Is real estate REALLY a bad idea? If so, then what?

January 5, 2007 11:19 AM

With the housing market slowing, where are people "in the know" putting their money so that it generates income or equity for them? How did they find out?

I'm 28 and trying to figure out an early retirement plan.

My expenses now are about 50% of my salary. I'm 5-6 months away from paying off credit cards, then I'd start investing or saving money for a down payment. I want to use that time to make a plan.

My current hope is that in 5-7 years, I can move to a smaller town with lower salaries and not have to work full-time. So, I'd need to have largely paid off that house and/or have income from rents or dividends. (Isn't this nearly everyone's goal? Maybe this won't be as easy as I think?)

I lean toward real estate because I work in city planning, so I know something about it and hear some of the gossip. I've been planning to buy real estate in areas I'd consider moving to (houses I could sell if I decide against that town), and/or a place here in the Bay Area that I could sell when I'm ready to move.

But I've been reading blogs on the housing bubble.

Still, nothing makes more sense to me. For the cost of a down payment, I can get renters to be paying a mortgage -- ie, equity. I wouldn't want to rely on appreciation (buying low and selling high), so I'd have to find somewhere that rents are pretty close to mortgage payments. (I know this is not easy, but a friend just did it, so I believe it's possible.) Appreciation may be slow, but it's not like I'm buying the property outright with cash I could put elsewhere.

Since I can't understand why people would put their money anywhere else, my question is -- what am I missing? Where are people "in the know" putting their money to accomplish goals similar to mine? Are there other options that make more sense in today's economy? Is there somewhere that money is going to triple (just sell a little stock and buy a house that way)? Is silver the next housing? And how do people find out?

I'm trying to find ways to keep on top of these things over time, so I'm interested in blogs and other ways to learn about this. Thanks in advance for any suggestions.

posted by salvia to work & money (19 comments total)

Nobody really knows; lots of people place their bets and some folks get lucky, that's really what it comes down to. An amazingly large percentage of people that "actively" manage money fail to meet let alone exceed returns on their target index, be it The Dow, S&P500, etc, etc.

So you're not missing anything but at the same time you're doing the right thing by saving money and acquiring a capital base that will let you exploit the next opportunity that arises. By this I mean a sharp correction in asset values such that you know the market price is well below fair value. Think the equity market collapse of 1987; that was the time to buy.

Silver? I went heavy into metals in 2004, completing my last purchase of both gold and silver in July of that year, and in spite of the sharp appreciation in prices I'm holding. But I wouldn't advise anyone to acquire metals until they had an otherwise well diversified pool of assets, starting with ample cash, both stocks and bonds, and a house as well.

So I'd suggest you keep saving, keep asking questions and continue to education yourself. When you've acquired sufficient capital begin to deploy this money into no load index funds for long term holding. Keep loads of cash available so you can immediately exploit any market opportunity you might come across, whether in shares or in housing

You've already got the best possible tool available - a long term horizon.
posted by Mutant at 11:35 AM on January 5, 2007 [1 favorite has favorites]

My one piece of advice:
You definitely need to get yourself out of high-interest rate debt before you do anything else. Pay off those credit cards first before you start investing.
posted by ZackTM at 11:44 AM on January 5, 2007

Google Group focusing on investing.
posted by JohnnyGunn at 11:53 AM on January 5, 2007

This is my advice from my financial advisor. I'm about the same age. No debt for the last 3 years.:
-Long Term goal - your retirement. I put about 10% here.
-medium term goal - diversified pool of mutual funds. I expect to not touch this money for at least 5-7 years. I plan on leaving it in there longer if I can. I put about 8-10% here.
-short term - capital for investment opportunity or down payment for house. I want to be able to get at this money quickly. Its in a 4.5% savings account. I put about 15% here.

As of right now, my assets are broken up between these pools at 37-18-45.

I'm assuming that your question is more along the lines of 'what do I do with the short term savings'. This is my strategy. I'm not too hot on the economy right now, so I want to make sure that I have my a$$ covered in case something happens. That short term acts like a buffer with my long term investments. However, I don't want it to sit there either. I'm currently saving up for a situation where I'm 20%+ down payment on a rental property. I'm not there yet. I wouldn't buy property in the current market either. So in the meantime, I'm holding out keeping that portion growing. But I understand your frustration. I went through it about 3 months ago.

That being said, my goal is to go in on a multi-family rental property with a few other investors once we have enough capital to make the down payment. Once I get there, that would be my bet.
posted by kookywon at 11:59 AM on January 5, 2007

I totally agree with ZackTM. It's great you are thinking about the future, but if 50% of your income is disposable I think you should look to get out of debt much faster than 5-6 months. The rates on credit cards are ridiculous. You should really get them paid off, and then make it a point to never carry a balance.

Once out of debt, how long do you think it'll take to save up for a down payment. How much are the houses you are looking to buy? Saving up a down payment can take a good while. If houses are as expensive as I think they are in San Fran, it could take years to get a down payment. Also, paying off a house in 5-7 years is doable, but takes a lot of money each month unless your mortgage is quite small.

