One of the most common investment concerns I hear from people is that they feel more comfortable investing in real estate than in stocks and bonds. It’s a common sentiment, namely because people feel more at ease investing in things they can see and touch (like a home) rather than something perceived as amorphous (like the stock market). Similarly, it’s easier to understand what drives housing costs – location, square footage, finishes, etc., whereas understanding the drivers of financial markets can be considerably trickier.
While those are totally reasonable feelings, the reality is that the rationale behind them is based on a number of very common real estate misperceptions. Read on to separate fact from fiction in these common real estate myths.
MYTH 1: “Buying is a good investment because renting is a bad investment”
That’s a little misleading because rent, in fact, isn’t an investment at all. The longer-term financial impacts of renting vs. owning are quite different, namely that you take on considerable financial risk (debt) when you buy a home. In contrast, renting affords you considerable flexibility with no ongoing financial risk. One is an investment, and one simply isn’t, so drawing the conclusion that buying is a good investment because it’s better than renting is a bit flawed.
MYTH 2: “Real estate pricing keeps going up, up, up, so I’m guaranteed to make money”
Certainly it’s been true over the last ten years that housing prices have shot up dramatically. But just because prices have been going up doesn’t mean they will continue to go up indefinitely (nor at the same pace). Anyone old enough to remember the Great Recession of 2008-2009 can attest to that. So while it’s probably likely that over a long span of time (think 20 years) homes will go up in value overall, it’s not certain that a house worth a million dollars today will be worth that or more in two or three years.
MYTH 3: “Home prices are really high, and I need to buy before it gets worse”
Much like myth #2 above, it’s important to remember that the price of buying a house is not guaranteed to continue to increase indefinitely. So while it may feel like every day you don’t buy means more money you’ll have to pay when you do, that’s not necessarily the case. Plus, home ownership is the largest investment that most people will ever make and it also has a meaningful impact on one’s day to day lifestyle (your commute, your children’s education, etc.) That’s why it’s critical to make sure you buy a house when it feels like the right time in your life rather than trying to time the market (which isn’t really possible.)
MYTH 4: “Mortgage rates are low, so it’s a great time to buy”
When the government reduces interest rates to stimulate the economy, financial assets tend to increase in price (not only the stock market, but real estate as well). As a result, when mortgage rates decline, this change is reflected in rising home prices. While low mortgage rates on their own don’t signal a good time to buy, it can be highly advantageous to refinance if you already have a mortgage.
MYTH 5: “Home equity will protect me during a recession”
Real estate is notoriously illiquid, which means that even though there is the expectation that it will appreciate over the long run, you cannot quickly or easily convert your investment into cash without taking a discount. When people talk about being prepared for a recession, the biggest risk that people need to be prepared for is having enough cash on hand to cover living expenses in the event that they have a gap in employment. While it is possible to get a home equity loan or line of credit, paying interest to a bank to access your own equity isn’t ideal.
MYTH 6: “Paying down my mortgage as quickly as possible is the best use of excess cash”
When people have excess cash after covering their expenses, it’s important to take into account all forms of debt that you have. Among consumer debt, credit cards tend to have the highest interest rates of all, followed by student loans, and then mortgage and auto loans. Many people learned this from their parents who may have purchased a home when mortgage rates peaked in the 1980’s. (In 1981, the average rate for 30 year fixed mortgage was over 18%) For people who are a ways off from retirement, it’s also important to consider the return profile of investment opportunities as well.
MYTH 7: “My primary residence isn’t really an investment”
People often mistakenly believe that their primary home isn’t actually an investment. But just because it’s your home and not a separate “investment property” doesn’t mean that it’s not an investment. For many people, their home is actually their largest financial investment, and even as a primary residence, the expectation (and hope) is that the value of your home increases over time.
MYTH 8: “Investing in real estate involves low financial risk”
Typically, when purchasing real estate, people will make a down payment of 20%, and then have a mortgage (debt) for the remainder which they’ll pay down over time. What this means is that if the property were to decline in price by 20%, your entire initial investment would be wiped out. And worse, a substantial decline in value could even mean you’d end up owing the bank money when you went to sell – if the future buyer was only willing to pay less than the outstanding balance of the loan. In cases where the seller doesn’t have the cash on hand to pay the bank the difference, this becomes an obstacle to relocating for a new job.
Ultimately, the right time to buy a home is a combination of when it makes sense from a lifestyle perspective and when you’re ready and willing to make a large financial commitment.
If you have questions about an existing or future investment, Paceline can help you find balance among competing financial priorities. Contact us today for a free consultation to see how we may be able to help.
This blog was written by Jeremy Bohne, Principal & Founder of Paceline Wealth Management. Paceline is a fee-only investment advisor serving clients in the Boston area, and on a remote basis throughout the country. Paceline specializes in helping tech and biotech executives, physicians, and those seeking financial planning services.