trends
THE NORMAL DEVIATE
Home Economics
Even when it comes to a house, active investors don’t have to be passive By Tom Preston
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itting down? Good. At home? Even better. Because beneath you lies your biggest single investment. Or should I say so-called investment? That would be your house. That’s where most people place most of the money they’ve earned. For others—those with significant savings in a 401(k) or trading account—a house might seem to have a lower value. But individually, the stocks, options, futures and funds in those accounts may have a lower value than the home. Put another way, a home is the single biggest piece of undiversified risk in most financial portfolios. Fluctuating value One of the difficult aspects of a home as an investment is that unlike stocks, options and even mutual funds, it’s hard to know exactly what it’s worth until it comes time to sell it. Real estate brokers’ sites can give an idea of what home prices are in the area, but so many variables come into play that it takes a lot of work to come up with a reasonably accurate value for a house. What’s more, house prices fluctuate. A home’s value is sensitive to the strength or weakness of not just the local economy but also the national economy. Interest rates are an important determinant of demand for real estate, particularly residential. The reason is that when people seek a mortgage, a higher interest rate means higher monthly payments. Higher monthly payments mean fewer people can afford the mortgage, which means less demand for real estate.
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The opposite—lower interest rates—can mean more demand for real estate. And as mortgage rates from different banks across the country tend to hover around a national average, with some regions higher or lower, demand depends on the overall interest rate environment. Interest rates fluctuate, creating fluctuating demand for homes. As the prices for other things— such as cars, gas and food—go up and down, the extra savings or spending can make a monthly mortgage payment possible or impossible, again influencing the demand for a house and its price. So, the country’s monetary policy, overall employment rate and even consumer confidence can influence the value of a home. But even so, real estate is a safe investment, right? Despite the ups and downs of supply and demand, real estate prices generally have gone up between 1% and 4% a year, outside of some notable crashes. Yes, certain real estate markets have seen much higher increases, but those gains tend to be short-term, and catching them is a matter of timing. Slow recovery In some markets, it took 10 years for home prices to recover from their collapse in 2008 and 2009. That said, residential real estate prices aren’t typically very volatile. For example, between July 2018 and July 2019, the price of the average home in the U.S. had about 1.7% volatility. That’s extremely low compared with the volatility of the S&P 500, which averaged about 19% during that time.
A home is the single biggest piece of undiversified risk in most financial portfolios.
The short-term rental market was valued at $100 billion in revenue in 2016, and grew to $167.9 billion in 2019. Source: VRMA
But because of the size of the value of the average home—about $280,000—the dollar amount of that volatility was about $4,600 per year. That means the average home could see prices land between $275,400 and $284, 600 about 68% of the time in a year. If a home’s value is larger, the price range is wider, too. And that was a period of relative price stability for houses, not like 2008 to 2009. Also, the time it takes to complete a real estate transaction is usually measured in weeks, if not months. Compare that to a few milliseconds for an online stock trade, and it’s clear why real estate, even in the best scenario, is not a liquid investment. So, even someone who knew the price of a home might crash next week would find it tough to sell it in that time. Every investment entails risk, and choosing when to enter and exit is an important way to manage. Real estate isn’t exactly safe by that measure. But technology is beginning to help manage it in other ways. Short-term rentals The recent growth (and more recent crash) in the short-term rental market has let homeowners monetize their homes with relatively low barriers to entry. Renting out a spare bedroom via Airbnb or one of its competitors has been a way to generate extra income. From the perspective of an investment, though, the income from a rental is reducing the cost basis of a home, thus reducing its risk. That’s how it works when selling calls against stock. The cheaper the
luckbox | july 2020
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6/22/20 10:11 AM
