Why Your Home is a Poor Investment

A couple we know moved to a new house recently.  They sold their old for a little more than twice the price they originally paid.  Doubling your money sounds like a great deal, right?

Not so fast.

To determine if the house was a good investment we need to make some calculations.  They originally bought their old home about 33 years ago.  That means that the return on their investment was just 2.4% per year.  To put it in perspective, 33 years ago CD rates were around 10%.  Viewed strictly from an investment perspective, they could have made a better return on their money if they had bought a CD.  And that’s to say nothing of maintenance and upkeep, costs not associated with CDs.

On the other hand, you can’t live in a CD.

How about investing that money in the stock market?  Over that same period the S&P 500 grew 8.5% annually.  That means that every $100 invested in the market 33 years ago would have grown to $1476!

The reason that so many people think that their home is their best investment is that they don’t sell their home very often.  As a result, they look at what they paid and what they sold it for.  If they held it for many years, it usually looks like a big number, and it is. But when viewed strictly as an investment, the annual growth rate is small compared to the alternatives.

As we alluded to earlier, home ownership also involves many other expenses.  There are property taxes and insurance.  Homeowners know that repairs and maintenance are expensive and never ending.  After all of the expenses are taken into account, the real return on home ownership may be even less that our earlier calculation.

But a home is much more than an investment.  It’s a place to live, a place to raise a family, a place to call your own.  A home is a refuge from the rest of the world.  The alternative is renting, wherein you often have more flexibility and are not on the hook for all of the repairs and maintenance.  But it also means that your monthly payment to your landlord is not going into equity that home ownership provides.

We are homeowners and advocates of home ownership.  The point of evaluating the true value of the home as an investment is to bring reality to the financial aspects of home ownership. It’s also a warning against investing too much of our resources in the family home, making many people “home poor.”

Buy a Paper Mill Heiress’s Greenwich Mansion for $5.5 Million

 

Having recently inherited her mother’s house in the same community, Zelinsky is selling her old home for $5.495 million. The buyer of the 6,100-square-foot house (that measurement doesn’t include a partially finished basement) will benefit from Zelinsky’s family’s connection to the property and its surroundings.

 

Just in case you wanted to know what you could get if you had the money.  The grounds need some work.

Should you own real estate?

We visit Nerdwallet from time to time to answer questions from readers looking for financial advice.  One recent question was from a single mom who’s buying a new house and is thinking of keeping her old house as a rental property.  She wanted to know if it was a good idea to sell most of her stocks and use the proceeds to buy the new house rather than selling the old one.

This question is not uncommon.  We have a number of clients who have invested in rental real estate.  The answer is not clear-cut and depends to a large extent on the individual.  Are you are a handyman and love to work on carpentry projects?  Or are you a single mom who’s disappointed with her stock market investments?

In the run-up to the Great Recession, lots of people got into real estate, flipping houses for a quick profit.   For many people that experience ended in grief when housing prices collapsed.  However, many people view real estate as an investment rather than a place to live.

So what are the issues involved?  Here’s part of my answer (edited):

You have to take taxes, liquidity and return on equity into consideration.  First, when you sell your stocks you will have to pay capital gains taxes on any profit.

The second issue is the fact that while stocks are liquid (easy to sell) a house is not liquid in case you have to sell to meet a financial emergency.

The third thing to consider is what the return will be on the equity on your rental property.  The rent you receive is not all profit.  From this you have to deduct taxes and maintenance.  Then there’s the problem of actually collecting your rent: some tenants won’t pay on time – or at all – and how do you evict them?  And when people move you will have to repair and paint to get it ready for the next tenant.   Unless you’re handy you may have to pay a company to manage the property for you, which reduces your income.  Finally the return on real estate has actually been lower than the return on stocks over long periods of time.

On the plus side, you can view free cash flow from rents as similar to dividends from stocks.  And there are tax benefits from deprecation on rental property.

The bottom line, there are benefits to owning commercial real estate, but there are also drawbacks. Once you make a commitment to owning rental property, there’s no easy way out.  People should think long and hard before plunging into this market.

