their investments would go up in value. Some got lucky. Most did not. The significant error was in blind-faith that property values would appreciate over time. Instead, the smart way to view properties as investments is to look at how much tax advantaged income can be made from them right now. You want to ask yourself, how much money has this investment property brought in recently?
Single family rental property can be a wise investment. First, your renter pays you monthly. If that rent is greater than your monthly expenses (mortgage payments, taxes, insurance, maintenance), you get an increase in cash flow. Plus, part of your mortgage payment may trim down your overall mortgage balance, therefore allowing your tenants to actually pay off your loan. Secondly, thanks to depreciation, the money that you are bringing in is very tax advantaged so you should pay a very small amount of income taxes on it.
The most positive way for an investor to appraise buying a single family home for long term investment reasoning is to figure out how much positive cash flow it will bring in starting on day 1 (as opposed to how much it might appreciate in the future).
Exceptions to the Rule
An important fact to keep in mind is that Shiller’s discoveries are based on national averages and as they say in real estate, it’s all about location, location, location. In certain areas, property values have not kept up with inflation. For example, in Baytown, TX, your average 3 bedroom 2 bathroom house ran about $80,000 in 1980. That exact house will cost you around the same today. It’s been 35 years and house prices are the same, so much for keeping up with inflation! There are other areas where home values have outpaced inflation and have appreciated. The trialing part, of course, would be in figuring out which areas will beat the national average of 0.2%.
Usually, making assumptions, however educated they may be, on the likelihood of area home values appreciating would be useless. People have historically proven to be awful predictors. Relatively, the best plan might be to live where you want to live, and if you decide to convert to a homeowner, buy a house you can manage to pay for and that meets your housing requirements. If you want to capitalize in single family homes, make sure you buy properties that truly turn a profit from the instant you buy them. If you are blessed enough that your home is positioned in a location that really does experience some appreciation, consider it to be an added bonus.