Real estate has an unmistakable mystique in the world of investing. Especially in North America, “home ownership” is regarded as some sort of Holy Grail of financial planning.
For many younger couples in particular, their entire life revolves around planning for their first real estate purchase. When? Where? How much to save? How much to spend?
This obsession around home ownership is based upon the conventional belief that owning real estate is the #1 path to (at least) financial security – if not affluence. But is there really substance to this belief?
No. Not today.
Residential real estate in Manhattan is arguably among the most coveted real estate in the world. It is a small island, in the commercial heart of one of the world’s largest, most affluent, and most powerful cities.
So, obviously, investing in Manhattan real estate is a great investment, right? If someone bought some residential real estate in Manhattan 100 years ago, they would have made a fortune on it by today, right?
Wrong.
The best real estate on Earth can’t compete with gold as an investment
In fact, residential real estate in Manhattan has increased
nominally in price by ~10,000% in the last 100 years. That sounds impressive – until one learns that virtually all of that price increase has been
inflation.
Manhattan real estate hasn’t gotten 100 times more valuable over the last 100 years. Rather, the U.S. dollar (in which those real estate prices are denominated) has lost 99% of its value over that period of time.
This can be easily illustrated.
The price of gold has also increased by roughly 10,000% over the last 100 years. The gold hasn’t gotten any more “valuable”. It’s the same metal. Rather, the U.S. dollars used to buy that gold have lost 99% of their value.
In fact, if we price Manhattan real estate in gold, we discover that over a span of 100 years,
the price of Manhattan real estate in real money (gold) has only increased by 25%.
Let’s put this another way. A hundred years ago, a wealthy investor is deciding on a long-term investment for their newborn grandchild.
The investor is trying to decide between gold and Manhattan real estate. If the investor opted for real estate instead of gold, then over the next 100 years, his/her grandchild would have netted
a gross return on investment of 0.25% per year versus simply holding gold.
But, of course, the granchild wouldn’t
netted 0.25% per year. Every year, over that entire century, the real estate-holder would be paying property taxes and upkeep on that property – taxes that would steadily rise with the nominal value of the property.
In other words, net of taxes, the Manhattan real estate-holder would be significantly worse off financially than the gold-holder. And that is a best-case scenario: buying the most-coveted real estate on the planet and paying cash for it.
In fact, the vast majority of real estate that is being bought today (at record prices) is not coveted nearly as much as Manhattan real estate. And the vast majority of home-buyers can’t pay cash for their properties. They take out large mortgages.
By the time the average purchaser is finished paying off their mortgage, they will have spent anywhere from
two to four times the original purchase price – when interest and other charges are included.
If buying the best real estate on Earth for cash (the original purchase price) is not a great investment, then what kind of investment are you getting paying two to four times the purchase price – for less valuable land?
Not a very good one.
The false economics of home ownership in the 21st century
For a homebuyer looking to live in the real estate unit that they purchase, there is an obvious rebuttal. From the cost of their home (including interest), they can deduct what they would have otherwise been forced to spend on rent.
This is the one, viable argument that real estate is a great investment. But does it hold water?
At one time, the numbers may have added up. When real estate prices were rational/reasonable
and the supply of real estate was finite, disciplined homeowners could make home-buying a successful financial strategy.
Those days are long gone.
Today, prices are not merely at all-time highs. They are at absurd, bubble extremes. This can be demonstrated in a number of ways.
Already, prices are so high in many larger markets (cities) that the vast majority of people who live in those cities cannot afford to own land. Obviously, real estate that is priced beyond the reach of its residents is neither “rationally” or “reasonably” priced.
There is no real “housing shortage” in these bubble markets. Rather, there is a drastic shortage of housing units in which the residents of these cities can
afford to live.
Taking these markets from unreasonable to simply insane, greed-crazed speculators are now frequently bidding well above the (bubble)
asking prices on these properties.
However, that’s only the beginning of the insanity.
Once upon a time, real estate as an investment benefitted from one supremely important trait: it existed in
a finite supply. But in the 21st century, this has ceased to be true.
Yes, the surface area of the planet Earth remains finite. And yes, the global population is still increasingly rapidly.
But as real estate developers build
up (straight up), the supply of real estate units is increasing at a faster rate than the overall population. In the case of the bubble real estate markets of Western cities, real estate units are increasing at many multiples of the increase in population.
Indeed, in some of the U.S.’s most troubled cities, the supply of real estate units is shooting higher (along with prices) as the population
decreases.
The supply of real estate units has become effectively infinite. This comes at a time that real estate is more over-priced than at any other time and there is more excess supply of real units than ever before.
In this market, first-time buyers are forced to take on huge mortgages. Even with mortgage interest rates temporarily and artificially depressed, 30-year mortgages are now very common.
Any investment return in such a real estate purchase is eaten up long before 30 years (or even 20 years) of mortgage interest is added to the (record) purchase price of the house – along with the property taxes and upkeep that are required during the term of the mortgage.
And that is if
somehow the largest/most-unstable real estate bubble in history doesn’t collapse.
Real estate: the fastest way to make – and lose – fortunes
Real estate makes little sense (and cents) as an investment even for homebuyers planning on living on/in their real estate. What about real estate speculators – who are doing most of the buying in these bubble markets?
It is a fact that more people become rich through investing in real estate versus any other financial strategy. It’s also true that real estate speculation is the fastest/easiest way for wealthy people to
lose their wealth.
Most real estate speculators have their own idol: Donald Trump – the “self-made billionaire” who amassed a fortune (with little more than the $1 million he was given by his rich daddy).
Yes, Donald Trump: real estate mogul. Lost in the small-print of the Trump mythos are the
six bankruptcy declarations made by Trump over the course of his business deals.
Indeed, if it wasn’t for Trump’s expensive lawyers and a U.S. legal system designed to strongly protect the Rich from their own failures, Trump would be a pauper today, absent his inheritance.
For would-be Trumps, who are not nearly as wealthy and without an army of their own lawyers, it can be easy come/easy go in the world of real estate speculation.
Some people manage to strike it big in Vegas. That doesn’t mean that casino gambling is a “good investment”. Because most casino gamblers
don’t get rich – just like most real-estate speculators don't.
Real estate is a gamble, gold is a good investment
Once upon a time, real estate was a good (not great) investment. Those days are gone – for the foreseeable future.
Today, real estate, even in a prime market, is not a good investment. It is
a wealth-trap, pure and simple.
Grossly excessive prices combined with grossly excessive supply is a recipe for investment disaster. And this bubble has been pumped up to insane extremes by the longest stretch of record-low interest rates in history.
In the United States, interest rates have now been well below historical norms for 13 years, and for most of these years rates have been frozen at all-time lows.
What about the future?
Prices cannot possibly be sustained this high over the longer term. And interest rates cannot possibly be sustained this low.
What happens to the biggest real estate bubbles in the history of humanity when these market turn and interest rates start to normalize? A crash unlike anything seen in the history of real estate markets.
For people who don’t want to gamble their financial future in the real estate casino, they have an obvious choice: gold.
“As good as gold.” “The gold standard.” “The Golden Rule.” A gold medal.
There is a good reason why humanity has a long list of gold-related metaphors that imply quality, success and excellence.
Gold has
a 2,000-year track record as a perfect vehicle for wealth preservation. Gold equals financial stability and security.
As an investment, it performs (at least) as well as the best real estate. But gold is both portable and instantly liquid. Real estate is neither of those.
What is the best way to become wealthy today? Buy real estate and hope that (somehow) the bubble doesn’t burst?
No. Rent and invest in gold. As 100 years of history clearly shows, real estate is
not “as good as gold”.