Living like the Earls of Downton Abbey

Want to live in grand country house in the English country side?

Some of these homes have been divided in apartments.  Here’s Apley Park.

 

 

The Liquidity Trap – Or How to Lose $4.5 Billion

Liquidity is defined in the Dictionary of Finance and Investment Terms as “the ability to buy or sell an asset quickly and in large volume without substantially affecting the asset’s price.”

In layman’s terms it means being able to get to your money quickly and without a major loss.  Liquid assets are things like checking accounts and money market funds.  They can also include mutual funds and stocks in large companies that trade on a major stock exchange, although in times of severe financial stress even these may see major price swings.

But there are lots of things people own that are not liquid.  The typical family’s home is a large part of their wealth.  Homes are not liquid; they can’t be sold quickly and converted to cash in times of need.  What a home can be sold for is a guess; something that millions of people learned when the housing bubble burst in 2008.  Families found that the value of their home was tens, even hundreds of thousands of dollars less than their mortgage.

Besides a home, many stocks are not liquid.  Shares in small companies with a few shares outstanding may not be liquid.  Even the very wealthy are finding out that the liquidity trap can turn them from billionaires to paupers in short order.  Forbes Magazine listed Elizabeth Holmes, the founder of Theranos,  as America’s richest self-made woman last year with a fortune estimated at $4.5 billion.  The most recent listing gave her net worth at zero.  The reason for this is fairly simple.  Her net worth was based on the value of one stock: Theranos.  The stock was not publicly traded and if she had tried to sell some of it the share price would have plummeted because it would show a lack of confidence in the future of the company.

So when Theranos ran into serious problems Holmes could not get out and her fortune literally disappeared into thin air.

The average person can avoid the liquidity trap by following a few simple rules.

1. Do not put too much of your personal wealth in things – like homes – that can’t be easily sold.
2. Do not put too much of your personal wealth in one stock. You do not want your net worth to evaporate because of poor decisions by corporate management.
3. Smart investors spread their financial assets widely.  Realizing that they cannot accurately predict the future, they own stocks and bonds, domestic and foreign.  If they don’t have the means to diversify using individual stocks and bonds they use mutual funds or ETFs.
4. Get an advisor. Most smart people use professionals when they need medical, legal or financial advice.

For more information, contact us.

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Buy an Irish Castle for $7 million

It’s fun every once in a while to think about what it would be like if money was no object.  For today’s thought experiment we went to Ireland and found a storied castle for sale.

It’s Glin Castle, 700 years old, which was the ancestral home to the FitzGerald clan.  Think of it as Downton Abbey set in Ireland.  Located in west County Limerick, it sits on 380 acres, 23 of which are “pleasure grounds”—the woodland walks and gardens, both landscaped and informal, that surround the building. It’s been upgraded and operated for a time as a luxury bed-and-breakfast.  The furnishings are extra.  See HERE for more views.

Rent or Buy?

Should you rent or buy a house? That’s a question often asked by young couples, recent divorcees and people who are undergoing life changes. The main reason that people want to buy rather than rent is because they view renting as throwing money away. In addition, buying a home provides a feeling of stability.

However, there are downsides to buying. Buying a house locks you into a situation. If your life changes, you lose your job, or wish to move, selling a home can be difficult and expensive. Owning a home means that you have upkeep and maintenance costs. If you rent they are borne by the landlord. The cost of rent is often less than the costs associated with home ownership; mortgage payments, real estate taxes, insurance and all the other costs that a home owner faces.

Over the long term, home ownership has been a good investment for many families. But the last decade has clearly shown that the assumption that a home will always go up in value is not true. Just ask the people whose homes are on the market as “short sales.”

If you are an individual who is contemplating whether to rent or buy, keep these issues in mind. If you’re not sure, get the advice of a financial planner who can run the numbers for you and help you make the right decision.

Just How Rich Is Donald Trump?