You can use craigslist to determine what houses/rooms in the area rent for, and plan accordingly. However, renting can be quite risky. If you can't carry the house without renters, I would be wary of buying a place.

Personally, I think right now is a horrible time to buy a house as an investment. (If you intend to live in the place then that's another story.)
posted by chunking express at 12:00 PM on January 5, 2007

There are real estate options. So if you feel most comfortable with real estate, you might buy in an area that seems less bubbly, then hedge your investment with something along these lines.
posted by condour75 at 12:03 PM on January 5, 2007

Thanks for all the great answers so far.

Re: chunking express's question on down payments--

If I buy in the Bay Area, I would have to use a program for low-income first-time homebuyers that lets you put no money down. It'd take years and years to save up 20% otherwise. This would probably just be a small place to live. (If I borrowed part of the down payment, I would save up a bigger emergency fund so I definitely would not find myself forced to sell.)

If I bought outside the Bay Area, I'd buy it to rent it out, and I'd try to find something much cheaper than anything available here, so it wouldn't take me as long to save a down payment.

So chunking express, why do you think property is a bad investment now? Even if it doesn't appreciate, the renters are building equity, right? If that equity is greater than the return I'd otherwise be making on my measly down payment, isn't that a good investment? What am I missing here?
posted by salvia at 1:29 PM on January 5, 2007

I think the problem is making sure that you get enough money to cover both your living expenses as well as that of the investment property. If you have a property that is not rented out for a couple of months, then you have a mortgage and rent (or 2 mortgages) to cover. That will take down your short term savings buffer pretty quickly. If you live in it, then you only have one.

Also, if something happens to your rental property and you need major repairs, or you need to renovate in order to attract renters you're gonna need to come up with money quickly. If you're living in it, you may be able to live with it for awhile while you come up with some cash and not subject yourself to higher interest rates.

Also (from my financial advisor), you will get lower interest rates (which will save you money in the long term) if you can come up with a larger portion of the down payment. If you go 80-20, you may get a 7% loan on the 80 and 10% on the 20. If you can pay the 20 up front, you may be able to get a 6% loan on the 80 and already have some equity. Those were made up numbers to illustrate my point.
posted by kookywon at 2:04 PM on January 5, 2007

If I buy in the Bay Area, I would have to use a program for low-income first-time homebuyers that lets you put no money down. It'd take years and years to save up 20% otherwise.

Just think of how many years it'll take to pay off 100%. Or rather, 150% when you're finally finished paying back everything.

For the cost of a down payment, I can get renters to be paying a mortgage -- ie, equity.

For the cost of a down payment, plus the cost of getting renters, plus the cost of keeping renters. You think it's as simple as "renters move in, mortgage gets paid?" There are plenty of expenses in renting a place out. There are plenty more expenses in buying a place. Taxes. Closing costs. Etc.

Is there somewhere that money is going to triple (just sell a little stock and buy a house that way)?

I've heard Google is rumored to top 1000 / share in the next year. Then again, the market could tank and you could be out thousands of dollars. That's the risk part of the equation. I'd be more concerned about dumping a hundred grand of hard-earned money into a place that quickly plummets in value.

Is silver the next housing?

Is copper the next silver?
posted by Civil_Disobedient at 3:36 PM on January 5, 2007

C_D is certainly onto something here. Renting is not a "sure thing" any more than anything else. The house could sit empty for lack of (quality) tenants. For months. You might need to repaint or change the carpeting between tenants, and this could leave the place vacant for weeks. And of course there would be the cost of actually doing the repairs, checking people's credit, processing their applications, chasing down their bad checks. Being a small-time residential landlord is not *that* fun.

Salvia, I think that you need to consider that many many other intelligent(?) people did what you're planning to do -- buy real estate as an investment or as passive income -- and that's how we wound up in this bubble to begin with. This is not the case in SF (as far as I know), but in cities like SLC and Pheonix, this is rampant. I think that as interest rates rise from their historically low levels, and "exotic" mortgages (ARMs and other ways to get yourself wayyyyy underwater) go away, then things will settle down. A house is an investment. That you can live in. But housing prices have risen so much than in many places, the mortgages at (6% fixed 30-year kinda terms) would not possibly be covered by rents that you could charge. This mismatch will painfully go away soon, but it's quite real today.

Salvia, you probably won't be able to do what you want, with the resources you have. Everybody wants to retire at 40. But not many can without incredible luck. I hope that you're that lucky and that, here, on a public message board, a stock or other investment vehicle that will pay 3 to 1 over the next (short) while. But I doubt it.
posted by zpousman at 5:19 PM on January 5, 2007

I like the way you worded this question. You're clearly thinking lucidly and along the right lines.

Is there somewhere that money is going to triple?

Yes, certainly. Let's call it X. You can put $N into X, and a year from now it'll be worth $3N. However, right now most folks who are buying X for $N are probably not sure of this. In addition, if you look, there are a lot of folks right now who are saying, "No, don't put your $N into X, it's only going to be worth $0.5N a year from now if you do." They're wrong - but they don't know it yet.

