Cents and Sensibility
Don’t get caught up in the real estate frenzy
If you've owned your home for a while, you know that it's probably worth a lot more than what you paid for it. In fact, over the past five years, U.S. residential property has increased in value by almost 50 percent, according to the Federal Deposit Insurance Corp. That's a pretty impressive appreciation -- but it doesn't mean that real estate is a "can't miss" investment.
Of course, you wouldn't be alone in thinking that now is a great time to become a "person of property." Some 23 percent of all homes purchased in 2004 were for investment, and an additional 13 percent were vacation homes, according to surveys done by the National Association of Realtors. And the number of chapters of the National Real Estate Investors Association jumped from 44 in 2002 to 170 in 2005.
Clearly, real estate investing is hot. Over the past few years, the combination of low interest rates and high demand for housing has pushed prices up, up and away. But how long can they continue to soar?
Not for much longer, according to some experts. Yale economist Robert Shiller, in his book "Irrational Exuberance," writes that the real estate "bubble" may soon burst, and he supports his claim by showing that median home prices are now six to nine times greater than median income in some areas of the country. He also shows that U.S. home prices, when adjusted for inflation, have not constantly risen in value.
And there's certainly historical precedent for housing prices to fall quickly and sharply. Many areas of the country have experienced "boom and bust" cycles in their housing markets.
Does this mean you should avoid real estate entirely as an investment possibility? No. But before you sign on the dotted line, keep these two rules in mind:
» Don't expect huge returns. From the start of 1980 to the end of 2004, home sales prices increased 247 percent -- which looks pretty good, until you see that, over the same period, the S&P 500 rose more than 1,000 percent. In other words, don't anticipate that real estate is going to constantly beat out your other investments, because it probably won't happen. Do keep in mind that past performance is not a guarantee of future results.
» Don't "leverage" yourself too heavily. With interest rates still so low, it can be tempting to buy more and more property, if you've got at least enough cash for down payments. But it's never a good idea to go heavily into debt for any type of investment.
If you're going to invest in real estate, you may want to look at real estate investment trusts (REITs), which provide diversification by property type and location. You can purchase REITs in appropriate amounts, without borrowing, and they offer greater liquidity than individual properties.
Also, most REITs provide attractive current income, which can prove valuable should real estate prices decline or remain stagnant for a long period of time.
But whether you buy REITs or other types of real estate, don't go overboard. As a general rule, you should probably have no more than 5 percent to 10 percent of your portfolio in real estate. By sticking to that level, you can help avoid a lot of problems and you won't get drenched if a bubble pops.
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Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734,
or call 254-0688