Better off Buying a House than Investing in Stocks? Unlikely, unless You Paid Cash.
Over the weekend, a friend of mine sighed in resignation: “Given that my stock portfolio is down 40% and the real estate market in my area is down ‘only’ 20%, we would have been better off buying a house last year.”
While the numbers she quoted may be a fairly accurate reflection of the situation in the San Francisco Bay Area, her conclusion could not be further from the truth. Had she bought a house last year – unless she paid cash – she would be much worse off than she currently is. Why? Because of leverage.
Here’s how the math works: Let’s assume she had $100,000 saved to start with. Her options were to save and invest it, or to use it as a down payment for a house. Investing in an equity portfolio yielded a loss of 40%, or $40,000, leaving her $60,000 at the end of the year. If she had instead bought a house, she would have easily “afforded” a house with a price tag of $500,000, with $100,000 down and a mortgage of $400,000. I think you see where I am going: come this year, given the 20% decline, the house is worth $400,000. Her mortgage is still $400,000. What is left of her $100,000? A big zero. And who really owns the house now: the bank, of course!
Having $60,000 left in cash and no debt is clearly better than being under water on a mortgage with no cash at all. With her $60,000 she is free to do what ever she pleases, perhaps even buy a foreclosed property for less than its market value. Having liquid assets gives you freedom, having debt limits your freedom. Using leverage works great on the upside, but can be lethal on the downside.
Note that in my example I used rather conservative leverage: 20% down and 80% mortgage. Many people took out a mortgage with an initial down payment ranging between 0-10%. These people are now in a much worse position, with the value of their mortgage in many cases exceeding the value of their home.
We are not saying that you should invest everything in equities and nothing at all in real estate. As a matter of fact, we believe there is good reason to have a diversified approach to investing. We are just pointing out how some things — like investment performance — look different on the surface than they are in reality. Sometimes it is hard to see through this, especially when the so-called experts tout otherwise. A real estate broker will perpetually only see the rainbow (and the commission), whereas we try to point out both the rain and the sunshine. Knowledge and action lead to financial security. That’s Sustainable Wealth.
This article was prepared by SustainableWealth.org and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advise nor a solicitation or an offer to buy or sell any products or services. Sustainablewealth.org is a trademark of Merk Investments, LLC.
