My father once told me that real estate was a good business because the population is always going up, therefore more housing is needed, and the space on earth remains the same, so house/apartment prices go up. Is this true? Edit: Maybe population will actually go down, who knows. For BlueishGoldfish: he meant investing in real estate. Sorry, my question was a bit misleading.
No. Just no.
This is a cheesy sales pitch from someone who wants you to take their course on real estate investing for the low low price of $499.
It's a non-sequitur: the conclusion does not follow from the premises.
- Population generally increases: true.
- More and more real estate will be needed to house them: true, with caveats.
- And thus you should go into the real estate business: does not follow from 1 and 2.
To clarify, an example:
I can reliably predict that telecommunications technology will be profitable. So I should go into the telecommunications business!
No, no, no.
I can't predict which telecommunications technologies will be big, I know nothing about how it works, etc. etc. I can bet on a broad swath by buying an index fund that tracks the relevant sector, but these aren't as profitable because it doesn't take much mental expenditure to figure out that people really like e.g. smartphones.
There's a rule in investing: only buy what you know. If all you know about real estate comes from owning n houses for n < 5 you should not go into the real estate business unless you're prepared to learn it, most likely by losing money at first.
I've owned a 5 unit rental and flipped one house. I more-or-less broke even on the rental after a number of years including selling it at a loss as the rental market changed. Flipping the house was a big win, but even then I had to sit on it (live in it) for a couple of years longer than I planned when the market tanked.
It is possible to learn the real estate business just like any other business, and it is possible to make money in it. But it's not that easy, which is why more people don't do it.
The basic premise of what your father is saying is equivalent to:
Buy land. They ain't making any more of the stuff. - Will Rogers
And probably, if you look at this at the timescale of centuries or millennia, it's probably roughly right ignoring volcanic islands.
But There are some complicating factors to this:
- Not all property grows in value at the same rate. Some will decline in value over a human lifetime.
For example, the suburbs had a lot of growth over the last century in the US. Now people want to move into the cities and suburbs are on the decline in many locales. Environmental disasters can really decrease the value of property. Consider the Salton Sea for example.
- Because governments have an interest in seeing land put to productive use, it is usually taxed.
Real estate is a little unusual in this way. If you own stocks and they don't make any money, you don't pay any tax. If you own a bunch of land, you typically have to pay taxes on it based on the value of the property. This can really cut into the profitability of such investments. Whatever plan you have for income off of a property better consider the tax burden and the fact that it will increase with the value of the property. This means it's not typically profitable to simply own property and sell it later. Such situations occur but there needs to be a driving factor causing a sharp rise in value such as government investments or a rapidly growing business (e.g. Seattle.) It's all about the timing.
- Property typically requires upkeep.
If you buy an apartment building, you don't just kick back and start collecting checks. You have to maintain it so that it doesn't lose value and also to make it a desirable place to rent. You also need to make sure people actually pay their rent.
Real-estate can be profitable but it's not a slam dunk. If it were that easy, everyone would do it and drive the cost of property to the point of unprofitably. The key to making money on real-estate is what you do with it.
Depends what your father meant when he said "real estate was a good business" and that "real estate prices mainly go up." You could be a real estate agent, a landlord, a commercial property investor, or even the guy with a hardhat and hammer who builds houses. Each of these folks can have radically different outcomes from being in the real estate business.
And it is true that real estate prices go up on average. However there are many pieces of real estate that have lost all their value, or are even negative in value.
I think I'd try to get clarification from your father about what he means, maybe we can provide a better response for you.
Its worth noting that population growth rate has fallen to the floor in many western countries. Europe had its first negative growth year in 2000, and has increased thereafter only due to immigration. In the US, it is now down to increasing at less than 1%, and half of that is due to immigration (which the current administration is trying hard to curtail). Many individual US states (eg: The traditional real-estate investment haven of New York) actually lost population last year.
So if the argument in favor of any investment is based on population growth, then long-term that investment is getting less and less of a sure thing.
This image by author YaledUp. (Attribution required)
This chart was created with the data from the Case-Shiller index, Shiller being a Nobel prize winning economist.
It shows how, long term, home prices have tracked inflation, and virtually not any more than this.
There are are 2 things to note. The bubble from the late 90's into 2007 was caused by a number of factors. A drop in mortgage rates accounts for a large portion of the gain. As rates fell, the same payment would afford a much larger mortgage. At the same time, it's fair to say that questionable lending practices pushed demand and speculation thru the roof. It was an unnatural fast rise and ultimate fall.
One can look at incomes, and match up an income at about the 60% percentile, calculate the mortgage, at a 30 year fixed rate, and add a downpayment. That creates an equilibrium home price. Long term, home prices will follow that trend. Prices will follow wage inflation.
