Wednesday, August 25, 2010

Real Estate as an Investment?

The lastest US new home sales numbers hit new record lows in July and am amazed how long this downcycle is. Inventory numbers are close to the lows of 40 years ago when population and household numbers were much lower but no sign of a rebound in sales.
Calculated risk has the analysis and the charts as usual:

The Baseline Scenario ponders why so many believe real estate is such a good investment after all. Looking at this long term chart nothing to be too excited about. Exclude bubble years and real real estate prices in the US have barely moved over longer time periods:

They argue:
"Housing is generally a worse investment than either stocks or simple U.S. Treasury bonds. Then why do so many people think it’s such a great investment?
  1. Leverage. Let’s say inflation is 2% and housing returns 3% (1% real return). If you put 10% down, now your house is returning 30%, or a 28% real return; subtract a 6% fixed-rate mortgage, and you’re making about 22%–or twenty-two times the real return of the underlying asset. Of course, we all know the dangers of leverage.
  2. Price illusion. People remember the nominal price they paid for their houses. When they sell them thirty years later, they look at the difference between the nominal purchase and sale prices and think they made a ton of money. This is especially true of the generation that bought houses in the 1960s and early 1970s before inflation hit; they saw their home prices go up by a factor of ten and thought it was due to high real returns.
  3. Bubbles and optimism bias. Every now and then we have a huge bubble like the one at the right-hand end of the chart above. For a while, people think that’s the new normal. For a while after that, they continue to think it’s the new normal, because they are biased toward optimistic expectations about the world. (Note that during the first half of the decade that I was advising friends that housing was a bad investment, housing was actually a great investment, assuming you could get out in time.)"

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