The Fundamental Value of Real Estate

by: Tim Iacono November 25, 2008    

Tim Iacono

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

When will you know that home prices are likely to stop their decline?

When people stop talking about real estate as an investment, the chief offenders being the staff at the National Association of Realtors who continue to stand by the party line that housing is the typical American's best and most important asset.

While home prices may have appreciated a percentage point or two over the rate of inflation over very long periods of time, like stocks, there are no guarantees over shorter time frames, a reality that is hitting home for an increasing number of homeowners.

Plus, real estate has huge upkeep costs and tax liabilities that are too easily forgotten when prices are going up. When home prices go down, these costs just make a bad situation worse.

The real value in real estate is in its function as shelter - a place to live, a place to raise a family - a point nicely made by Steve Kersch in this column at MarketWatch today.

For most Americans, their home is their biggest investment. So when we read about record declines in U.S. home values, we naturally think our investment is in the tank.

But just because buying a house represents the biggest financial commitment most of us will ever make does not mean that its value is in its price and that if that price does not go up year after year we are somehow an investment failure.
...

At its core, a house is a shelter. Unless the roof caves in, there is always some economic value in that.

But most people when they dream about a house or start looking for a house or actually buy one think about value in a whole different way: they think about the fireplace they can gather around with their families, the kitchen where they can show off their culinary skills, the bathroom that they won't have to share, the schools they will be able to send their kids to, the neighbors they will be able to entertain in the backyard, the parks they can bike and hike and the community events they will be able to attend.

Yes, you have to make a price decision. And that can come back to haunt you if you're forced to sell in a market like this. But that doesn't mean you value any of those other things any less.

That's a nice holiday sentiment for all the struggling homeowners around the world, for whom things look decidedly different today than they did just a year or two ago.

Related Articles

This article has 14 comments:

  •  
    Nov 25 04:44 PM
    If all anyone wanted was a place to live, they would rent. It's a lot more flexible. Buying a house is a money decision, and pretending otherwise is unrealistic.
    Reply | Link to Comment
  •  
    Nov 25 05:45 PM
    Your comments are valid unless of course, the same basic, fundamental investment principles are applied to purchase of rental/investment properties that should be applied to any investment purchase.

    In the case of a rental property, the investment is in a future stream of earnings. Pretty easy to construct a set of buy/no buy parameters.

    Purchase of the property on based anticipated future value of the property is, well, speculation... Easy to get burned on speculation...
    Reply | Link to Comment
  •  
    Nov 25 05:48 PM
    I agree with author (sigh). We are paying for 2000-2006 real estate bubble, when everybody was talking about real estate investments. Lots of people, even some people I know, speculated on real estate. Now bubble is popped, leaking gas which doesn't smell good.

    House is the shelter.
    Reply | Link to Comment
  •  
    Nov 25 05:59 PM
    The real value of Real Estate is 100 times the real or hypothetical monthly rent. A house renting for $ 500 is worth $ 50,000!
    Reply | Link to Comment
  •  
    Nov 25 06:18 PM
    Here is my 2005 response to a young couple who were preyed on by a slick real estate agent…
    No, using a mortgage to buy a home is not a good investment because it will not generate any monthly income for you. Instead, it will only bleed large monthly and yearly expenses. Mortgage bankers and tax collectors are the only ones who will receive monthly income from “your” home.
    In the long run, a $500,000 home costs 1.5 million after 30 years and even if the home value triples, the value of money will be half or a third what is was 30 years earlier.
    Real estate is in a huge bubble and when it bursts, you will be stuck with a 30 year, $500,000 mortgage for an asset that is only worth $300,000.

    Reply | Link to Comment
  •  
    Nov 25 08:12 PM
    no appreciation in home prices until at least 2011.

    and thats after about a 25% further decline from today.

    all the FHA mortgages written today

    will be underwater in a matter of months.

    System is still beyond broken and getting even worse.




    Reply | Link to Comment
  •  
    Nov 25 09:28 PM
    real estate has made more millionaires than any other industry because real estate is not an investment.
    Reply | Link to Comment
  •  
    Nov 25 10:04 PM
    Um ask a financial advisor. Homes underperformed the stock market and bonds in return on asset for the past 100 years. It is a place to live not an investment asides from the fact in that it used to require you to do some forced savings (which isn't bad for an American who tends to have a - savings rate recently).

    Unfortunately, with secondary mortgages, refinancing etc. it has become a ATM machine. So what is the value of a house? It is only what someone wants to buy it at or as a revenue stream based on rent. Considering you would be lucky to rent an average given house over 1,000 a month and it's estimated property tax on $150,000 house is about $2,500, 2.5% goes to maintenance -3,750, you make a revenue stream of about $5,750. Versus a 4% bond that makes $6,000. Let's wash capital gains and income tax. So after 20-30 years you are the proud owner of a pretty run down dingy house which you could have gotten better returns in a common long term bond or maybe even a bank CD.