There will be time periods that you can draw a nice line showing tremendous growth, but the trendline will always win, in the aggregate. There will also be areas that can sustain a higher growth that eventually crowds out a section of the population. Areas can gentrify, and the children inherit a house they could never afford to purchase but might be able to maintain and pay the taxes.
In the aggregate, I talk about the 60% percentile and the mortgage they can afford. This is based on a well written loan, 28/36%, where 28% (of income) goes to the mortgage, property tax and insurance and 36% towards all debt. When prices rise too far above this line, demand falls, much below, it rises. It's silly to think that real estate, again, in aggregate, can rise 5% above wage inflation for long. 14 years of that and a home would cost 56% of one's income. It simply can't work that way. Even though short term, it seems otherwise.
NO, it's not true.
Over 345 years, prices have gone both up and down. The average real price rise is 2.187^(1/345) per year or 0.23% per year. I wouldn't call this a significant increase. Stocks yield about 6.0% per year over inflation. Houses yield less, mainly due to rent, but you may get a minuscule 0.23% per year increase on top of rent, but do take into account expenses needed to get that rental yield.
The largest crash has been from 317.9 (in 1778/9) to 68.1 (in 1814/5), meaning the real price went 79% or approximately 80% down.
If you are not prepared to take a 80% decrease in property values, DO NOT invest in houses!
Interesting piece of trivia: Dow Jones Industrial Average fell from 5000 to about 1000 (ok, it was bit lower very temporarily, but if you don't sell at the absolute worst moment, in practice it was down 80%), during the Great Depression, so the worst-case scenario for stocks (minus 80%) is the same as it is for houses (minus 80%).
Note also that the 345 year study is for a well-diversified housing portfolio. If you buy a single house, it has a much, much higher risk than a well-diversified housing portfolio.
My advice? Invest in stocks, because the worst-case scenario for a well-diversified portfolio is the same (minus 80%), but they yield more and it's easier to diversify.
Since none of these answers touched upon the main profit of real-estate...leverage. When you "invest" in a stock market, usually you are using your own money. Unless you really want to "invest".i.e. Gamble.
When you "invest" in a property, usually you are using the banks money. If the house appreciates more than your mortgage interest, you win, if not, you lose, but historically having an underwater standard 30 yr mortgage is rare. The downside risk is usually much smaller than the upside potential.
Bought (20 years ago)
Risk = Detroit
Lotto = San Francisco
Upside = NY, CO, CA... etc...
The mainly constantly go up due to inflation, but that does not actually change their effective value. 1$ of 1915 is equivalent to $24.87 today.
They sometimes artificially go up due to very large business interests supported by media propaganda. But in such cases they also sometimes reset at more acceptable margins.
The rest depends on specific countries. For example, high prices will eventually drop in many East European countries because more and more people go to work aboard and the overall local population is in a constant decrease. This was enough in the last few years to overcome the increase due to inflation.
On average, and over a great many years, perhaps. Benjamin Franklin was perplexed at the increasing values realised by his neighbours (he himself bet against that trend).
Real estate is local, one nuclear accident can ruin your portfolio. Within living memory a third of some US states changed hands in the course of days (dust bowl, anyone ?). You can't put it in your pocket, and you cannot defend against resumption (Emminent Domain).
The stroke of a pen can also ruin your day. China has recently introduced restrictions on property ownership, causing the divorce rate to soar as couples separate to keep entitlement to more property between them.
It is not that simple. Consider :
- Land Tax.
- Changes to Immigration Law.
- Death Duties.
- Borrowing restrictions.
- Capital Gains Tax.
- Reduced Demand from foreign investors.
- Changes to Auction Law.
- Mine/Mill Closure.
This is not doing wonders for values (what you might get) in Sydney, Australia. Never mind that it will be too hot for human habitation in the future.
What impact is Brexit going to have when people have to relocate?
But if there is a trend and you can buy on Margin, then yes potential exists to pump and dump pyramid style.
One can easily search for charts showing housing prices. Here's one: http://observationsandnotes.blogspot.com/2011/07/housing-prices-inflation-since-1900.html This shows that in inflation-adjusted terms, housing prices have increased about 18% from 1900 to 2010, an annualized rate of 0.15%, or 15 basis points.
One important consideration when deciding whether to invest in housing are the fact that although demand may increase in the future, that possibility has already been priced into the current prices. Another is to take into account the opportunity costs. While investing in housing will likely get you some money over several decades, there are other things you could be doing with your money. For comparison, the stock market has returned 1.6% over the same period, or about 10 times as much.
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protected by JoeTaxpayer♦ Mar 12 at 20:25
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