Real estate, especially for residential properties,
has experienced an amazing appreciation over the last decade. Like many
situations where prices rapidly appreciate there is little agreement as to
whether this is a bubble about to burst or a more normal market adjusting to
increased demand. The question for you as an individual is do you care, or
more importantly do you need to care.
This sounds like a silly question but let’s
consider it. Most individual’s real estate holdings fall into one of two clear
categories, real estate held solely for investment or real estate held for
use. While personal use real estate (your home or vacation home) can be a good
investment over time, the reality is that the largest value you derive from
ownership is as a place to live and/or enjoy. This is very different than
investment property where your concerns are almost purely economic.
You do care about a bubble with investment property
because like all investments you are trying to make a return. However, like
your more liquid investments you also have to consider your intended holding
period. A long term outlook suggests you should try to weather the ups and
downs and avoid transactions costs. On the other hand, if your holding period
is intended to be shorter, you should give serious consideration to the
"what-ifs" of a significant drop in real estate prices. If your liquidity
needs are such that you may be forced to sell in the middle of a downturn then
the prudent approach would be to sell now and re-invest in another, more
liquid asset class. Either way, the approach should be like with all your
investments, keep your eyes open and make decisions with your mind, not your
emotions.
Personal use real estate is altogether different.
Unless you are planning to move, either geographically or with a considerable
upgrade or down grade in property, the real estate markets ought not to really
matter. Those who have been fortunate enough to own property for the last
several years probably have nice gains in their home equity. But what real
good is that gain? Unless you plan to sell and move to a much less expensive
location you can’t spend the gain. While you can borrow against your newfound
equity you’ll still have to pay back the loan so it’s not at all like money in
the bank. Furthermore, when you move, the price of your new home is going to
have appreciated too so you’ll probably need that extra equity to put toward
the new house. Similarly, if the value of your house goes down, as long as you
can still afford the mortgage, taxes and expenses it still ought not to matter
to you. You are paying to live in a house you like and if/when you sell, your
new home will also likely have gone down in price and so be more affordable.
The net of this is if you have a personal use
property that you can afford to own and are planning to stay in for the
foreseeable future, the ups and downs of the housing market aren’t very
important. The key here is that you need to be able to afford it. New
homeowners with interest only loans or loans with low up front interest rates
need to very careful. From a financial planner’s perspective the most
important aspect of real estate is not just location but also staying power.
Downturns in the real estate market tend to be coincident with a weak economy
and high unemployment so if you fundamentally can’t afford to own your home
when your loan costs move upward, there’s a better than even chance you’ll be
forced to sell in a weak housing market. Location is great but if you really
can’t afford to own your home then look for a less costly location. If you are
prepared to carry the costs of owning your home over the long term then relax,
the ups and downs of the housing market are more relevant to cocktail party
conversation than your long term financial health.
As always, I welcome your questions and comments.
Randy Gridley
September, 2005
