First, I wish to make it crystal clear up front that I’ve always looked up to Mr. Stein. I have the deepest respect for him not only because of the life he’s led, but because of the kind of person he is. He’s a brilliant, hard working man who generally has not a negative word to say about anyone. In many ways I’ve used him as a partial role model when it comes to how I deal with people. He’s simply one of the kindest most empathetic public figures in America today. And even though what he said Friday in A Home Truth About Real Estate Investing is mystifying to say the least, my opinion of him hasn’t changed.
He’d just finished recalling the condo he’d purchased many years ago, and that the almost identical condo now, though worth much more, had “not fully kept up with inflation.” He then went on to say the following:
On the other hand, if the same person had bought the Dow in 1982, he would’ve made roughly 10 times the money by now, not counting dividends, which would have meant he would’ve made close to 20 times the money.
In order to avoid any confusion here, Mr. Stein is saying if you’d invested $100,000 in real estate back in 1982 and the same amount in the Dow, the Dow would have outperformed real estate by close to 20 times.
I read the piece over just to insure I truly got his intended meaning. I had. I’ve come up with two potential explanatons for this astounding statement.
- He’s so entrenched in ‘old school’ thinking that when he compares the two investment vehicles he is not allowing for any financing whatsoever on the real estate side.
- He simply has so little experience outside Wall Street that he literally isn’t aware that 99% of real estate investors use leverage.
Neither explanation makes sense to me. He’s way too smart. Given the history of the two investment choices is there anyone out there who would make that claim so clearly?
His entire position relies on hindering the real estate investor to buying only property for which he can pay all cash. There were over 100 comments before noon. The huge majority of them were flummoxed by the piece, offering various takes on the concept of leverage.
Stop me if you think I’m in error here, but isn’t the appeal of leverage one of the main factors that draws investment capital to real estate? I’m dumbfounded I even have to ask that question. Surely Mr. Stein knows this. I’m totally mystified by his take on the subject.
If Mr. Stein had indeed invested $100,000 dollars with a conservative 25% down payment, and traded up as the market dictated, he would have passed the DOW like it was standing still. One of the commenters noted, with nose firmly in the air, that the DOW has averaged 12% growth since, well, for a very long time. For the capital inside the real estate investment to exceed 12% annual growth the property need only appreciate at a rate higher than 3%. We won’t even address the dividend claim made by Mr. Stein, as after tax income is enhanced significantly for real estate through depreciation. I’d dare say cash flow from real estate even before tax is higher as a percentage of investment capital than the average dividend spit out by the DOW – even when borrowing 75% of the purchase price.
I can only conclude Mr. Stein knows he cannot compare the performance of even mildly leveraged real estate to the historical return of the DOW. Fair enough. But to act as if 99% of real estate investors don’t use leverage, thereby almost insuring a superior rate of return, simply makes no sense. There’s something I’m missing here.
For every millionaire created by the DOW there has many more created by real estate. I’m hoping Mr. Stein has a Part II in mind in which he fills in some of the blanks, and maybe addresses the bulk of the comments disagreeing with him. He’s still one of my role models.
Marty Van Diest says:
I may be way off base here, but isn’t it also true that many of the companies that were in the DOW in 1982 are not in the DOW now because they have been devalued?
You don’t just invest in the DOW, you invest in specific companies that are in DOW. And when those companies are not in the DOW, they are no longer measured but your investment is still in them? So that the current DOW is not monitoring the same companies that were the DOW in 1982. Let me know if I’m wrong.
And yes, leverage is the big deal in real estate, but that is also the reason you can lose more money in real estate than you can in securities.
If you real estate investment drops below you purchase point, it will actually cost you more money to sell it than you invested in it in the first place. That doesn’t happen with stocks. They can go down to zero, but not below zero. Unless you are in futures.
It just doesn’t seem to be an apples to apples comparison.
January 25, 2007 — 1:09 pm
Jeff Turner says:
I have only one comment on this. If I had invested every penny of the proceeds from the sale of my last company in real estate and NOT in the stock market in December of 1999, I would still have some of those very large sums of money and I would not be getting angrier and angrier with every letter I type in this comment box.
I agree with the commenter above as well. This is not an apples to apples comparison.
January 25, 2007 — 1:19 pm
David Phillips says:
I agree with your opinion of Ben Stein. I am constantly facinated by his depth of talent.
Also, I wonder what his motivation could have been to make such a comparison? It was either real estate or the stock market for me 15 years ago, so I got into both. When the time came, it was an easy choice to break off from Wall Street and fortify my position in real estate. There is simply no comparison.
Is it possible he is simply taking the average return of the regular home owner, much as he is comparing the historical gain of the major indices?
January 25, 2007 — 1:19 pm
Jeff Brown says:
Marty – The DOW is, in the post’s context an entity by which Mr. Stein chose to measure performance of real estate. It’s easily documented over time. I’ve been told by those who understand it, that 12% is high, that 10% is what the actual annual growth rate has been for quite awhile. The ‘invest in the DOW’ line was a paraphrase of Mr. Stein.
