Real Estate

Buy Your Dream Home This Year. Buy Your First Home Next Year.

IMHO, this is the year to buy your dream home, but not your first home.

I agree with many of the experts who predict that the average sales price of homes will continue to decline, or at best stagnate, over the next year or two.  The primary reason for this is the large number of foreclosures that will hit the market over this time period.  They will keep the average price down because they are keeping down the price of entry-level homes.

If you are looking for a first home, which is usually priced below the average price in your area, you will see a buyer’s market.  Foreclosed homes coming on the market will be priced well below their original purchase prices.  For a new homebuyer, especially one who is willing to put some work into a neglected foreclosed home, the low end of the market will offer an abundance of choices.  Because of foreclosures, supply of lower-priced homes will exceed demand until the foreclosures are off the market.  This could take a couple of years.

If you are planning to buy an above-average-priced home, you might want to start looking right now.  Without the pressure of foreclosures coming to market in your price range, there is little to cause prices to fall.

Most of the homeowners who were forced to sell have sold already.  Remaining homeowners are the ones who could afford to wait for a market recovery.  They may be willing to consider selling at today’s prices, but not at lower prices.

Homeowners who want to upscale their home may think that if their home value goes up just a little more, they can afford to sell and buy a more expensive home whose price is also discounted.  If homeowners who are only slightly under water see their home value rise to break-even, they may be willing to sell and buy a larger home.  In other words, future sellers will most likely be buyers at a higher price.

Employment is also starting to improve.  People who already have jobs are feeling more confident that their jobs are safe.  People who are re-entering the job market will be less likely to sell unless they can move up.

Mortgage interest rates are very low.  It’s hard to believe that you will get a lower rate by waiting until next year.  The problem with mortgages seems to be that it’s harder to qualify for one than it used to be.  If the Federal Reserve raises, just slightly, the rate it charges banks to borrow from the Fed, the banks will be more willing to lend money to home buyers.

Currently, banks can borrow money from the Fed at essentially zero interest.  They can then buy risk-free Treasury Bonds that pay over two percent.  Traditionally, banks are willing to lend money if they can make at least two percent over their borrowing costs.  If the loan is even slightly risky, they want to make more margin on the loan.  If the Fed requires banks to pay even 25 basis points (0.25 percent) more interest, banks can’t make enough money buying Treasury Bonds.  The next level up in risk is mortgages.  With banks more willing to lend, more people will qualify for mortgages, and home prices will rise.

So, my theory (and without supporting evidence, it’s just a theory) leads to the conclusion that if you would like to buy an average-price or above-average-price home, start looking now.  Get pre-approved for a mortgage in your price range and start talking to a realtor.

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Tuesday, April 3rd, 2012 Real Estate Comments Off on Buy Your Dream Home This Year. Buy Your First Home Next Year.

A Sustainable Jobless Recovery

The July 8, 2011 jobs report was shockingly disappointing:  The USA added just 18,000 jobs in June.  For the workforce just to maintain the status quo, we need to add 125,000 jobs every month.

The unemployment rate is 9.2%.  If you add in the number of workers who have stopped looking for work, those whose unemployment benefits have expired, and those who are severely underemployed, the unemployment rate is 16.2%.

There is now a lower percentage of Americans working than at any time since 1983.  The percentage of American adults (16 years and older) who are working has dropped to 58.2%.

So, the US economy is doomed, right?  Not necessarily.  Businesses have downsized and become more efficient.  They have learned how to produce goods and services with fewer employees.  These employees may be overworked compared to their workload three years ago, but they have a steady job, and they are more confident that they will keep the job than they were a couple of years ago.  When you believe you have a stable job, you are more willing to spend.

American business has entered a “new normal.”  In truth, business has never sold much to unemployed people.  So the American worker/customer base has dropped from 94% (6% unemployment is considered “full employment”) to 91%.  American manufacturing and retail businesses are expanding their customer base overseas to the 80% to 95% of foreign workers who are employed.

Due to the expanding international customer base, sales are increasing.  Due to workforce reduction and technology, profits are increasing.  Business is adapting much more quickly to the new economic situation than individuals are.  Let’s face it, most of the lost jobs are not coming back.  Business is moving on.  The economy has changed; as investors we have to change with it.

