Catch a Falling Knife – Buying the Housing Slump

catch a falling knife Let’s review the last six months of the US economy: Home values and prices fall. New home sales reach 12-year lows. Resetting mortgages push people out of their homes, destroying their credit on the way out. Home builders slow down construction as housing inventory reaches a 40-year high. The financial system takes a blow and economists cannot accurately predict the future. Fear and uncertainty set in as stocks tumble, rebound and tumble further. The Federal Reserve makes an emergency interest rate cut and the White House pushes a major plan to stimulate the economy as the media debates about whether the US will avert a recession.

For someone who has some extra cash they are anxious to invest, it’s tough to find some safe ground. Anywhere you look the housing slump and mortgage meltdown has affected investment returns, whether it be CDs, international investments, investment properties or the US stock market. Where is an investor to find a safe haven?

If you have the guts, there are some fantastic opportunities in both the housing and stock market. According to Money Magazine, over the next 2.5 years $233 billion in home values could be lost and an estimated 3.5 million homeowners will enter default on their mortgages. As a buyer in this market, this puts you at the upper hand to negotiate prices and pick up property on the cheap. On the other hand, price-to-earning ratios and other indicators suggest that stocks are also very cheap and will pay handsome returns to the long-term investor who can ignore the short-term whipsaws.

So What’s the Better Move – Investment Property or Stocks?

According to a 2004 article, real estate has surged 56% from 1999 to 2004 where the S&P 500 sank 6% during the same time period. But over the longer term, the S&P 500 grew 1,000% between 1980 and 2004, where home values only grew 247%. CNN Money also reported that stocks are the better deal for the long-term investor, with a 13.4% annual return in the S&P 500 versus an 8.6% average annual return in home appreciation between 1978 and 2004.

But there’s more to consider than just the return on investment. Let’s compare the pros and cons of investing in real estate versus the stock market:

Real Estate Pros:

  • Buyer has greater ability to negotiate price and bid on foreclosures
  • Borrowing money to invest is relatively easy and amplifies returns
  • Rents go towards equity in the house and can provide additional cash flow
  • Appreciation in property value produces additional equity
  • Greater tax benefits on capital gains
  • You can borrow against your home equity

Real Estate Cons:

  • Hunting for the right property can be rather time consuming
  • Land lording can create headaches
  • Vacant properties, maintenance and repairs reduce profits
  • High purchase costs/fees/expenses
  • Housing Prices can continue to decline

Stock Market Pros:

  • Buying an index fund involves minimal effort
  • Little to no account maintenance. Just buy and hold
  • Minimal purchasing costs/fees/expenses
  • More liquid than real estate. You can sell and get your money out quickly
  • Diversification

Stock Market Cons:

  • Day-to-day ups and downs can have a psychological toll
  • Borrowing money to invest is more complicated. Buying on margin is highly risky
  • Volatility: Stocks can see dramatic movements that gain and lose money in relatively short periods of time.
  • No tangible assets

While the current economic conditions are offering opportunities to purchase investments that can provide substantial long-term returns, you need to decide which option is most appropriate for your situation, ability, risk tolerance and overall investment strategy. If you are currently heavy on equities, consider adding some investment property to your portfolio. If you are just building up your nest egg, buying an index fund may be ideal in order to create a foundation of core, diversified holdings.

Millionaire Money Habit: Taking advantage of buying opportunities means having the guts to purchase investments that you see value in while others are apprehensive about them. Figure out the investment vehicle that is appropriate for you, and do your homework. You will certainly find some bargains during these times of panic and uncertainty. -RT

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4 Responses to Catch a Falling Knife – Buying the Housing Slump

  1. If you have the resources to buy a house that could give you slightly better gains over a short period (thanks to leverage), but it’s a lot harder to do and it may be harder to catch a low point (it’s hard enough in the stock market, which has more transparent prices and trades a lot faster). On the other hand, I put an extra $100 into the S&P 500 for fun a day after the latest bottom - if I saw returns like this every week I’d stop working next week :)

    Only time will tell what it will do over the next year, but anything with houses would have to involve tens of thousands of dollars and take weeks or months to do a transaction. There might be more to gain, but it comes at a price - not to mention that I know far less about real estate than equities.

  2. Ron Holland says:

    We are in a real estate recession. The housing downturn is negatively impacting property sales in second home communities in Florida. This is also slowing sales in NC mountain resorts that depend on Florida buyers.

    Still the downturn in prices and building of inventories is starting to attract second home buyers from Florida looking for cool temperatures in our mountains. Also the dramatic decline in the dollar combined with weakness in American real estate markets are beginning to interest some bargain hunting European investors.

    Ron Holland, Broker/Realtor with Wolf’s Crossing Realty. See Ron markets resale mountain and ski resort properties in NC in Wolf Laurel and The Preserve at Wolf Laurel.

  3. I liked your analysis - it was clear and concise!

    However, I’d like to dispute one of the things you put as a con for Stock Markets. I don’t believe the "tangibility" thing is really an issue for any type of investor. Sure, it’s nice to say that the four-family unit over there is yours, but it’s equally as nice to say that you own 10,000 shares of TSM that aren’t being affected by the downturn in US Markets!

    In the end, as an investor, it’s really just what brings you the greatest return for an amount of risk and worry you can tolerate. Is it not?

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