Ask an advisor: How can you use real estate as an investment?

Ask an advisor: When is real estate an investment?

June 6, 2023 7:05 PM

A person's home is often their most valuable asset, but some wealth managers say it shouldn't be thought of as an investment.

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

This week we're taking a different approach: The question comes from yours truly, retirement reporter Nathan Place.

My question is about a highly unusual asset: real estate. Should a home be looked at as an investment? That depends on the context, and on which financial advisor you ask. Some see buying a home as the gateway to building wealth. Others are so wary of real estate's complexities that they recommend renting instead.

The one thing that's clear is housing prices are up — way up. In the fourth quarter of 2020, the average price of a home sold in the United States was $403,900, according to the Federal Reserve Bank of St. Louis. By the end of 2022, that average had risen to $552,600 — a 37% increase in just two years.

It would seem that someone who purchased a home in early 2021 — as this reporter did — could benefit from all this inflation by selling that home a few years later. But the timing isn't that simple. For one thing, mortgages have skyrocketed — as the Fed worked to tame rising prices by raising interest rates, the average 30-year, fixed-rate mortgage jumped from 3.11% at the end of 2021 to 6.79% in June 2023.

Even apart from picking up a sky-high new mortgage, there's a paradox inherent in selling one's primary residence: If you sell when the market is high, you must also (unless you rent) buy when the market is high.

Is there any way around this conundrum? Can one "time" the real estate market? Does it ever make sense to look at one's home as an investment? Like many of our readers, I turned to the experts for guidance. Here's what I wrote:

Dear advisors,

Many people refer to real estate as an investment, but how does that work in practice? The part that puzzles me is the timing. At what moment in the housing market can you make enough of a profit to buy a bigger home? If you sell high, won't you then also be buying high?

For context, my wife and I own a two-bedroom apartment in New York that we bought for $520,000. The three-bedroom apartments in our building cost about $1.1 million. Someday we'll want a bigger place, but even if we sell our two-bedroom apartment for more than we bought it for — let's say $700,000 — by that time the three-bedroom apartments will also be worth more — probably about $1.5 million. How can we ever catch up?

Thanks in advance — for answering my question, and all the others in this column!

Sincerely,

Nathan "Wondering in Washington Heights" Place

And here's what financial advisors wrote back:

Timing isn't everything

Crystal Cox, a certified financial planner and senior vice president at

Wealthspire Advisors

in Madison, Wisconsin

How do you time the real estate market? You don't. I always tell my clients, you could get it right, or you could get it wrong. Instead of trying to time the market, do whatever is best for you at the time it makes sense for you and your life circumstances.

Don't focus on profit

Jay Zigmont, a certified financial planner and the founder of

Childfree Wealth

in Water Valley, Mississippi

The challenge with real estate is that all too often the property you would buy for yourself to live in is different from the property you would buy as an investment. It used to be that owning your house was a cornerstone of your retirement plan, but that was back when people bought a property, paid it off, and lived in it for life. As you point out, we often move, upgrade or otherwise change our home, which means we are never really going to pay it off. In particular, anyone who is using one of the 40-year mortgages which are now being offered is unlikely to ever pay it off in their lifetime.

While the growth of your home value is good, it can be difficult to tap, especially if you keep upgrading. You may be better off separating your primary home from your investments in your mind. If you can make a profit, great. If not, you still get the enjoyment.

A home is more than an asset

Jeremy Bohne, the founder of

Paceline Wealth Management

in Boston

Real estate is an investment when the primary, or preferably exclusive, purpose of buying a property is to produce either rental income or to gain a profit when selling the property. In cases where you rent out a property to a full-time tenant for income, or renovate a property to sell it at a gain, these are each investments.

As far as a primary residence goes, it's a living expense, not an investment. The best time to buy or sell a home is when life conditions are such that you need one, rather than uprooting your family every time market conditions might make it beneficial to do so.

When market conditions are advantageous, you can sell any amount of a portfolio to take profits, but you can't sell half a house, and you wouldn't sell your primary residence unless you had another suitable place to live. Just imagine what would happen if someone came home to find out one day that on a whim their spouse had sold their home for a profit. That wouldn't go over too well.

With a primary residence, also keep in mind that whenever you sell a property you need to buy or rent another so entering and exiting the market is a complicated process. If your plans are to upgrade, it's a better time to do this in a down market, and if you want to downsize, this works well in a hot real estate market. This is highly dependent on finding a suitable replacement property, and with mortgage rates high and prices down from peak levels many potentially sellers are sitting on the sidelines.

The illiquidity trap

Leibel Sternbach, a chartered financial consultant and the founder of

Yields4U

in Melville, New York

Your question gets to the heart of the problem: Real estate is not the best investment. It's illiquid, it's subject to the whims of the market and politicians and you have constant costs and labor required to maintain your value — not to mention that you almost never have control over when you sell. Most often people sell because they get a new job, or they want to be closer family, or they outgrow their home.

The one thing going for real estate is that it utilizes an insane amount of leverage. Ordinarily, if I tried selling you an investment that was leveraged five times and could take months to sell and generated a yearly tax bill, you'd look at me like I was insane. But when I tell you that you can live in it… all of a sudden it's OK.

So why do people favor real estate as an investment?

Put simply, for many Americans, owning a home is their primary ticket to financial freedom. It forces people to leverage the cash flow of their jobs to accumulate wealth — wealth that they can someday tap into by downsizing in retirement or by moving to lower-cost areas. This behavior has been incentivized in the tax code and by federal government policies.

So when is real estate a good investment? If you are living in your forever home and will only sell to downsize or cash out, if you aren't good with savings, if you're middle-class and your real estate taxes are below the state and local tax limits, or if you are using the home as an investment property that generates cash flow (as well as depreciation).

So, is real estate a good investment for the average American? Probably not.