Bursting the housing bubble is a bigger hurdle to business growth than the unemployment hurdle.  The destruction of home equity has reduced the spending ability of employed Americans.  Gone are the days of using your home as an ATM machine to give you cash to spend.  Working Americans are actually having to learn to “live within their means.”

In the short term, the housing bubble bust has hurt the economy; but in the long term, living in a growth economy rather than a bubble economy will be a good thing.  Industries will shift; spending patterns will change; and priorities will realign.  Get used to it.  The future will not be like the past.  Go ahead and moan and whine and then get over it.

That’s not to say that unemployment won’t have lasting negative political and social effects.  I’m lucky; being retired, I don’t have a job to lose.  I truly feel very sorry for people who have lost their jobs.  I personally know recently-unemployed workers, and I know business owners who have had to close their businesses due to the changing economy.  Politically and socially it’s bad to have too many people unemployed.  It’s much better for society if people are able to earn a living in productive ways.  I don’t know what to do about that.  I try to live with the way things are, rather than the way I would like for them to be.

Providing jobs is not the primary goal of business.  Hiring is needed only when demand for the company’s goods or services is too great to be met by the current number of employees.  The good news is that the recent downsizing has very likely resulted in companies having the minimum number of workers to produce the current sales.  Any increase in business should result in gradually increasing employment.  But there will be a lag.  Businesses are skeptical about demand increasing very quickly, so we will initially see part-time employment increase until the “new normal” is understood.

The stock market will have ample opportunity to grow in the new economy.  In fact, if the US dollar loses value, as I expect it will, all asset values will be inflated.  This means that the dollar-value of assets will increase.  This applies to Gold, Commodities, Stocks and maybe even Real Estate.

Just because things will be different, doesn’t mean that they will be catastrophic.  It also doesn’t mean that things won’t be unsettled for a while.  I expect that it will take about six to twelve months for the “new normal” to be fully accepted and adapted to.  I expect Gold and Commodities to adapt in three to six months and Stocks in six to twelve months.

Real Estate is another story.  You need to have a job to buy a house, and 84% of US workers have steady jobs.  A declining dollar should inflate the values of Real Estate, but Real Estate is a leveraged investment.  Most people have to borrow money to buy Real Estate.  The availability and affordability of borrowed money directly affects the value of Real Estate.  Currently, mortgage rates are low, but mortgages are hard to get.  It takes a very good credit rating to get a mortgage, and larger down-payments are required.  With a declining dollar, interest rates will be higher, but banks will be more willing to lend.  Banks will want to get rid of their declining dollars and earn good interest on loans backed by Real Estate.  Therefore, the recovery of Real Estate is hard to predict.

The important point here is that for growth in Stocks, Gold and Commodities, decreasing unemployment is unnecessary.  From a cold-hearted investment perspective, the Jobless Recovery is sustainable.

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Saturday, July 9th, 2011 Work Comments Off on A Sustainable Jobless Recovery

Asset Classes For Portfolio Diversification

“Don’t put all your eggs in one basket,” is a traditional idiom that warns us not to risk everything on a single venture.  If you divide your eggs into two baskets, and one basket is dropped, you have still preserved half your eggs.  Applied to investing, this strategy is referred to as diversification.

Many years ago, when I was in the financial planning business, “diversification” was interpreted to mean, “Divide your investments between US stocks and US bonds and make sure the stocks cover all the market sectors.”  Today, even the average investor can be much more sophisticated in portfolio diversification.  Using Exchange Traded Funds (ETFs), any investor can diversify much more broadly than was possible in the old days.

For example, you shouldn’t limit yourself to only US stocks and bonds.  It is very easy to invest in foreign stocks and bonds using ETFs.  Going back to our egg-harvesting example, international diversification is analogous to, “Even if you have your eggs divided into two baskets, don’t let the same person carry both baskets.”  This way if one person (country) stumbles, you have another person carrying some of your eggs.

How to Diversify

The diagram below illustrates how I approach asset diversification.  It may be a little complicated for some people, but it illustrates my view of the investment universe.

Asset Diversification

As you move from left to right in the diagram, each box represents a filter or a categorization for the asset to the left.  For example, both Stocks and Bonds are first divided into either Domestic or Foreign.

