Photo illustration by Kathy De La Torre
Playing the stock market is usually more of a throw-of-the-dice investment compared to purchasing a home and hoping for it to increase in value.
Housing can be a good investment
By Jean Newton
It's clear that all the dot-com fervor with it's focus on Wall Street, IPO's and stock options, isn't going to fulfill the "strike it rich" dream for most people who want an easy investment. However, the sharp changes in the financial markets over the last year underscore the stability of residential real estate as a safe choice for consumers.
"Housing continues to be a solid investment, largely unaffected by the volatile movements of the stock market. The stock market has more of a yo-yo affect, while real estate doesn't have as much cyclical activity," says Fred Marcussen, a certified public accountant in San Carlos. "In our area with such strong supply and demand, appreciation of real estate over the long run will probably outpace the stock market."
Homeownership should be viewed as a long-term investment, providing both equity accumulation and tax benefits over time. According to Marcussen, buying your own home allows you to deduct the entire mortgage interest, in most cases, and "hardly any other areas are available to lower income taxes."
How do stocks compare with home investment? The National Association of Realtors reports the median existing-home price increased a little over 4 percent last year, while Freddie Mac said home values increased 7 percent in 2000. At the same time, stock indexes finished in negative territory.
However, the true return on a home investment should not be based simply on home appreciation, but also the amount leveraged. Home buyers typically use their own money to cover only 5 to 20 percent of the home purchase price, yet the appreciation they realize is based on the total value. In other words, homeownership is a leveraged buy-in.
In addition, home buyers receive tax benefits for their investments, in the form of deductions allowed for mortgage interest and property taxes. This leveraging of borrowed funds gives housing a return far in excess of the market's appreciation.
The 1998 "State of the Nation's Housing" report from Harvard University's Joint Center for Housing Studies shows a dramatic increase in the rate of return on housing the longer it is held. For example, the housing survey shows that the typical homeowner, who experiences an annual appreciation rate of 5 percent and who made a down payment of 10 percent, will generally receive a 94 percent return after owning the home only three years.
After owning for five years, the rate of return increases to 225 percent; after 10 years, the rate of return jumps to 623 percent. For those making a 20 percent down payment and experiencing the same amount of home appreciation, the rate of return is lower, but still very respectable: After owning three years, the average rate of return is 46 percent; after five years, 110 percent; and after 10 years, 305 percent.
In comparing changes in stock prices to changes in housing prices, while the stock market experienced wide swings in value over the past 20 years, home values, overall, continued to rise steadily. Between 1976 and 1997, before the more recent period of wild stock market variations, the Standard & Poor's 500 composite stock price index (S&P 500)--a widely accepted measure of the performance of the U.S. stock market--recorded an annual average growth rate of 11.7 percent. At the same time, the resale value of homes rose at an annual average rate of 5.7 percent.
However, during four of those years, the S&P 500 posted a decrease in overall stock prices, while housing prices in general increased consistently. In fact, during that time period, the variance in stock returns was more than 13 times the variance in home appreciation at the national level.
Investing in your own residence is one thing, but, said Marcussen, who serves as the CPA for Silicon Valley Association of Realtors, there are some caveats for other types of real estate investments. The once-popular real estate syndicates, that attracted multitudes of investors in the late 70s for limited partnerships in big apartment and condo complexes, prompted a change of rules around 1986 for tax shelters that affects investors today.
"The rule is still in effect and makes it difficult for people who buy houses or small apartments from leveraging the investment since they can only deduct passive activity income and can't deduct losses from real estate investments against other income, like earnings," said Marcussen. "If people have rental properties that generate income and, with the mortgage rates down, that could be one way to get into real estate, but it can be hard to work out a way to break even."
Second residences are another investment possibility, but stringent rules apply as to what deductions can be taken. especially if it is used as a rental vacation property rather than a second family residence, said Marcussen. Checking with your tax advisor or Realtor is a good idea ,before buying a second home, to make sure you understand all the nuances of the investment.
Another area of real estate investment that might provide some additional tax benefits, would be owning the building in which your business is located, said Marcussen. Wearing both hats, that of the landlord and the tenant, allows the tenant to pay rent to themselves and can work around the passive law. But, Marcussen said he believes the best investment in real estate is to buy your own home and take advantage of the tax deductions available to you.
"Housing is not a quick-in, quick-out investment. However, when purchased for the long term, housing is one of the safest investments a consumer can make. In addition to the savings accumulated through a buildup of equity and the tax advantages, a home provides shelter. Absolutely no other investment provides this benefit," Marcussen said.
Before making any kind of investment in real estate, it's important to consult with your Realtor and tax advisor, or financial consultant. Their expertise can prove invaluable in making sure your investment is one that provides the most benefits for the long term.
Saratoga, California Since 1955
