The Risks of Real Estate

I've been a Fool writer for more than a decade now, singing the praises of stock investing as the best way to amass long-term wealth, so I'll admit I'm a bit biased in favor of the stock market. But every now and then, I'll run into someone who's just as excited about real estate.

It can be hard to argue with someone who's realized significant gains on a smart real estate purchase. Some people bought homes for $12,000 that are now worth $300,000 or more.

The possibility of such a profit is enough to lure lots of folks who rightly want to build their nest eggs. But these people should be careful, because real estate isn't a slam-dunk investment -- it can go sour, too. And even if the price of real estate keeps rising, it still hasn't grown as fast as stock values, historically speaking.

Sure, that wasn't the case during the housing bubble. As measured by the S&P/Case-Shiller U.S. Home Price index versus the S&P 500, housing trounced stocks between 2001 and 2006, averaging 12.4% vs. 4.3% yearly.

But that's a short period. A study by Roger Ibbotson and Jack Clark Francis found that between 1978 and 2004, residential real estate offered a solid 8.6% annualized return, while the S&P 500 averaged 13.4%. Meanwhile, Yale's Robert Schiller looked all the way back to 1890 and found that real estate just barely kept up with inflation over the subsequent century.

The folks at Zillow.com have even worse news. According to the site, a quarter of all homes sold nationwide fell in price from what the sellers paid for them. As you'd expect, the likelihood of such losses is higher in previously hot areas like California.

So go into real estate with your eyes open. It can truly be an excellent investment, but it's not risk-free. For a safer, more diversified approach to real estate investing, consider real-estate-focused mutual funds like CGM Realty (FUND: CGMRX  ) , which has averaged 22% over the past decade. Its top holdings recently included General Growth Properties (NYSE: GGP  ) , Mosaic (NYSE: MOS  ) , and Annaly Capital Management (NYSE: NLY  ) .

If you'd like to find top-notch funds for your portfolio, take a free trial to our Motley Fool Champion Funds newsletter service. It's helped me find a bunch of winners for my own holdings.

Longtime Fool contributor Selena Maranjian owns shares of CGM Realty. CGM Realty is a Motley Fool Champion Funds pick. Annaly Capital Management is a Motley Fool Income Investor recommendation. The Motley Fool is Fools writing for Fools.


Read/Post Comments (6) | Recommend This Article (6)

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  • Report this Comment On August 21, 2008, at 11:09 AM, canndogg wrote:

    If you want to invest in real estate, buy Washington Real Estate Investment Trust (WRE) and don't look for a while. They are the premier company when it comes to not over-levering themselves and growing slowly.

    Cheers

  • Report this Comment On August 21, 2008, at 2:06 PM, amortgagedude wrote:

    Not so sure NLY is the safest place to invest in real estate. You want to invest in real estate, find an area where incomes support the price of houses - no more than 2-3 times median income for median house and buy it and live in it. At least then if it doesn't go up in value you got the use out of it. NO INVESTMENT IS SAFE. Balance your portfolio with stocks, bonds, real estate and save your money.

  • Report this Comment On August 21, 2008, at 5:29 PM, aamire wrote:

    I for one have made extraordinary returns on real estate compared to stocks. Real estate investment is just like any other vehicle of investment: you find high growth potential location at cheap price, buy, wait, bingo!

    One factor that is not considered when comparing real estate to stocks is ready availability of funding options. I have been able to secure mortgage funding on all properties and hence a 10% increase in their value translates into 100% for me :-)

  • Report this Comment On August 21, 2008, at 8:33 PM, AndyVA2 wrote:

    Your article ignores several of the primary reasons that make real estate attractive:

    You get equity buildup over time as you pay down the loan, but you also have the benefit of forced appreciation. A little sweat equity invested in repairs and upgrades can increase your value. (Try that with a blue-chip.) You can also purchase at less than market value for instant equity.

    Monthly Income from rentals surpasses the dividends of stocks. Real estate has depreciation and other tax benefits. There's natural appreciation over time, assuming you hold for the long term.

    And of course, leverage. As aamire pointed out, a $10,000 down payment will get you a $200,000 house and a 10% increase in value nets you $20k or 200% ROI.

    Sure the media is doom and gloom these days, but isn't it best to buy when everything is on sale?

  • Report this Comment On September 03, 2008, at 6:52 PM, lunasea22 wrote:

    What is it with those who insist that investing in real estate means some residential house somewhere??? what about small office buildings, warehouses, strip malls, etc? I guarantee that broadening the definition of investment real estate to include these asset classes (as opposed to houses) will reflect a return much closer to the historic returns of the DJIA and the broader market indexes.

  • Report this Comment On February 04, 2009, at 1:15 AM, gracyalora wrote:

    Hi,this is alora.It is very hard and patiently job.When you are entered in medical college you must sacrifice the time for unhealthy people.Then only you will get good result to patients.

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