The Fairy Tales of the National Association of Realtors

Better Than Nothing reports:

The National Association of Realtors (R) wants you to know that home values usually double every 10 years. They also want you to know that Real Estate is a great way to build wealth. They want you to know that the only people who can possibly do a good job of helping you sell or buy a home, are Realtors(R). They have launched an advertising campaign using TV ads, print ads, billboards, radio commercials, bus shelter signs, and posters, all to tell us, the ignorant public, that 1) we really, really need a Realtor(R); 2) Realtors(R) are terrific, honest human beings; and 3) Now is a Great Time to Buy a House! They don't qualify that statement, so don't try to sue them if you buy a house and lose your shirt - now is a great time to buy - a great time for Realtors(R).

One ad says: "You might be wondering if buying a home right now is a smart financial decision. The fact is, homeownership is key to building long-term wealth, no matter when someone buys." They cite a N.A.R. study as evidence of their claims that real estate is a better investment than stocks. "Thanks to the power of leverage, a homeowner’s return on investment is even more impressive over time. For example, over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5 percent would return nearly 5 times the stock market return, at $110,300."

Begin rant:

My stockbroker can't tell me that buying stocks on margin is a good idea,
but the N.A.R. somehow gets to tell us that housing is a good investment,
encouraging us to use margin (leverage, mortgage loans, debt) to increase our
payoff, without even a footnote about the risk of leverage. What's up with that? Are they trying to position themselves as investment advisors?


End rant

What's wrong with the N.A.R. logic? Carrying costs, transaction costs, liquidity and leverage.

That theoretical $200k house -let's put it in California to make things simple - has monthly carrying costs. Property tax ($167), insurance ($120), maintenance ($85), and the mortgage payment ($1,022 P&I) add up to a monthly carrying cost of $1,392. Assume a 23% combined federal/state tax rate; the homeowner might save $215 a month in taxes, for a net housing payment of $1,178.

Homes are complex because they combine the saving/equity building function with the gives-us-someplace-to-live function. As an investment, any savings below comparable rent is analogous to cash-flow income from an investment (think dividends or interest payments) and any excess cost over comparable rent is a loss. So we have to look at rents. First, let's notice that the homeowner will pay his/her own water, Mello Roos, trash, etc. A renter usually gets basic services included for free with their rent. Let's put the theoretical buyer into the Sacramento housing market because you can find $200k fixers in bad neighborhoods around Sacramento. (We won't burden the house payment with the Kevlar vest, alarm system, Glock, and carry permit you'd need in the neighborhoods with homes priced under $200k.) Okay, so trash and water service will run about $100 a month. Add that to the $1,178 net housing cost and you get a rent-comparable monthly cost of $1,278. $200k buys a crummy house in a crummy neighborhood; Sacramento area rents start at $650 for a house, $1000 will get a 2-bedroom.

So the carrying cost in excess of rent has to be charged against the "investment" value. $1,278 minus $1,000 equals $278 a month. If you didn't buy a house, we assume you would have left the $10k down payment in the stock market, paid $1,000 a month rent, and invested the $278 extra dollars per month. At 10% compounded annually, your $10k investment plus $278 monthly deposit will grow to $73,410, roughly three times more than the Realtors(R) acknowledge in their comparison, but still less than the $110k the Realtors(R) claim you will make on a house.

Oh, but you don't get to keep all of that $110k appreciation. Transaction costs are relatively low in the stock market and more than a little higher on houses. First, you buy the house, and pay closing costs which vary dramatically from one community to another, but 2% is not unusual. That's $4k rolled into the loan on our theoretical house (remember, you only have $10k to "invest"). Then, when you sell you have transaction costs - typically, about 8% (6% to your Realtors(R) and 2% to all the other miscellaneous parasites). So subtract the $4k closing costs you paid at time of purchase, and the roughly $24,800 closing costs you'll pay to sell, and that $110k appreciation you earned on your "investment" is only $81,178 net. But you've also paid down the loan by a little more than $52k; so you walk away from closing with $133k.

Not bad. Except that the Realtors(R) are assuming 5% annual appreciation on a house, an assumption that is aggressive at best in the current housing market. If the home price depreciates 10% in the next two years and then grows at 5% annually, the $200k house will only be worth $253k 10 years after you buy it, slashing your appreciation in half. You pay the Realtors(R), title company, county recorder, etc. 8% of your selling price - about $20k in closing costs - and the loan is paid down by $52k (you took a fixed-rate mortgage, didn't you?). You walk away from closing with a check for $80 Grand. Oh, wait, did you remodel the kitchen or install landscaping? Subtract those costs from your theoretical gains.

Imagine that.