The vast majority of homeowners and investors (and the real estate agents who sold them those houses) believe that house values appreciate over the long haul. What you’re about to discover may surprise you. And it may also influence your thoughts about homeownership and investing in single-family homes. Brace yourself. It’s about to get a little bumpy ...
The Cold Hard Truth About Real Estate Values
Yale economist Robert Shiller, arguably the foremost expert on the study of home values, made some very interesting discoveries after carefully analyzing home prices over the course of the past century. He found that over the long term, home values remained relatively the same when adjusted for inflation. From 1900 to 2000, the national average of the real rate of appreciation on home values was only 0.2%. (Queue the organ ... dun, dun, dunnn).
In most cases, the price increase you’d be seeing would largely be the result of inflation, not a real appreciation of the value of the home.
But wait, wouldn’t the price of a house you want to buy today cost more 10 years from now? Probably. But in most cases, the price increase you’d be seeing would largely be the result of inflation, not a real appreciation of the value of the home.
Inflation is the devaluation of your money as time goes on. A dollar today will buy far more than a dollar 10 years from now because of inflation. For example, if a house has a sale price of $200,000 today, in 10 years, it may have a price tag of $250,000, but the $50,000 increase is simply a devaluation of the dollar. What costs you $200,000 today, in this example, would cost you $250,000 after 10 years.
What This Means to Homeowners
For many, it can be quite shocking to hear about Shiller’s findings. However, it may also provide a different perspective on the purpose of owning of a home. A house is a place to live, a place to call home and hopefully a safe haven to raise a family. It’s not an investment.
However, your home can be considered a forced long-term savings plan because each mortgage payment may include a portion of principal pay down, and the actual value of the home will usually keep pace with inflation. Ideally, at some point in the future, your mortgage gets paid off so that your total monthly payment is much lower than the cost to rent a similar house.
Being a homeowner has many benefits, but unfortunately, buying a home is not guaranteed to be a good investment.
What This Means to Investors
For those who purchase single-family homes for investment purposes, understanding the real rate of return of houses is extremely important. Too many speculators in the mid-2000s bought houses with the hope that their investments would go up in value. Some got lucky. Many didn’t. The fundamental flaw was in assuming that home values would appreciate over time. Instead, the wise way to view houses as investments is to look at how much tax-advantaged income can be generated from them right now. You want to ask yourself, how much money has this investment home put in my pocket, lately?
Single-family rental properties can be a great investment. First, your tenants pay your rent. If that rent is larger than your expenses (mortgage payments, taxes, insurance, maintenance), you get a positive monthly cash flow. Tenants thereby help you pay off your home loan. And second, thanks to depreciation, the money that you do bring in is very tax-advantaged, so you may pay very little in income taxes.
The best way for an investor to evaluate buying a single-family home for long-term investment purposes is to determine how much positive cash flow it will provide starting on day one (as opposed to how much it may appreciate sometime in the future).
Exceptions to the Rule
It is worthy of note that Shiller’s discoveries are based on national averages and as they say in real estate, it’s all about location, location, location. In some areas, home values have not kept pace with inflation. For example, in Baytown, Texas, your average three-bedroom, two-bathroom home ran about $80,000 in 1980. And that same home will cost you about the same today. Here we are 33 years later, and house prices in that area are the same as they were in 1980. So much for keeping up with inflation! There are other areas where home values have outpaced inflation and have appreciated. The challenge, of course, would be in determining which areas will beat the national average of 0.2 percent.
In general, making guesses, however educated they may be, on the likelihood of area home values appreciating could be an exercise in futility. Human beings historically have proven to be terrible prognosticators. Rather, the best plan may be to live where you want to live, and if you decide to become a homeowner, buy a home you can afford and that suits your housing needs. If you want to invest in single-family homes, make sure you buy properties that actually turn a profit from the moment you purchase them. And if you get lucky and your home is situated in a location that actually does experience some appreciation, consider it icing on the cake.