To be more accurate, I should have called “Stocks” “Equities” because further to the right I divide them into Stocks, Funds/ETFs or Options.

For each Domestic Stock, I categorize it by my goal for that stock.  My goals are either Growth, Income or High Risk/Reward.  Both Growth and Income Stocks are intended to be held long-term, while High Risk/Reward Stocks probably can’t be held for very long because they are volatile and were purchased with the hope of a good short-term gain while being watched carefully.

If a Domestic Stock can’t provide me with Growth, Income or the prospect of a short-term gain, I shouldn’t own it.

Foreign Stocks are first classified as Developed Markets or Emerging Markets before assigning each Stock to a Sector.

Second in importance, after the investment goal for a Stock, is the business Sector it falls into.  Most often, you see sectors categorized in a couple of ways:

Morningstar Sectors S&P 500 Sectors
Business Services
Consumer Goods Consumer Staples
Consumer Services Consumer Discretionary
Media
Energy Energy
Financial Services Financials
Health Care Health Care
Industrial Materials Materials
Hardware Industrials
Software Information Technology
Telecommunications Telecom Services
Utilities Utilities

These categories are too granular for me.  I divide stocks up into eight categories:

My Sectors

  • Technology
  • Consumer
  • Health
  • Energy
  • Financials
  • Industrials
  • Utilities/Telecom
  • Commodities

I group Consumer Staples, Consumer Discretionary, Consumer Goods, Consumer Services and Media all together into “Consumer.”

I also group Telecommunications Services (e.g. AT&T, Verizon) and Utilities (e.g. Con Edison, Duke Power) into one category.  The rationale here is that they are both semi-regulated services for the consumer that bill monthly and usually pay dividends.

There is one obvious overlap/redundancy in the diagram.  One of the Stock Sectors is “Commodities” and one of the major asset types on the left is also “Commodities.”  Following the Commodities major type all the way to the right shows that one of the three ways to invest in Commodities is Producer Stocks.  These Producer Stocks also fall into one of two Stock Sectors: Commodities or Energy.  The reason I have this in two places is because many stock ETFs are diversified across Sectors including Commodities and Energy, so I have Sectors for this.  Other Individual Stocks or specialty ETFs are exclusively Commodities, so they go into Commodities Producer Stocks or Commodities ETFs.

Both Foreign and Domestic Stocks are classified as either Large Cap or Small Cap.  After you have allocated a portion of your portfolio to Domestic/Foreign, Goal/Market, Sector and Capitalization, you can put that money into either Individual Stocks, Mutual Funds or ETFs.  For Domestic Stocks, I also consider Options.

The diagram shows a similar treatment for classifying the other investment types.

I have a separate major asset type for Gold & Silver.  In a previous post I explained why I don’t consider Gold to be a Commodity; it should be thought of as the Universal Foreign Currency.  However, I only put fiat (paper money) foreign currencies into their own major asset type — Currencies.

Gold could be a major type all by itself, and Silver could be under Commodities, but Gold and Silver are enough alike and track together well enough to lump them together.

Why Bother?

So, why do I bother with this taxonomy of assets?  Two reasons:  1) If you already have an investment portfolio, you can see what percentage of it fits into each box.  This will reveal holes in your coverage which you can decide to ignore or fix.  2) If you are planning a portfolio from the top down, you can allocate percentages to each box according to your individual needs, goals and philosophies.

Although I am not as rigorous as the diagram might indicate, I do try to keep track of the percentage of my portfolio I have allocated to each box.  If I think I’m too heavy or too light in a category, I will fix it.

For many investors, this level of analysis will be overkill.  There are so many category possibilities that you may not have enough money to allocate to all, or even most, categories.  That’s perfectly OK.  In fact, even if you do have enough assets, you may choose to put nothing into one or more categories.  For example, contrary to conventional wisdom, I have almost nothing in Bonds of any type.  I have very little in the Currencies box or the Other box.  When I was an entrepreneur, all my assets were in the Other box.

How Much Should Be Allocated to Each Box?

This is the fundamental question, and, unfortunately, one answer does not apply to everyone.  In fact, even if every investor agreed with my taxonomy and had lots of money to invest, each investor would probably have a different allocation.