    So unless you can make more than $1,000 a month renting your house and the cost is under $150,000, I'd say you better not think of your house as an investment because it isn't. It's just for your own luxury.
    Reply | Link to Comment
  •  
    Nov 26 08:13 AM
    I do not necessarily disagree with you, but you are forgetting one thing. No one is going to loan you $150,000 to invest in a series of bonds. That kind of loan is only going to happen for something with large tangible value, aka a home. Also, forced savings should not be overlooked in this day and age. It is disgusting how much money is blown on worthless meaningless junk. And there are defintely areas thaty one can buy a home for less than $150k and rent it for $1000-1200 a month. Check out areas around military posts.

    Ryan
    Reply | Link to Comment
  •  
    Nov 26 01:12 PM
    I bought and paid for a nice house, on a 30 year mortgage (old school.) I have done the math countless times, now, and I can tell you I would have been better off renting comparable housing. Now the full cycle has run its course. It's simple, now. DO NOT BUY A HOUSE. You can rent the same kind of housing, and have a very noticeable amount of money left over. And, of course, if you do buy a house you will lose money, because you who are living now will never be able to sell that house for a profit, and you will have absorbed an unbelievable amount of expenses along the way.
    Reply | Link to Comment
  •  
    Nov 26 06:30 PM
    Differentiate between rent, buy and own
    I look at my home as a shelter and I own it outright,
    There are no comparable rentals in terms of privacy, flexibility & stability.
    A house is a money decision in terms of budgeting & appreciation.
    There is certainly risk in terms of income loss (layoffs) or rate adjustments or price drops (bubbles).
    What's happening now is the reevaluation of real estate investments in terms of efficent frontier risk-rewards. It doesn't help that the govt actively endorses and subsidizes homeownership.
    There are many intangibles in home ownership that make it right for some and wrong for others.
    There is a vast industry around residential real estate as an investment; books, realtors, advisors, hard money lenders, etc
    Mixing the home investment with the home shelter through equity loans is the cause of much of the current grief. Who would have expected that doing away with the interest deduction on all but home loans would concentrate leverage / debt in this sector?
    There is a constant temptation to use leverage through debt on one's largest asset for investment. Unfortunately, like most leverage, this also magnifies the risk if it's invested in the same asset class. Many advisors are touting tapping home equity to buy more real estate. This is far from a gamble I'm willing to take with my shelter.

    Reply | Link to Comment
  •  
    Nov 26 09:01 PM
    Double the money supply, double prices and incomes, double house prices, problem solved. Already underway, coming soon to an economy near you.
    Reply | Link to Comment
  •  
    Nov 27 04:54 AM
    Righto tinytim. You buy for livability and for amenities not as an investment or ATM. A house is nice as a home, not as a get rich scam.

    BTW yes, a house gives you leverage ryanh. It also forces you to save. The first isn't necessarily good if you're under water, the second is good if you can't save. The big issue is, should you really be leveraging and why you are doing it. You can get 50% leverage on margin and 90%+ leverage buying raw options. Do I suggest you do it? Nope. Same with home buying.
    Reply | Link to Comment
  •  
    Nov 27 02:30 PM
    On November 26, 2008, at 06:30pm, Tiny Tim wrote, "I look at my home as a shelter and I own it outright, There are no comparable rentals in terms of privacy, flexibility & stability." When I first read that statement, I thought I had mis-read it. But no, this commentor is claiming that there is NO rental house like HIS owned house, in terms of "...privacy, flexibility & stability." HOGWASH. I have associates and friends who rent perfectly private, flexible, and stable dwellings. I don't know where Tiny Tim lives, but if Tim can't find ANY comparable rental(s) there, maybe he's living a little too far out on a finger of land, jutting into the ocean, in which case he will simply have to realize that there are prices to pay for any chosen situation. Tim's rationalization about there being something that is somehow "special" about a particular house, and that the house becomes magically even more "special" because someone "owns" it, along with the bank, for oh, say, twenty or thirty years (!), is just another aspect of this ridiculous, dog-eared myth of the great benefits of owning a house. I suppose it is difficult for most people to admit to themselves that they made a fundamental mistake many years ago, a mistake that cost them a great deal of money and offered few real advantages. However, that is exactly what all of us did,who paid, and paid, and paid, and paid for the right to be called a "homeowner"

    Reply | Link to Comment
Top Rated Comment Streams:

Numbers are net rating-

See all Top 100 »
More by Tim Iacono

Investment Resources
Money Management
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Housing & Real Estate
Economy
Bonds
Dollar/Currencies