This is a hard question, but here is my opinion (please excuse my typos if there’s any).
Many people ask me this question, and think our real estate price is too high. They have claimed asset bubble for a few years, but so far the bubble still hasn’t bust and price keeps increasing.
Let’s take a look at the stock (also mutual fund) market. In 2015, I heard on radio that some “advisers” saying the stock had reached the top and would start to go down. Two years later the stock market continues to go up, even though we know one day it will turn to the other direction. The problem is when. If we buy now, we may buy at top price and lose money when market goes down; If we do not buy, we may lose the opportunity of growth. This is why it’s a tough choice.
As we have no “crystal ball” to foresee what will happen, most predictions are only “guesses”. The economy relies on too many items, so we’d better to have a strategy to deal with it.
First, let’s look at the history. The picture below shows the history of average price for a small area, which is around the first house I bought in US in 1996.
In 1996, the average price was $73695, and in 2017 (as the date of this article) the average price in that area is $340824.
To be fair, I set the radius of house sold in 0.5 miles around the address 4610 Philco Dr, Austin TX 78745 and house build time must be before 1972 (so the sold houses are similar). The data are from my own research from Austin board of Realtor MLS system.
Then, let’s see the S&P 500 index (data from YAHOO finance).
The S&P 500 index includes dividends already, so it is a real reflection of investment return. In real world, different S&P index funds may have some difference on their returns.
In 1996, the index was 670 and in Oct. 2017, it goes to 2572. It’s 3.8388 times more. That means if you invested $1 in 1996, now you should have about $3.84.
On the real estate side, if we bought a house (of average condition) in the area in 2006 and sell it now, it should sell 4.6248 times more.
You may say, “ Hei, you forgot about tax, insurance, and maintenance cost.” My response will be that house should not stay there vacant. The rent income should cover all costs (mortgage, tax, insurance, maintain cost) and bring positive cash flow.
Above picture also shows that the house price is much more stable than stock’s. When stock gets down,house price changes much less. Also do not forget most people buy houses with loans. Assuming the investor paid 25% down and bought a house then. Let’s see how much return he can really get.
Assuming price was $74000 and closing cost was $3000, the real out-of-pocket money from the investor was $21500. He then sold the house last month for $340824 with cost of 7%. He needed to pay off mortgage which was $34000, he then got $340824 * 0.93 – 34000 = $282966 at closing. His investment return is $282966/21500 = 13.16 or 1316%.
Assumption for above case is rent covering all mortgage, tax, insurance and maintenance costs. Is it possible in reality? Sure.
In year 1996, the 30 year fixed rate mortgage rate was about 8.25%, and mortgage payment was $417 per month. Tax about $166, insurance about $40 (per month), so total $623 per month. I then added $50 per month for maintenance cost, which means about $600 per year. It is more than necessary. Total monthly cost $673 and the rent was about $735 per month back then. If taking vacancy and management cost into consideration, it should break even or just a little negative cash flow.
Currently the average house rent has increased to $1660 per month while mortgage payments never increase. Actually it should even decrease, because after 2002, mortgage rate continues to decrease and landlord can refinance to reduce mortgage payment. Even though today’s property tax, and insurance payment increase, with an estimate of tax $766 per month, insurance $120 per month, and maintain cost $100. The mortgage payment is reduced to $285 as a result of refinance and total monthly payment is $1271. There’s a little more cash flow.
Here we did not consider income tax. As tax brings benefit (depreciation, capital gain tax, 1031 exchange), the real return might be higher.
In real life practice, as recent interest rate is low (low mortgage payment), the rent to price ratio is lower than before. House in this area may be not the best for today’s investment, but good if we bought in middle 90s.
My personal view is we should buy at any time. As we do not know exactly what will happen in future. In long run, house price will continue to increase. The house in Texas will be much safer than most other investment products.
In 1996, it is a good area to invest. Is it still good now? I believe so. As there are personal preferences on investments, different people may have different opinions. Above is just mine own two cents. If you are interested to discuss real estate investments with me. Please join my social media. or contact me.
Xiaomin James Wu