Homeownership--still a good investment?

THE BALTIMORE SUN

Your real estate agent knows real estate.

So does your brother-in-law, your postman and your dog's psychiatrist.

Everyone, it seems, knows real estate. Especially residential real estate.

Of course, what most people "know" about real estate is that it's a great investment, a tool for the average person to build wealth.

But is it?

Analyzing a home purchase purely as an investment is exceedingly tricky business, enough to make a calculator overheat. One must factor in property taxes but also large income-tax breaks; enormous fees when buying and selling; upkeep and insurance; a huge down payment but also the leverage that permits you to reap the profit off a $200,000 investment with just a $40,000 initial payment.

In fact, no one has ever derived a formula for figuring out bottom-line gain or loss on a home sale that everyone could agree on.

And it's just as tricky trying to figure out the flip side: What is the actual long-term gain of stocks or bonds if you factor in the cost of renting an apartment all that time?

Such confusion leads to confusing signals from the experts:

The real estate consulting group at the Arthur Andersen & Co. accounting firm recently issued a bullish report on homes as an investment.

Meanwhile, Jon Fossel, chief executive of Oppenheimer Mutual Funds in New York, is sticking to his prediction that real estate "will be the worst investment in the 1990s."

The bottom line:

As investments go, buying a home is no sure thing. Of course, renting isn't necessarily a lucrative alternative. Ultimately, say advisers, your decision to buy or rent should be based more on lifestyle considerations than hopes for a financial windfall.

That said, what follows are positive, negative and neutral factors when considering the home as an investment, as opposed to shelter:

* A healthy track record. "Some people are saying you can get more for your money by renting [a house] and investing in a T-bill than you can by buying a house," said Ed Mauss, 27, who recently purchased a two-bedroom condominium in Laguna Hills, Calif., with his wife, Debbie.

"But we figure that even if a worst-case scenario comes up and we only make 5 percent a year for the next few years, we'll still make money," Mr. Mauss added. "Historically, home prices never go down in Orange County, [Calif.]"

History might side with Mr. Mauss. Stock gains (11 percent a year) beat homeownership profits nationwide (8.3 percent), says study of price changes between 1947 and 1982. But in some areas, such as Southern California, annual price appreciation from 1968 to 1990 favors property over stocks, 10.1 percent to 9.8 percent.

* A savings habit. When you own a home, you have little choice but to make those monthly payments. From an investment standpoint, that forced payout is healthy: It means that like clockwork, you are putting money away.

Of course, banks, mutual funds, credit unions and insurance companies also offer savings plans that automatically take money each month and sock it into investments -- from stocks to bonds to gold.

"Those are nice plans," said Michael Sumichrast, a Maryland real estate expert. "But people just don't want to save -- unless they're forced to it."

And the ultimate forced savings plan is a house.

These regular home payments -- often dubbed "building equity" -- do not guarantee you'll make any money. The only way your investment return will be positive is through price appreciation.

"The two most important things to remember when investing in real estate are location and timing. If you don't hit both of those things just right, you can lose your butt," said Roger McKinnon, owner of Roger's Realty in Corona del Mar, Calif.

But even if your house appreciates little, come the end of three decades, you still have an asset likely worth many thousands of dollars.

* Tax advantages. Homeownership's biggest tax lure, say some investment experts, is its ability to shelter profits from income tax.

Say you bought and sold stocks and made a killing. Unless those trades came in a qualified retirement account, you must pay taxes, which can cut returns by as much as 40 percent.

After a home sale, no tax is due if you repurchase another one at the same or greater cost within two years. And after age 55, $125,000 of home-sale profits are free from taxation.

These tax breaks can dramatically improve after-tax returns.

What isn't as well-known -- and what some home sellers discovered this past tax season -- is that losses from the sale of stocks and bonds and investment real estate are tax deductible. A loss from the sale of an owner-occupied house is not.

Of course, there is the mortgage-interest deduction, the only consumer debt that's still a tax write-off. That deduction translates into a 20 percent to 40 percent write-down on a monthly mortgage bill. But the after-tax cost must be compared with the cost of renting to get a true value of this "tax break."

And this deduction is not etched in stone. Taxpayers with incomes of more than $100,000 will learn this year that up to 3 percent of their mortgage interest is no longer deductible on federal returns.

* Smart buying habits. Famed money manager Peter Lynch always marveled at how people picked their investments. They slaved over home selection, interviewing agents and neighbors, studying school districts and pricing the block. Then they'd plunk half their life savings on some technology stock they heard about at a cocktail party.

"They'd buy Astrobionetics Integrated Technotronics because it sounds exotic," he said. "Imagine buying a house that way."

Engineer Jim Clement recently spent about $495,000 on a house in Cypress, Calif. He knows what Mr. Lynch is talking about.

"Before I bought my house, I was foolish with my money," he said. "It used to be that when I had an extra $10,000 or something, I'd invest in the stock market. It was a spur of the

moment thing."

As a result, Mr. Clement wasn't a winner in stocks. And, like many, he was usually interested in owning for the short term.

His house, he adds, will be a "longer play." Before buying his house, Mr. Clement looked for nearly a year.

"If I'd watched stocks as long as I watched this house, I probably might have made some more money."

What about leverage? The ability to buy a home with a tiny down payment is one factor that can make a house a great investment. But it's also why homebuyers sometimes lose their shirts.

Another way to look at leverage is using standard deviation, a complex calculation to check the steadiness of returns. The homeowner who put 20 percent down to beat stocks from 1983 to 1990 took four times as much risk when comparing standard PTC deviations of the annual returns, according to Charles Rother, a Los Alamitos, Calif., investment analyst.

In fact, few investors use leverage when buying stocks. By law, you can only borrow $1 for every $1 of stock you already own. To get the leverage a homeowner can enjoy, a stock investor has to play the high-risk options game.

"Most people think real estate's risk free," Mr. Rother said. "It isn't."

* Forced staying power. The lack of a daily home-price tote board creates an illusion that home prices are more stable than other investments. Imagine looking at stock prices perhaps once a year. For 1987, for example, you'd find the S&P; index was up 3 percent -- even after the October debacle.

However, because stocks are so easy to sell and daily fluctuations are so visible, many investors are quick to pull the plug on investments that over time may fare well.

Conversely, because a home also serves as physical shelter and the cost of selling is extremely high, buyers typically weather out price-fluctuation storms.

"If it was liquid, they might sell it," said Paul Boltz, chief economist for the Colonial Group in Boston. "It isn't, so they just hold on."

This illiquidity can hurt when it is time to sell a home, however.

Want to sell $300,000 in stocks or mutual funds? A phone call or a visit to a broker will have it done virtually instantly, no matter what the economic climate.

Try that with a house. Many homeowners learned an "illiquidity" lesson in the past few years. It can take months to sell and, if forced by a non-economic factor such as a job transfer, homeowners could be forced to take a bath.

Trying to calculate the rent-or-own situation can be tricky. One must include all costs of ownership (don't forget property taxes or condominium association fees) and the tax breaks placed on those payments (no break on fees). Also, the yields that the down payment money makes in other investments can be used to lower one's estimate of rental costs.

Of course, such pencil exercises do not note the comfort people with fixed mortgage payments enjoy by not worrying about rent increases. But fees can clobber you: Many home shoppers have received a rude surprise when entering the home market. Saving for a down payment isn't enough.

Transaction costs also are steep. Expenses to buy a home (from loan fees to title insurance) can run up to 3 percent of the purchase price.

Selling a house can run up to 8 percent of sales price. Compare that with commissions on stocks (typically less than 1 percent) or no-load mutual funds, which charge nothing either coming or going.

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