How are Investors Getting a Rate of Return in This Uncertain Housing Market?
That is a really good question! To help put things in perspective, I went back and thumbed through a book my Dad gave me when I graduated college in the year 2000.
The book is called “Rich Dad, Poor Dad” was originally published in 1997. For those that aren’t familiar with the book, it’s a quick (and entertaining) read about financial literacy – comparing two fictional Dads.. The author, Robert Kiyosaki, shows how Dad #1, works for money, while Dad #2 has his money work for him.
The lessons of the book ring true to me a even a quarter of a century later.
Without getting into a formal book review, the chapter that I learned the largest lesson from was the one that talks about leverage and buying homes. (Surprise, Surprise! How do you think I ended up in the mortgage industry? :-)
Regarding the housing market, leverage is essentially using the tool of a mortgage to help generate wealth. Back in 2000, when I read the book – I was very leery of taking on too much debt – and I was very cognizant of trying to build my credit profile.
It took me a while to realize that debt against credit cards, auto loans, etc. really limits wealth generation, while a mortgage against an appreciating asset can accelerate wealth generation. As you all know by now, I’m a bit of a math nerd – and creating an excel worksheet is really what made the light bulb go on. So without putting together a Pivot Table or excel formulas, I’ll explain the concept below.
In 2000, in the State of Oregon, mortgage rates were pretty darn close to what they are today. The median price of a home in 2000, in our state was $152,000. According to Zillow, it’s now just about $496,000. A 226.3% total return on investment sounds awesome! However, it only equates to an average 6.51% annual rate of return. BUT, if you were to pay all cash for that home back then… this rate if return in not too shabby!
However, what the book would suggest is if you had $152,000 to invest – you can accelerate your wealth growth by diversifying your investment pool and taking on a mortgage. For example, let’s break up that $152,000 into 2 different investments.
A) 20% down payment ($30,400) on your home (and assume a 30 year fixed rate mortgage at 8%).
B) 80% in stocks/bonds ($121,600)
Let’s tackle (A). That $152,000 home in 2000 is still worth $496,000 today (that part didn’t change). Assuming you sell it after 23 years, you’d have a remaining mortgage balance of $57,753 and had paid $181,909 in total interest. Your initial investment of $30,400 just turned into $225,938 (the math is $496,000 sale price, minus your initial investment of $30,400, minus the remaining mortgage balance owed, minus the total interest you had paid). That is the power of leverage! Your investment multiplied 7 times over in 23 years!
Now let’s tackle (B). The S&P 500 has an average rate of return of about 10% per year. So let’s put $121,600 in the S&P 500 back in the year 2000 and fast forward to today. That investment is now worth $967,243.
By deciding to take on a mortgage and investing in the stock market that $152,000 is now worth a total of $1,193,181. This return is obviously FAR greater than the return on investment than having bought that home with straight cash back in 2000.
This general concept is why, even with mortgage rates above 7%, the United States is seeing Investment Property purchases at an all time high. One in three homes in the US are being purchased as investment property.
But what about the uncertainty in the housing market? Why are Investors heading to the housing market? It could be because folks like Warren Buffet are forecasting a tough 12 months ahead in the Stock Market – so investors are coming to the safe harbor of housing. It could be because rental income is also at an all-time high. It could be because more and more folks are understanding the power of leverage.
Because of low supply in the housing market, the Federal Agency, Freddie Mac, is still forecasting a national 0.8% appreciation rate over the next 12 months. (Source: https://www.freddiemac.com/research/forecast/20230817-economic-housing-and-mortgage-market-outlook-august-2023) The annual rate of appreciation in 1997 when the book came out in the western region of the US? Answer = 2.1%
Even with low appreciation rates, remember your 20% down investment is appreciating at the level of the entire property’s value. So a $500,000 home with a 20% down investment, at a 2.1% rate of appreciation is worth $510,200 after one year. Meaning you invested $100,000 and now have $10,200 in value to show against the investment. If you can have rent of offset the interest, property taxes, and home insurance expense – well, I think you are getting my point.
In the last 50 years, there have been only 5 years where year over year there was a reduction in housing pricing. That means 90% of the time in the last 50 years our country as seen an increase in pricing. So, pulling back the lens, historically speaking there is a 90% chance your home will appreciate in any given year.
Because of all of this, investors are signaling it’s a great time to buy Real Estate.
I’m happy to dive into the numbers more! Just let me know!
Thanks for reading, and Disclaimer:
My predictions are my own and based on individual research and don’t reflect that of C2 Financial Corporation. If there are 36 super computers predicting the weather, just imagine how many there are used to predict economic conditions! And still, they aren’t always right! Do not use this article as a basis to make financial decisions in your investment portfolio. Only do so with the guidance and advice of a licensed Financial Advisor.
* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.