NEW YORK (MONEY Magazine) -
In large swaths of the country, today's real estate prices look too high. If you own a house or an apartment that has appreciated a lot during the recent boom, you may wish that you could find some way to cash out.
After all, why not sell when prices are high and invest the money -- or wait and buy a nicer place after prices have pulled back a bit? If you sell now, your profits are likely to be so great that you can easily afford to rent while you're waiting.
For some people, of course, moving is so unpleasant and disruptive that they wouldn't sell a home no matter how profitable the transaction might be. But if you're like me, the prospect of holding several hundred thousand dollars in your hand is an almost irresistible opportunity that doesn't come along very often.
I got such an opportunity six and a half years ago, when I decided to sell my co-op apartment because I thought Manhattan real estate prices were close to a peak. The results of that move have made me think a lot about real estate and its role in a portfolio.
Viewing my apartment purely as an investment, I earned a high return. But from a broader perspective, the strategy was a failure. My net worth suffered, and I never did end up living in a place that I really loved.
The numbers were great
I've never particularly wanted to own real estate because I've always thought that the long-term return on stocks is likely to be higher, and I worry about tying up so much capital in a home.
Nevertheless, in early 1994 I was renting a perfectly comfortable apartment when I spotted an ad for a remarkably cheap one-bedroom for sale by owner, meaning no broker's fee. On top of that, the apartment had an assumable mortgage with a very low interest rate.
There was just one catch: I didn't really like the place. It was a decent size and the neighborhood was trendy, but the ceiling was low and there wasn't a lot of light. None of the original fixtures had ever been replaced -- and they were awful.
The numbers, however, were terrific. Even before tax benefits, my costs would be lower than the rent on my old apartment.
The price was so cheap, in fact, that I decided to spend money on a makeover. The living room got a built-in bookcase. In the kitchen went stainless-steel appliances, custom cabinets and a black granite countertop. I had the kitchen floor redone with terra cotta- and mustard-colored marble tiles from a quarry in Italy reportedly favored by Michelangelo.
The mistakes I made
The apartment turned out to be a very smart investment. By late 1998 it was worth two and a half times what I'd paid for it. I sold and figured that after the next economic downturn, I'd be able to find great bargains in top-quality stocks and to start looking for a better apartment.
But things didn't turn out as well as I expected. I missed out on the continued appreciation of my old apartment, but that doesn't especially bother me. If you figure the return on the cash I actually put up for the down payment and the remodeling, I earned the equivalent of a 20 percent annual return. And that isn't even counting tax benefits. When you manage to buy low and sell high, you really shouldn't complain if your investment keeps going up after you've sold.
My mistakes were in the other portfolio decisions I made. Because I thought stock prices were also too high, I had moved my taxable brokerage accounts almost entirely into tax-exempt bonds.
After I sold my apartment, I added the proceeds to my bond portfolio. That was smart -- I made about 15 percent over the next couple of years thanks to a decline in interest rates. But after stock prices plummeted during the bear market, I thought I could hop from a huge profit in real estate and a nice gain in bonds to a great buying opportunity in high-quality growth stocks.
What actually happened, though, was that stocks kept declining -- a lot. As a result, I'm still 20 percent below where I was at the stock market peak.
The lessons I learned
I've thought a great deal about this whole experience -- and specifically about the role of real estate in an investment portfolio. Here are the conclusions I've come to.
1. Real estate isn't like other investments Quality-of-life considerations count more than the numbers do.
Imagine you had a choice between earning an annual average return two percentage points below that of the stock market while living for 20 years in a home you loved, or beating the market but having to move five times and never really liking the place you were living in. Almost everyone would accept the lower return.
2. Market timing with real estate is a hopeless exercise Buying and selling are slow and transaction costs are high. In addition, moving and setting up a new home is time consuming.
Worst of all, you not only have to call real estate correctly, but all your other forecasts have to be right too. If you sell overpriced property and move into stocks, you've accomplished nothing if share prices go down.
3. You should buy as much house as you can reasonably afford Because I got such a great deal on my apartment going in, I earned an excellent percentage rate of return even though I sold too soon. So if you have an opportunity to buy during a dip in the real estate market, grab as much house as you can.
Even today, when prices aren't cheap, it makes sense for anyone under the age of 45 to buy the best property possible without getting overextended. If you're still below your peak earning years, you'll likely want more space in the future rather than less.
4. If you get a shot at the home you really want, go for it I've had several opportunities over the years to buy apartments that would have met my needs -- if not forever, then certainly for a long stretch of time.
None was a perfect investment, but had I bought any of them, I wouldn't have wasted a huge amount of time over the past 20 years looking and moving. When it comes to your home, stability, predictability and security are ultimately the greatest rewards.
For more of MONEY Magazine's special, Your Home 2005, click here.
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Read editor-at-large Michael Sivy online every Tuesday at money.com/sivy. E-mail him at email@example.com.