I’ve been in real estate for almost 40 years Marty, and have met maybe one or two investors who became wealthy exclusively through the stock market. I’ve met easily over 100 investors who’ve made themselves millionaires through their real estate investments.
Yes, leverage can be dangerous if put to use by ignorant investors. Just like the people who lost their shirts when NASDAQ went face down.
January 25, 2007 — 1:58 pm
Jeff Brown says:
Jeff – It’s never been an apples to apples comparison. But Mr. Stein wrote his piece as if it was. By ignoring leverage he was able to control the outcome to favor DOW.
The quickest way to create a believer in real estate is to have them invest in the stock market. 🙂 They tend to be the ones at your BBQ who always want to talk sports when you bring up investing.
January 25, 2007 — 2:02 pm
Jeff Brown says:
David – If he’s using the average homeowner, he’s conveniently assuming they paid cash. Otherwise his position quickly turns into quicksand.
One of my favorite clients came to me because of losing their shirt when NASDAQ did its belly-flop. You couldn’t get them to be in stocks again. They lost 40% of their nest egg faster than they could watch it happen in real time.
In real estate they’ve regained that money and are now retired!
Your experience is shared by thousands.
January 25, 2007 — 2:08 pm
Jeff Turner says:
Well, I certainly wouldn’t mind switching this entire conversation to sports right now, that’s for sure. 🙂
January 25, 2007 — 4:19 pm
Jeff Brown says:
I feel your pain Jeff.
January 25, 2007 — 5:18 pm
NVmike says:
Well, the problem is clear: Mr. Stein isn’t smart enough to keep his home leveraged to the eyeballs, as you (Jeff) often suggest in your writings as the best investment strategy.
Only a fool like Ben Stein pays down his mortgage!
January 25, 2007 — 8:42 pm
Kaiser Sose says:
Stein didn’t say that the Dow outperformed real estate by 20X. He said that an investment in the Dow would be 20X what it was in 1982. Regarding the changing composition of the Dow, you can either buy the ETF or a Dow mutual fund and not have to worry about it.
Naturally, real estate out-performs stocks when you are allowed leverage. Throw in depreciation and other tax avoidance methods, and its even better. I think Mr. Stein is looking at both assets from a cash basis. Of course, if Stein bought leveraged Dow futures, his investment would have been much higher than real estate. Leverage again.
That is why the real estate market is cooling off. Too much leverage inflated prices. Same thing that happened to the stock market in 1929 when margins were 10% compared to 50% today. Real estate used to be margined at 20%, now it’s 0% with variable rate, no-doc loans. That’s why it is a risky investment (GENERALLY SPEAKING) at this point in the price cycle.
January 25, 2007 — 10:49 pm
Jeff Brown says:
NVmike – For some investors that’s the way to go, for you it’s not. You’ve given me enough of your opinions that I’m pretty sure where it’s best for you to go.
Thanks again.
January 25, 2007 — 11:44 pm
Jeff Brown says:
Kaiser – In fact, when I do the math, I realize that it hasn’t fully kept up with inflation. Plus, the owner would have had to pay rental fees (it’s on land leased from a Native American tribe), condo fees, taxes, and insurance. Granted, he would also have gotten the great pleasure of living there, but it wouldn’t have been a great investment at all.
On the other hand, if the same person had bought the Dow in 1982, he would’ve made roughly 10 times the money by now, not counting dividends, which would have meant he would’ve made close to 20 times the money.
He WAS comparing it and said exactly what I said he did.
I made the same point about leverage you have. The mystery is his assumption that an every day comparison would automatically include investors buying RE for cash.
When is our modern day 1929 coming?
January 26, 2007 — 8:37 am
Kaiser Sose says:
Jeff, our modern day 1929 isn’t coming simply because you can’t buy stocks with as much margin as you could back in 1929. Unlike real esate, where you can buy with no margin.
We’ll have to see what effect the variable rate and sub-prime mortgages will have on the market this year and in 2008. I don’t think it will be positive. Not catastrophic, but certainly not positive.
You should do some reading on the economist Ludwig Von Mises. He’s widely respected as one of the best of our time, up there with Milton Friedman. One of his fundamental premises is that credit-driven inflationary expansions can ONLY be followed by deflationary contractions. Even helicopter Ben Bernanke can’t print enough money to stop it. That is what is happening in Phoenix right now, as well as other parts of the country. How widespread and severe will it be? Nobody knows for certain.
I’m sure there are still some opportunities out there in real estate, but even you have to admit that they are fewer than they were 5 years ago.
January 26, 2007 — 9:30 am
Jeff Brown says:
Kaiser – I’m sure there are still some opportunities out there in real estate, but even you have to admit that they are fewer than they were 5 years ago.
Irrefutably so.
January 26, 2007 — 9:52 am