The Investment U E-Letter
Monday, July 14, 2003 * * * * * * * The Best Place to Put Your Real Estate Dollars Today
By Dr. Steve Sjuggerud
President, Investment U
"Oh, I'm estimating 15% a year in home price appreciation."
Is he crazy? I couldn't believe this friend of mine could even say this with a straight face… We were at a dinner party over the weekend, where he was telling everyone about his new investment… a rental property here near the Florida coast. He was working out his calculations out loud to see if it would be profitable. I was thinking to myself… how could it NOT be profitable, when he's counting on 15% a year appreciation PLUS rent. But his pie-in-the-sky math wasn't what really bothered me about the conversation. Rather, it was the fact that we were discussing the next "can't miss" investment at all. The last time that happened, the ensuing market drain sucked trillions of dollars out of investors' hands. Instead of following appreciation-fueled dreams, let's take a look at the history of real estate prices to draw some conclusions about where to really make money in real estate today. Staggering Findings I just studied the last 30 years of data on Florida real estate. And my findings on Florida real estate were staggering… Everyone in Florida knows real estate prices here have boomed since the beginning of 2000. The actual numbers show home prices up about 10% a year since then (7.5% when you take inflation into account). And where I live, in a quaint beach town, prices are probably up even more. The participants at the dinner party all agreed "you can't go wrong buying real estate here." (More on that thought in a minute.) But assuming that the last three years of appreciation will continue indefinitely is an awfully big assumption… especially when you study Florida real estate for longer than three years… I couldn't believe it. But it is true… In Florida, if you bought a home in 1976, you did not break even until 2001, when you account for the effects of inflation. It is absolutely true. Sure home prices in Florida rose at over 4% a year in that period. But inflation was over 4% a year over that same period. Adjusted for inflation, Florida real estate did nothing for a quarter century, ending in 2001. Unbelievable! The National Real Estate Picture I studied the national real estate picture as well. Going back to the 1960s (as far back as we have consistent data), home prices have risen at about 6% a year. But inflation has risen at over 4% a year in that time. So that means that, after inflation, home prices nationwide have only risen at less than 2% a year since the 1960s. But the nationwide picture hides local trends. In studying different states and metropolitan areas, the old saw "all real estate is local" seems to be true… While Florida home prices basically tracked with inflation for most of the last quarter century, California home prices experienced a few major booms and busts. I also checked out Hawaii, where prices are still 19% below their 1991 highs, adjusted for inflation. And Brian Hunt in my office is from Iowa, so we also ran the numbers on Iowa. Unlike Hawaii, returns have been positive every year in that same period of time. Of course, barely positive. There ain't no housing bubble in Iowa. The Iowa story sure was different in 1980… Iowa home prices fell by 15% in 1980, as farmers got squeezed. Sky-high interest rates and two years of horrible weather put the pressure on. Many folks declared bankruptcy. Brian's dad didn't, but sold off some of the farm. In retrospect, bankruptcy might have actually worked out better… Meanwhile, real estate prices in Florida and California weren't hurt. All real estate is local. What To Do With This Knowledge The talk I heard at the dinner party troubles me. Non-professional investors are starting to talk about real estate as a "can't lose" investment… just as they talked about dot-coms in late-1999. Could the peak in real estate be near? Could be. But I still think we're a little ways off… While home prices have risen in pockets of America, housing in 2003 is more affordable than at any time in the last
30 years, judging by the last few releases of the Housing Affordability Index. The last time homes were this cheap by this standard (the inputs to the Housing Affordability Index are mortgage payments, incomes, and home prices) was the early 1970s. And home prices doubled in six years after they reached this level of affordability. Stated simply, when mortgage payments are affordable people will buy homes. The way to play a continuation of rising home prices is NOT to take on more debt by buying another house. And if you do, by all means, please, do not put an expectation of 15% a year increase in your calculations. Two other viable options are shares of real estate stocks (like Equity Office Properties-EOP, the largest office landlord in America, paying a 7% dividend) and homebuilders. For speculators, I'd suggest buying shares of homebuilders. The homebuilders are super-cheap. Demand for their product is obvious (one new source of demand may just be guys like my friend). Beazer Homes (BZH) builds lower-end homes, pretty much everywhere but the Northeast. Readers of my newsletter, True Wealth, have enjoyed excellent gains in this stock so far. At a forward P/E of 7, it is still extraordinarily attractive. I expect housing to continue to be hot, as people look for a place for their money. The right homebuilding stocks (like Beazer) may be the way to speculate. Today's IU Cribsheet - While everyone thinks housing prices are going through the roof, the truth is, since the 60s, housing prices have only risen 2% on the average (when you account for inflation).
- For more details on the Housing Affordability Index, check out www.realtor.org.
Good Investing,
Steve | 