For example, let’s look at a traditional (old-fashioned) allocation strategy.  The following is copied from a Schwab newsletter I recently received.  They gave an example of three different portfolios:

Conservative Moderate Aggressive
15% Large Cap 35% Large Cap 50% Large Cap
0% Small Cap 10% Small Cap 20% Small Cap
5% Foreign Stocks 15% Foreign Stocks 25% Foreign Stocks
50% Fixed Income 35% Fixed Income 0% Fixed Income
30% Cash 5% Cash 5% Cash

Large Cap and Small Cap both refer to US Stocks.  Fixed Income usually means Bonds.  For Foreign Stocks, Schwab recommends for all three portfolios:  65% Foreign Large Cap, 15% Foreign Small Cap and 20% Emerging Markets.

As you can see, this is a much simpler diversification strategy than I have for myself.  It is easier to explain and (more importantly) to sell.  I can see the logic in their strategy, and I suspect that most investors are not even this diversified.  At my age, they would recommend that I have the Conservative portfolio, which I most certainly do not have.

Their portfolios completely ignore Gold & Silver, Commodities, Real Estate and Currencies.  I can understand this because the only Real Estate most people have is their home; Currencies are difficult to trade; and Gold is for paranoid nut jobs (Just kidding. I’m putting words into Charles Schwab’s mouth).  But even in Schwab’s simplified model, it takes three portfolios to meet everyone’s needs.

If I go into too much detail on how to allocate investment assets, I might cross the line into giving investment advice, which I am not qualified to do.  That being said, I think when it comes to stocks, I like to have between 60/40 and 40/60 allocated to Domestic/Foreign.  The same could be said for Developed/Emerging in the Foreign Stock category.

When it comes to Gold, even Jim Cramer recommends 10% to 20% of your assets in Gold, and I agree with him.

When it comes to Real Estate, I don’t include my home in my portfolio.  I realize that for many people, their home is their largest investment, but I choose to put as little money into my home as I comfortably can.  In fact, a case can be made for renting, but that could be the subject of another blog posting.  I do think that some of your assets should be in Real Estate, even if it’s your home.

I am also a fan of Commodities, especially Agricultural Commodities.  We are entering into a period of global food shortages, and I think this is a good investment category.

When it comes to Currencies, most people should probably not put too much money into this category.

Cash is probably the most important category, because it is the first box a beginning investor should fill.  If you don’t have enough Cash saved to cover at least four months of bare-bones expenses, you probably shouldn’t have any other investments.

I think I’ve rambled on long enough on this subject.  Maybe later I’ll have a few thoughts on some other aspects of my diagram.

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Sunday, March 6th, 2011 Gold, Stocks 1 Comment

Smackdown: Stocks vs. Gold vs. Housing

In a previous post, we examined the performance of single-family Home values relative to Stocks and various Commodities.  What about a direct comparison of the investment performance of Stocks, Gold and Housing?

The chart below examines the performance of these investments over the last twenty years.  The Stocks (S&P 500) graph does not include reinvesting dividends.  The red line plots Stocks (the S&P 500 index).  The pink line plots residential Housing (the Case-Schiller index).  The gold line plots Gold, and the black line plots a “Balanced Portfolio” consisting of one-third each of Stocks, Gold and single-family Housing.  If I had included reinvesting dividends, Stocks would have performed better.
Investment Performance
As you can see, both Stocks and Gold would have increased about 350%.  Housing would have increased about 200%.  The Balanced Portfolio did pretty well (at 300%) and was less volatile.

Here is the same data adjusted for inflation (using the CPI):
Investment Performance Adjusted For Inflation
I chose the last twenty years because this is about as long as many people hold investments before retirement.  These charts assume that you invested a lump sum of money in 1990.  The performance of an investment really does depend upon when you invest your money.  That’s why financial planners recommend that you invest monthly to “dollar cost average” the money you invest.

What if you had a time machine and could go back in time to invest a lump sum of money?  What would you invest in?  Which investment is best depends upon how far back in time you travel.  The chart below shows the best investment depending upon which year you invested your money.
Lump Sum Investment Required in Specific Year
This chart shows how much money you would have had to invest in order to have $100,000 in 2010.  If you only traveled back to 2006, you would have had to invest more than $100K in Housing or Stocks to have $100K today.  You need to travel back in time to a year where the graph dips lower so that less money is required for investment.  The lower a line dips, the better the time to invest.

