Saturday, June 25, 2005

Real estate and Early Retirement

Real estates in many parts of North America have boomed lately. House prices jumped as much as 100% in some large cities (New-York, San-Francisco, Vancouver, Toronto, Boston).

Feeling richer, people increased their spending level in the last few years like never before. Many people tap in the increased value of their house by refinancing the mortgage and use the credit to finance projects and spending.

I'm very cautious about the increasing real estate market. Some thoughts:

  • Your house is no ordinary investment and you should not add your house value to your wealth just as you add the value of you stocks to your wealth. When the value of your house increases, the cost of lodging increases as well, which means that if you need the cash flow from the value of your house during your retirement, you'll have to find some new lodging, which will also have increased in cost. The real gain in wealth is the difference in value you'll get if you sell your house and the cost of lodging somewhere else. Thus, you can actually be wealthier thank to the booming real estate market only if, for instance, you plan to go in a cheaper city or district or get a smaller house.
  • As your house value increases, so do your tax expenses. If you refinance, the interests on the mortgage also increase.
  • When people such as Buffet and Munger warn about a real estate bubble, you should be cautious. Any investment that is not cash or deposits has a value that is an estimate by the market and is highly volatile by nature when market conditions change. At the top of the tech bubble in 1999, people felt rich, but they forgot one thing: the stock market goes up and down and unless you are talented enough to know when you are at the top and the bottom of a market, you should not evaluate your wealth based on the value of what you own at a specific date, but rather on a longer term average (the real value of your house is more likely to be near its 10 years average value than as of today), taking into account volatility and risk.

Anyway, nobody that seek to retire early would tap into its real estate by refinancing the mortgage at a higher value. That would mean you are living beyond your means.

8 Comments:

Anonymous Anonymous said...

It is good you recognize the risk in real estate but curious that you are more cavalier about the stock market. The stock market and any investment you have in is is much risker than the market for real estate.

Real estate is also a less volitile market and you can talk long term all you want but if the market tanks when you're 36 or even retired and counting on dividends--you're screwed.

Real estate has never seen a price decrease across the board like some of the crashes experienced on Wall Street.

And, if your investment is in rental properties, economic downturns will often work in your favor.

If I was planning to retire at 37, I'd be putting my money into rental properties not the stock market.

In stocks, you have only two possible streams of revenue--price appreciation and dividends. Dividends, however, only if you hold individual stocks outside of mutual funds and that is another fools game, altogether.

Real estate, on the other hand, has price appreciation, equity growth, rental income, rental income appreciation and tax benefits.

My name is Roque Curiel, I am a former college instructor who taught classes in personal financial management, and I am the author of "Money Well Spent."

I owned rental properties between 1976 and 2002. I am out of the business now but I have never had any real money in stocks.

7:00 PM  
Blogger Jack said...

Hi M. Curiel,

First, I think it's not true that I'm more cavalier about stock markets, read carefully my last bullet point (I talk about the tech bubble). I know the risk of the stock market.

But also, my article was not about real estate as an investment, but about the refinancing of mortgages (now that house values have boomed) to get more cheap credit, with all the risk associated with doing that, particularly as some people are becoming concerned about a possible real estate bubble (not only Buffet and Munger, but even Greenspan and many others).

But I think you are wrong when you say that real estate never has seen a price decrease like that of Wall Street. In Florida, in 1926, you've seen a larger real estate crash that any stock market ever experienced. Land prices declined more than 95% in one year (something bought $4 millions could be resold $100k a year later, a decline of 97.5%). Compare that to the Black Monday when Wall Street declined 20% (and recovered most of it in the next year).

Also: the stock market always recovered (even after the 1930 depression), which is not true for real estate. The Florida case is one example: lands never recovered their 1926 value, even if we don't take inflation into account!

8:25 AM  
Anonymous Anonymous said...

being a landlord isn't my idea of retirement.

8:50 PM  
Anonymous Anonymous said...

being a landlord isn't my idea of retirement.

8:50 PM  
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