Simplosys Solutions Blog

People often over-estimate the returns from real estate in their mind. A house that they bought for $100,000 in 1985 that has appreciated 6 times in price and costs $60,000 now only returned 7.18% annually. If a house doubles in value every 10 years, that just means the annual rate of return is 7.18%. Doubling every 10 years is the most that can be expected from real estate, that's if you are lucky.

Use this calculator to see for yourself.

http://www.moneychimp.com/calculator/discount_rate_calculator.htm

And 7.18% return is something you can get even by investing in average corporate bonds (low risk) or generic exchange traded funds, without the additional cost of maintaining the house, society fees, property taxes, Etc - which usually compensates for the rent/tax savings. Plus real estate means committing a large sum into one area and very low liquidity plus there are ups and downs in real estate these days just like other investments. In the past, real estate went one way - up - but as we've seen in the US, that doesn't have to be true.

In other parts of the world, like India, for instance, property price rise is steeper but everyone agrees that a correction will happen some time in the future (as of December 2010 it is yet to happen). But in the long run, it's still safe to assume a 5-8% return annually with real estate.

Proponents of real estate investments argue that real estate offers leverage. In other words, the theory is the appreciation of 7.18% is happening on a bigger sum (say $300,000) even though most of that value is not paid for yet. Say you put $30,000 down for the house, and the house appreciates $30,000 in the first year, then it's like a 100% return. Such appreciation is happening right now in India, China, Brazil and other economies. The argument is short-sighted. In India, the current mortgage interest rate is 9.5%. So unless you were planning to buy with cash, you will end up paying $27,000 in interest each year on your loan, nullifying the effect of the leverage.

So, in reality, at 7.18% return and 9.5% mortgage rate, real estate is a lossy investment until it's paid off (which takes about 10-20 years at least if you  aggressively pay the house off).

 At present, it's better to invest in real estate here in the US, where prices are low right now and interest rates are ~4%.

Whenever I hear people talk about real estate that has appreciated like crazy in 1/2/3 or even 20 years, we've GOT to take it with a grain of salt. I think of this calculator. In the long run, returns from other forms of investments almost always meet or exceed real estate when you take everything into account.

That's not to say real estate is not a good investment - it is in fact, a great way to own a diversified portfolio. But it should never be more than 30% of anyone's net assets in my opinion. Say if you have a house already, then from a purely investment standpoint, it wouldn't make sense to invest in more real estate at this time - put your money elsewhere, preferably in a good mix of stocks, bonds and other diversified investments such as Lending Club notes. When your house ends up being less than 30% of your total net worth, consider buying another piece of real estate as an investment to hit the 30% number again. You could buy land, commercial space, Etc. as further diversification. 

Or another way to play in the real estate world without owning any physical asset is by buying REIT's (Real Estate Investment Trusts) or other similar mutual funds. That way you get to play in real estate globally - meaning more diversification and safety, and, fun too. It's like owning a piece of Brazil sitting here in the US

But I know there is a happiness associated with living in your own home but I'd personally wait until the time is right - in my opinion - the 30% mark.