If you traveled back to 1990, you could have put your money in either Stocks or Gold (a little under $30K ) to grow to $100K in 2010.  The first chart also shows this equivalence.

In 1999, you wouldn’t want to invest in Stocks, because that was a peak in the market and you would need to invest $125K to end up with only $100K.  1997 to 2003 would have been a great time to invest in Gold.

At no time was single-family Housing the best place to invest (the lowest line).  In fact, there were only twelve years that Housing wasn’t the worst place to invest.  Remember, this is a “buy low” chart; it tells you when you can buy lowest.

The Case-Schiller home price index averages twenty large cities.  There are certainly some cities where home prices have performed better.  There are also some stocks that have performed better than the S&P 500 index.

Just because the house you live in has under-performed as an investment, doesn’t mean that all real estate is a bad investment.  Many people have had good success investing in income-producing property such as apartment buildings, office buildings, etc.  Income producing property has a more rational valuation method than does single-family housing.  Just as the value of stocks is roughly based on the earnings of the stock’s company, income-producing property is roughly valued on the annual rent it produces.  There is a “price-to-earnings ratio” for stocks and a “gross rent multiplier” for income property.  Buying income property is a business decision, buying the house you live in is usually an emotional decision.

So what is the bottom line of the previous charts?  I think one conclusion is “You shouldn’t have most of your assets tied up in the house you live in.”  Also worth noting is that for the last nineteen years, Gold has been the best investment.  For ten of those nineteen years, Stocks were the worst place to invest a lump sum.

The Balanced Portfolio is one-third each Stocks, Gold and Housing.  Some financial advisors suggest that you have ten percent of your portfolio in Gold.  Is ten percent enough to diversify a portfolio?

Let’s see how four different diversified portfolios performed over the last twenty years.  The chart below shows our Balanced Portfolio in black.  A portfolio with only ten percent Gold and forty-five percent each Stocks and Housing is shown in gold.  A portfolio with ten percent Stocks and forty-five percent each in Gold and Housing is shown in red.  And a portfolio with ten percent Housing and forty-five percent each in Gold and Stocks is shown in pink.
Four Diversified Portfolios
It’s obvious that the worst performance is the portfolio that only has only ten percent in Stocks, the red line.

The portfolio that is only ten percent Gold performs best until 2008 when both Stocks and Housing are in decline and Gold starts to take off.

The portfolio that is only ten percent Housing performs second best until 2009 when it takes off and is the best performer.

This chart indicates that the most important part of your portfolio is Stocks.  If at least one-third of your portfolio is in Stocks, you would have done OK.  The two portfolios that had forty-five percent in Stocks (gold and pink lines) generally did the best.

So what kinds of stocks are best?  And what about bonds?  Maybe we will discuss those topics in another post.

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Friday, November 19th, 2010 Gold, Real Estate, Stocks 1 Comment

Buying Your House on Margin

Buying stocks “on margin” means that you don’t have enough money in your investment account to buy the stocks, so you have to borrow the money from your broker to make the purchase.  You have to pay interest on this money, of course.  Buying stocks on margin is considered to be very risky.  It is a technique that is sometimes used by “traders” but not by “investors.”  Even the risk-takers wouldn’t hold stocks bought on margin for a long time.

Why do traders buy on margin?  Because it is leverage.  If you buy $1,000 worth of stocks and you only put up $100 of your own money and borrow $900, you are leveraged.  If the value of the stocks goes up 10% to $1,100, you can sell the stocks, pay off your $900 margin loan and have $200 left.  You started with $100 and now have $200 for a 100% profit on a 10% stock value increase.

So why is buying stocks on margin risky?  Because stocks don’t go straight up in price.  As we all know, stocks go up and down daily.  If your stocks go down 10% in value to $900, and you have to sell, you only have enough to pay off your $900 margin loan.  You have lost your original $100 which was all of your money – A 100% loss.  Buying on margin is betting that the stock will go up rather quickly so you can make your profit and then sell to get rid of your risk.

When you buy a house with a mortgage, you are buying the house on margin.  This is the key to making money in real estate – leverage.  So if buying stocks on margin for a short period is considered risky, why is buying a house on margin for thirty years considered a conservative investment?

