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Article 14

Getting Going
Why You Should Think Twice About Investing in Real Estate
By Jonathan Clements
710 words
24 January 2007
The Wall Street Journal
D1
English
(Copyright (c) 2007, Dow Jones & Company, Inc.)

Real estate may be getting cheaper. But homes are always expensive.

Like any good knee-jerk contrarian, my enthusiasm for the property market grows as the bad news piles up. Only last week, the Federal Reserve's "beige
book" report on regional economic conditions noted that housing markets continue to soften, with sluggish home sales and falling prices in some areas.

So is it time to buy the vacation home you've always wanted? Should you trade up to a larger place? It is tempting. But if your sole goal is making money,
it's mighty hard to justify.

-- Counting costs. When analyzing the payoff from homeownership, it is critical to remember two key points.

First, home-price appreciation has historically been modest and certainly nothing like the heady gains enjoyed earlier this decade.

According to home-finance corporation Freddie Mac, U.S. house prices climbed 6.2% a year over the past 30 years, versus 4.3% for inflation. Beating
inflation by 1.9 percentage points a year is (pun intended) nothing to write home about. To make matters worse, after the current decade's blistering
performance, even slimmer returns may lie ahead.

Instead, as you toy with whether to trade up to a larger place or purchase a second home, your real focus should be the dividend. This dividend is the
rent you receive or, if you live in the house yourself, the "imputed rent" -- the rent you would have paid if you didn't own the place. This rent might be
worth 7% or 8% of a home's value each year, though the figure will vary depending on the location.

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That brings us to the second key point. Homeownership is horribly expensive. In fact, it's comparable to owning a mutual fund that not only charges 3%
or so in annual expenses but also levies a 5% or 6% back-end sales charge.

The back-end sales charge is the commission you will likely pay to sell your home, while the 3% annual expenses reflect the triple hit from property taxes,
homeowner's insurance and maintenance costs.

Your annual expenses would be even higher if you add in home improvements and monthly mortgage costs. But arguably, neither should be included:
Home improvements are optional expenditures, while a mortgage is a borrowing cost, not a cost inherent in homeownership.

-- Collecting rent. What's the implication of all this? If you subtract the costs of homeownership from your price appreciation, you are unlikely to keep pace
with inflation -- and you might end up under water.

True, if you have a mortgage, you could enjoy leveraged gains. But leverage can also bite. Indeed, from current levels, price gains may fall short of the
6.4% interest rate now charged by a 30-year fixed-rate mortgage. What about the mortgage-tax deduction? Even if you figure in the tax savings, the
leverage may still not work in your favor.

All that said, this could be a wonderful time to invest in real estate -- and, no, I am not making a market prediction. Frankly, it isn't that important
whether property prices climb at 4% or 6% a year.

Rather, what really matters is the long-run dividend. As savvy landlords will tell you, the key to a successful investment property is finding a place that
will attract good tenants who deliver a steady stream of rental income.

But what if you have no desire to be a landlord? What if, instead, you're thinking of trading up to a larger house or buying a vacation home for your own
use?

In that case, all bets are off. You won't collect any rental income and, after all costs, you probably won't make much on the price appreciation.

That doesn't mean you shouldn't buy that charming country cottage, assuming you have the financial wherewithal and you will get a lot of pleasure from
the place. And clearly, it's better to pay 2007's prices than 2005's. But don't kid yourself: You aren't investing in real estate -- you're consuming it.

License this article from Dow Jones Reprint Service

Document J000000020070124e31o0005c

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