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    You are here: Investing : Articles : Real Estate : General Tips

    Spot the Fallacy
    By Dolf de Roos
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    July 2002

    I am always amused to see how the media compares real estate with stocks. Most commentators compare dividend yields of stocks with the rental returns of property, or the growth in value of stocks with the growth in value of real estate.

    From an academic point of view, there is nothing wrong with such comparisons, and that is precisely why most of their readers will accept, believe and act on advice given by these commentators, many of whom earn their living by having clients buy, sell or switch stocks.

    The fallacy in this reasoning is that in real life, a valid comparison is not this simple. Whereas most stock market investors put up the cash required to buy a parcel of shares, most real estate investors borrow a significant chunk of the purchase price. Therefore, to be fair, any comparison should take into account this huge advantage that real estate has in being able to attract mortgage finance.

    The effect of this leverage is astounding. Consider what has happened to real estate values in the United States in the last 10 years, for instance. According to the National Association of Realtors, the median home resale price in 1991 was $97,100. Ten years later it was $147,500. The annual compounding growth rate is only 4.3%.

    However, if you consider that most homebuyers take out a mortgage covering some 80% of the purchase price (many mortgages go even higher), then the capital growth on the equity for that same 10-year period is 13.7%. Now 13.7% annual return is very respectable, but that is the return on the house with the median price (in other words, half of them are lower in price, and the other half are higher).

    It is my contention that it is extremely difficult to predict with any kind of accuracy and consistency which stocks will do better than average (nonetheless countless fund managers attempt to do just that). However, I also believe that it is extremely easy to predict which properties will do better than average.

    In my book Real Estate Riches, I outline several methods that make it child’s-play to do better than average. For instance, we all know that some cities, regions or areas have a higher growth rate than others, and that these trends are very slow to change and therefore easy to spot. So, simply by choosing the right geographic location, it is easy to have a return that consistently outperforms the national average.

    Similarly, the number of people (and proportion of the population) that is entering retirement is going to increase for a while as the baby boomers enter their retirement years. Any real estate investments that cater to this demand will also do well. Such investments could include retirement homes, assisted living facilities, rest homes, and any leisure-related real estate favored by the more mature, such as golf and bowls. There are many other ways of beating the average in real estate.

    Another obvious one is that any real estate by the seaside will increase in value much faster, and to much higher levels, than real estate that is not by the seaside. Make no mistake, this trend is happening already all throughout the Western World, from France, Italy, and the United Kingdom, to Canada, the US, Australia and New Zealand.

    Furthermore, if you capitalize on just one of these methods of beating the average, then you will in fact beat the average by a wide margin. However, there is no law against using a combination of all the methods you can think of. For instance, if you bought a retirement home in a high-growth geographic location that was, furthermore, by the sea, then your ability to beat the average would be even greater.

    None of this is rocket science, as the saying goes. So far we have seen that when you invest in real estate, you get the advantages of leverage (banks readily lend money on real estate, but not as readily, and certainly not at the same low interest rates, on other assets) as well as the ability to beat the average easily.

    But the advantages do not stop there! Unlike stocks, with real estate you can easily buy at way below the true market value. This ability comes about because the property market is very inefficient. The stock market, on the other hand, is very efficient, and anyone buying a particular share will pay the same price at that time as anyone else.

    Furthermore, when you do buy stocks, there is little you can do to increase the value of those stocks. Conversely, when you buy real estate, there are many things you can do to massively increase the value without spending much money. So many, in fact, that my forthcoming book, due to be released in the next couple of months, is called “101 Ways to Massively Increase the Value of your Real Estate Without Spending Much Money”.

    Finally, unlike most other investments, when real estate has gone up in value, you do not need to sell in order to capitalize on that increase in value – you can simply go back to the bank and arrange a new mortgage. For all these reasons, when I read some commentator’s writing that stocks are better than real estate, I hope that for them at least, they are speaking from experience and not hope.

    Successful investing!

    Dolf de Roos

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