Borrowing to buy real estate is a conservative investment because real estate always goes up in value.  You never have to worry about your house losing value.  Really, they aren’t making any more land, an increasing population keeps needing more housing; what could go wrong?

The housing bubble could pop; that’s what could go wrong.  Just like “dot com” companies in the 1990’s, anything can become overvalued and must eventually correct.

Here is a chart of house prices since 1950 (the Case-Schiller index):

House Prices

Buying a house on margin would have been a good investment if you bought and sold before 1990.  If you bought after 1990 you would have to wait to sell between 1999 and 2006 to come out ahead.  If you bought since 2004, your house has probably lost value, and you will have to wait several more years before breaking even.

Some families who have bought houses in the last five years have discovered that their homes are worth less than the mortgage.  If they sell, they will have to come up with extra money to pay off their margin account (mortgage).  They are faced with the prospect of continuing to make loan payments on a losing investment, or defaulting on their loan and losing everything.

Here is a chart of house prices adjusted for inflation (CPI):

House Prices Adjusted For Inflation

As you can see, from 1950 until about 1985, house prices mostly kept up with inflation.  The graph has a slightly negative slope from 1954 to 1974 which means that during that period, price increases did not keep up with inflation.

Starting around 1985, housing went through two boom/bust cycles.  From 1985 until 1998, house prices increased and then came back down to where they started.  The second boom/bust cycle started in 1997 and may not have finished yet.  Remember, this is adjusted for inflation.  On the previous chart, the first boom/bust cycle isn’t as evident.

The “conservative strategy” for investing in stocks used to be “buy and hold.”  Buy stocks of good companies, hold them for ten to twenty years, and then sell them at a profit.  It didn’t really matter when you bought, as long as you held the stocks for a long time, you would make a profit.

The stock market “crash” of 2008 – 2009 has caused many investors to question this strategy.  As we will see in a later blog, you could have held stocks for a long time and still lost money — It all depends on when you bought.

The “conservative strategy” for investing in your home used to be “buy, wait and move up.”  Buy your house on margin (borrow money via a mortgage), wait five years, sell at a profit and buy a more expensive house on margin.  It didn’t matter when you bought, because real estate always went up.

The bursting of the real estate bubble has caused home owners to question this strategy, too.  You could have bought your house six years ago, sold it, and not have enough money to pay off your mortgage.  It turns out it matters when you bought your house.

With stocks, you can buy low and sell high.  With your home, if you buy a new house when prices are low, you also have to sell your old house when prices are low.  You can’t “time the market.”  You have to buy and sell during the same market conditions.

Investing in stocks has another advantage – you don’t have to buy your whole portfolio at once.  You can invest a little each month and “dollar cost average” your purchases.  You don’t have to borrow money to invest in stocks.

With a house, you can’t “dollar cost average” your investment.  You have to buy the whole house all at once.  Also, very few people can afford to pay cash; they have to borrow the money.  Interest payments add to the cost of the house.  Houses also require maintenance and property tax payments – disadvantages that stocks don’t have.

I once told my brother that I had never made much money on houses that I lived in.  He replied that it was because I actually kept track of what the houses cost me.  Most people don’t keep track of how much money they actually put into their home.

Houses have a major advantage over stocks – you can live in them.  You have to live somewhere, so why not try to make some money off of it?  This is the same argument that is made for whole-life life insurance.  If you need life insurance, why not use it as an investment?

In most cases, it is better to buy cheaper term life insurance and invest the premium difference.  You have life insurance for the years that you need it, and you end up with a larger investment portfolio.

These days, many former home owners are renting a house for less money than it costs to make mortgage payments, tax payments and maintenance costs.  They can separate their living costs from their investment purchases.

But what about the mortgage interest tax deduction?  Doesn’t being able to write off your mortgage interest on your taxes make home ownership a better investment?

If you buy a house for $200,000 with a thirty-year mortgage at 4.50%, your mortgage interest payments for the first five years will total $43,118 which is an average of $8,624 per year.  The “standard deduction” on your 1099 tax form for a married couple is $11,400.  This means that you would need another $2,776 in tax deductions (such as property tax) just to break even with the standard (no itemization) tax deduction.

