The imaginary real estate bubble?
So what if the real estate bubble exists only in your mind? That’s the thought examined by Roger Lowenstein in a really thought-provoking piece in the New York Times called Pop Psychology. It’s become really pretty trendy to accept the obviousness of the real estate bubble which has swelled up in the US, and to accept the inevitability of it ‘popping’. So it’s really pretty contrarian to suggest that there might be no bubble- especially when those words aren’t coming from a wild-eyed risk-seeking investment maniac, or a glad-handed realtor trying to upsell you.
Lowenstein points out that for most homeowners, houses have appreciate at a much lower rate than the stock market in past years. It’s only in certain hot markets where things seem to have gotten out of hand.
So then, how have so many people made so much money in real estate?
The answer lies in leverage. The typical home buyer only puts up 10-20% of the value of the house purchased. The rest is borrowed from the bank. Leverage lets you play with other people’s money. The more leverage, the more you can accelerate your potential earnings (or losses).
Unlike with the stock market, in real estate you can borrow a much higher percent of your investment, and you also don’t have to worry about margin calls. Values may plunge, but as long as you can keep up your monthly payments, the bank isn’t going to come knocking for more equity from you.
A brief example of the leverage effect. Let’s say you buy a house for $100,000, and sell it a year later for $105,000. Ridiculous example, but we’ll keep it simple. Your return is 5%. That’s pretty paltry.
However, if you bought the house with a $10,000 downpayment, then your actual ROI is 50%! (You put in 10, you get back 105 - 90 = 15). Not too shabby a return.
It’s an interesting article with some points well worth reading, check it out. And if you want to run some numbers on some potential deals, check out the Real Estate Genius investment property calculator, which will break out your actual economic return on any potential real estate investment.
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