There is a problem with trying to figure out what a billionaire is worth. A lot of their assets are in things that are impossible to measure with precision.  The average individual can add up their bank accounts and investment accounts.  But once it gets beyond those numbers the exact value of “things” like homes gets murky.

For example, your home may have an assessed value, for tax purposes, of $500,000.  But the amount you can actually sell it for can range widely, often more than 10% of the assessor’s number.  So this typical homeowner can’t be sure of his net worth within $100,000.  So if the average American homeowner can’t determine exactly how much he’s worth, it’s a lot harder for a billionaire.  For example, some very wealthy people own sports teams and these are assets that are not publicly traded so their actual value is impossible to define as Donald Sterling found out when he was banned from the NBA.  The team was estimated to be $324 million but sold for $2 billion.

Donald Trump’s net worth includes lots of real estate, leaseholds and assets like the value of his brand name.  That means that the question of “how rich is Donald Trump” is a guesstimate not even Trump can be sure of.  But you can be sure that a man with his own Boeing 757 is rich.

Homes for the Super-rich are Springing Up Like Mushrooms After Rain

“Private Wealth” reports that the newest condo for multimillionaires and billionaires – 53W53 – is almost ready to open its doors.  Located next to the Museum of Modern Art in Manhattan, prices start at $3 million but if you want a 6,643-square-foot duplex you’ll have to come up with more than $70 million.  For the engineers among us, the small condos go for about $2000 per square foot, the duplex for about $10,000 per square foot.

For that you’ll get access to a movie theater, private dining room and a temperature controlled wine vault.  Of course if you have that kind of money you will want your household staff nearby.  Residents can buy studio apartments on the 14th through 16th floors for their servants.

The project was stalled for years after the real estate bubble burst in 2008.  But the interval since then has created a whole host of people with extraordinary amounts of cash.  Billionaires don’t keep their money in cash.  The part that does not go into stocks and bonds goes into real estate, art, sports teams,  and “toys” like yachts and airplanes.  This explains, in part, the reasons that art auctions are reaching extraordinary heights and the very wealthy are buying properties which they may not ever live in.

The people buying these properties come from all corners of the world.  In many cases, they are seeking diversification, not just in the kind of assets they own, but also as a refuge in case they need to flee their home countries.  For some, a place in Manhattan may be just the ticket.

Image courtesy of 53w53.

Are You an “Affluent Worker?”

Forbes magazine recently had an article about some of our favorite clients. They call them the “High Net Worker.” These are people who are successful mid-level executives in major businesses. They range in age from 40 to the early 60s. They earn from $200,000 per year and often more than $500,000. They work long hours and are good at their jobs.

According to the Forbes article, many have no plans to retire. Our experience is different; retirement is definitely an objective. But many have valuable skills and plan to begin a second career or consult after retiring from their current company.

At this time in their lives they have accumulated a fair amount of wealth, own a nice home in a good neighborhood, and may be getting stock options or deferred bonuses. That means that at this critical time in their lives, when they are focused on career and have little time for anything else, they have not done much in the way of financial planning.

When it comes to investing, most view themselves as conservative. But because of their compensation their investments are actually much riskier than they think. It is not unusual for executives of large corporations to have well over 50% of their net worth tied to their company’s stock. Few people realize the risks they are taking until something bad happens. For example, the industrial giant General Electric’s stock lost over 90% of its value over a nine year period ending in 2009. The stock of financial giant UBS dropped nearly 90% between May 2007 and February 2009. These companies survived. There are many household names, like General Motors and K-Mart whose shareholders lost everything.

The affluent worker’s family usually includes one or more children who are expected to go to college. Many of these families have a 529 college savings plan for their children. Most have IRAs and contribute to their company’s 401k plan, but because many don’t have a financial planner they do not have a well thought out strategy for this part of their portfolio.

At a time when many less affluent families are downsizing, many families in this category are either looking to upgrade their homes, buy a bigger home, or buy a second – vacation – home. They may even help their adult children with down-payments.

If you are an Affluent Worker, give us a call and see what we can do for you. If you already have a financial advisor, it may be time to get a second opinion.

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