Let’s say that you do break even with the standard deduction as described above.  Your monthly payment for mortgage and taxes would be $1,245.  This is probably about how much it would cost to rent the house.

So, if you want to live in a house that costs $200,000 or more, it probably makes more sense to buy it than to rent it.  If you don’t have to sell your current house, it probably makes sense to buy that new house in 2011.  Experts think the residential real estate market, in the USA, should hit bottom by the end of 2011.  Remember, you have to buy low and sell high for margin investing to work.

No investment is perfect, including real estate.  Real estate can be a pretty good investment though, and we will discuss how it compares to other investments in another blog post.

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Saturday, November 13th, 2010 Real Estate Comments Off on Buying Your House on Margin

How Much Bread is Your House Worth?

If you bought a house twenty years ago, your house would now be worth about twice what you paid for it – valued in American dollars.  But what if you valued your house in ounces of gold, or loaves of bread, or gallons of gasoline, or shares of stock?

Thinking of your house valued in something other than dollars may require a little stretching of the old brain cells.  We think of dollars as having a fixed value.  Things go up or down in price based on how many dollars it takes to buy them.  In fact, dollars don’t have a fixed value relative to the necessities of life.

Let’s say that twenty years ago you ate one Big Mac and a medium Coke for lunch at McDonalds.  Today, you would eat the same amount of food, but the price in dollars would not be the same.  Your basic need for nutrition hasn’t changed, but the number dollars required to provide the nutrition has changed.

Your house today provides the same shelter it did twenty years ago, but the number of dollars required to buy it has changed.

Housing is a basic requirement of life, but so is food.  What if your house were valued in loaves of bread?  If your house had the same value as 100,000 loaves of bread twenty years ago, what would be its value in loaves of bread today?  The answer:  about 100,000.  Selling your house to buy bread wouldn’t buy any more bread today than it would have twenty years ago.

Energy is also a basic requirement of life.  What if your house were valued in gallons of gasoline?  Today, it would only take about 80% as much gasoline to buy your house as it did twenty years ago.

Take a look at this chart.  It shows how the value of the average American home has changed over the last twenty years.  The green line is dollars; the brown line is loaves of bread; the yellow line is ounces of gold; the blue line is gallons of gasoline, and the red line is shares of the S&P500 stock index.
Housing Values

The housing boom from 1998 through 2006 is clearly illustrated by the rising green line.  The bursting of the housing bubble is shown from 2007 through 2009.

Doubling the value of your home (in dollars) over twenty years looks pretty good until you notice that the house value in bread is the same as its value in bread twenty years ago.  One way to look at this is that the rise in value of your house is entirely due to the same inflationary forces that affect the price of bread.

Your house is actually worth less today valued in gallons of gasoline.  If your net worth was stored in a tank filled with gasoline instead of a bank filled with dollars, it would be less expensive for you to buy your house now than it was in 1990.

What about gold?  Look at the gold line on the graph.  If your house cost 1,000 ounces of gold twenty years ago, it would only cost about 600 ounces of gold today.

The same goes for stocks.  If, in 1990, you put enough money into an S&P500 mutual fund to buy a house, you would only need to sell 60% of your shares today to buy that house now.  And that is without reinvesting dividends.  The chart does not take dividends into account.  During the “dot com” stock boom of the late 1990’s it would have taken even less stock to buy a house.

The purpose of this mental exercise is to point out that real estate isn’t the great investment you have been led to believe.  Sure, you get to live in your house while it appreciates, but with stocks you get to receive dividends as they appreciate.  And real estate doesn’t always go up in value; just look at the green line (based on the Case-Schiller housing index).

This isn’t to say that real estate is a bad investment.  It has its place in a diversified portfolio.  We’ll look at that in another blog post.

Oh, and if you want to see what the above chart would look like adjusted for inflation (CPI), here it is:
House Values Adjusteed For Inflation

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Thursday, November 4th, 2010 Real Estate Comments Off on How Much Bread is Your House Worth?

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I am not a registered financial advisor. I only offer opinions, and sometimes these opinions veer off at weird angles from conventional wisdom (That's probably why you are here). My advice is, "Don't take my advice." Read my sidelong glances at economic issues and form your own conclusions.

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