By the time that everyone pretty much knows that N is going to triple in 2007, the price is going to be something like $2.9N. So how do you find out first? Would you like to read things others have written about how they achieved their success in this area? I can recommend Warren Buffett's shareholder letters and Peter Lynch's Beating the Street without reservation, and I also gleaned quite a bit from George Soros' Alchemy of Finance.

Your question reveals an implied assumption that deserves further examination. You're talking about the housing bubble, but then you talk about renting in the same breath. Single-family homes, single-unit rentals, multi-unit rentals, and commerical real estate are really different sectors entirely, and the weakness is largely confined to the market in single-family homes. Commercial real estate is still in the middle of a boom at the moment; a lot of folks are getting into these by buying market-traded shares in REITs (real estate investment trusts).

To get more specific: Warren Buffett bought a lot of silver and a lot of foreign equity last year, to address what he sees as future weakness in the dollar that's baked into USAn fiscal and foreign policy for at least the next year or two. I didn't follow along with the silver, because that can be very volatile, but I have nearly half my portfolio in foreign equity at the moment. You should follow neither me nor Warren Buffett; you should do some reading up (money.cnn.com; Wall Street Journal, news.google.com/business, etc) and place your bets bearing in mind your desired returns and your risk tolerance.

And remember that nothing's foolproof, not even real estate - but people who bought California real estate have almost never been sorry.
posted by ikkyu2 at 6:14 PM on January 5, 2007

My mom is a real estate economist, and her strategy in buying currently involves finding great places on the ocean. The baby boomers are retiring, and damned if they want their beaches! It is not, however, a fool-proof investment. Even the most solid house might explode (or something) in the next few years. Land can be good, but only if it's buildable.
From my (limited) experience, young people like yourself would be wise to invest in higher risk mutual funds (thus diversifying without tons of effort) and slowly reduce the risk as you get older (my mom also told me that).
posted by nursegracer at 8:55 PM on January 5, 2007

>where are people "in the know" putting their money

Answer from a friend's mother who thinks she's in the know ... ? "Costa Rica".
posted by AmbroseChapel at 10:04 PM on January 5, 2007

If I buy in the Bay Area, I would have to use a program for low-income first-time homebuyers that lets you put no money down.

Does this sort of loan program require that the house you get the loan on be your primary residence? If so, I wouldn't recommend then renting it out.

You don't want to end up like that Casey kid who committed such fraud and is now really worried about the legal ramifications. He did it with four different properties in four different states, if I recall correctly.
posted by beth at 4:15 AM on January 6, 2007

Everyone else seems to have summed up why I think your plan isn't so foolproof. As I said before, pay of your credit cards ASAP, and then look around and see what the market looks like. The returns you get on investing need to be better then what you are losing by not paying your credit cards down. I think most cards have rates that are pretty high.
posted by chunking express at 10:28 AM on January 6, 2007

With regard to real estate, there are a couple of things to consider. Right now, in the Bay Area at least, the cost of owning housing is about 30% higher than the cost of renting it. Mortgage payments are usually the majority of this cost, but they are not the only factor. Property tax is another and you had better take it into account. A $500,000 home can cost upwards of $10K in property taxes annually. That's a large chunk of most folks' after-tax income.

Also, what about maintenance? It rains here in the Bay Area. If your roof develops a large leak, you have no option - you must pay to get it fixed. If you let it continue to leak, the structure will be destroyed by water damage. A new roof can cost $50K, and while you never know when you're going to need it, you are going to need it every 10-15 years or so. Do the math - that's a hidden cost of maybe $3K per year.

There are dozens, if not hundreds of hidden costs like this, making it hard for the new home-buyer to estimate accurately the cost of owning a home. You could probably find a book to read about this, too.
posted by ikkyu2 at 10:36 AM on January 6, 2007

chunking express and others, I do intend to pay off my credit cards as quickly as possible, thanks for the reminder. I'm just doing research and preparation for the next step now -- trying to find resources to learn as much as possible.

One main message I'm getting is to be careful about accounting for hidden expenses and contingencies (vacancy rates, maintenance, interest, taxes, insurance, catastrophe), do the math conservatively and see if the investment still pencils out.

ikkyu2's clarification that it's mostly single-family housing people think is really overvalued helps me understand why my assessment was so out-of-line with what I thought the conventional wisdom was -- the conventional wisdom wasn't including some of the multi-family or mixed-use rental properties that I was thinking of.
posted by salvia at 2:27 PM on January 6, 2007

Does this sort of loan program require that the house you get the loan on be your primary residence? If so, I wouldn't recommend then renting it out.

Good point, I'll check. But I'd get that loan on a Bay Area house that I wouldn't be leasing. I don't think you can get those kind of loans on investment properties (I think they're financed completely differently, actually).

Thanks to everyone for all the information & the encouraging comments.
posted by salvia at 2:31 PM on January 6, 2007

The house could sit empty for lack of (quality) tenants. For months.

Worse, it can sit filled with unquality tenants. With sympathetic judges on their side and a poor sense of hygiene and no sense of house maintenance. And these among people who appeared primo.

Sorry to sound paranoid, but I've seen people get screwed big time in such circs.
posted by IndigoJones at 3:29 PM on January 7, 2007