Does Real Estate Create Wealth...really?

Question

The 2 basic reasons we buy real estate, according to conventional wisdom, are:

• 1.To protect buying power
• 2.To increase buying power

However, it has been well documented that RE does not outpace inflation. Check out this thread…

Therefore, it seems that the statement - real estate doesn’t create buying power, seems to be a true statement. All it does, it seems, is keep our value relative with inflation. Purchase price of real estate increases by the same amount the value currency decreases.

This accomplishes the first objective of protecting buying power. But, what about objective #2?! We are not in this sport just to remain even-keel. We want wealth…

There are 3 items on the list:

• 1.Forced appreciation
• 2.Income-producing property
• 3.Land-locked markets in which due to fundamentals growth outpaces investing

I don’t know any other ways to create wealth, which is to say to increase my buying power. It’s got to be one or a blend of several of the items on the list.

Thoughts?

Larry Turowski · Answer

@Ben Leybovich Well, this is really just a lovers quarrel.  :)  I leave you the last word on the wealth preservation point and just agree to disagree.

But I completely agree with your and @Andrew Syrios points on building wealth.  I might also add that with leverage you also leverage appreciation.  So even if appreciation is only at the rate of or even lags inflation, by leveraging you can outpace inflation.

Example.  Say you have invested in a $100K property with $25K down and leveraging the other $75K.  Say inflation rate is 2% over a period of a year, but the property appreciates only 1% or $1K.  That is a $1K gain on $25K, or a 4% gain on invested capital--better than inflation.  Of course, it is a little silly talking about this over a single year, but you get the idea.

Andrew Syrios · Answer

I think there are two additional points that make real estate such a great wealth building strategy: 1) the power of leverage and 2) the risk-mitigating factor of an inefficient market.

With real estate, you can leverage properties fairly easily, which multiplies your return. Invest $20,000 in a $100,000 house and if it goes up only by 5%, you make $5000 on your $20,000 investment, which is a 25% return. Hell, it could only keep up with inflation and you would still make a return substantially above the rate of inflation.

Of course, there's the other side to this, if it goes down 5%, you lose 25% on your money. That's where the inefficient part comes in. The stock market is very close to efficient, almost all the information is out there and studies have repeatedly shown that beating the market consistently is a rare feat. But with real estate, there are motivated sellers and value add propositions all around. So if you buy a property 25% under market value, it could down 5%, but you still have a major equity cushion.

Real estate allows you to take advantage of leverage while mitigating your risk, if you do it right of course. That's why it's such a great wealth building strategy in my mind.

Ben Leybovich · Answer

Perhaps you never heard of a dumb newbie chasing the shiny objects investing in RE to preserve wealth. And yet, most wealth is preserved in RE. Most highly sophisticated investors/funds are today buying for the delta between Cap Rate of 7% and cost of money at 4.5%. Larry - what the hell are they doing with that 2.5% delta if not preserving wealth...?!

Dr. Scott Benjamin · Answer

Interesting concept.  As you mentioned, purchasing at current market value "should not" increase buying power and thus does not create wealth over the long term.  I have found that true value creation relies on purchasing market value real estate at a discount or injecting value through rehabilitation or repositioning the asset.  This resembles the active actions of a job more than an investment.

Steve Olafson · Answer

There is a number 4 also.  Buying in the path of progress.

Any and all of these can make you a lot of money.  Of course you need to make good purchases and manage well along the way.

Richard C. · Answer

4. Pure dumb luck.  Which does exist.

Andrew Syrios · Answer

Then I think we are in full agreement: Real estate is awesome.

Ben Leybovich · Answer

Larry - RE is illiguid, which is why by and large it is the domain of BIG money. People/entities who can afford to park millions and never need them in the foreseeable future. And while some choose not to leverage, most indeed leverage extensively - for 2 reasons:

1. Having having this much exposed equity is too much of a target on their back, and

2. Unlevered transactions kill the IRR. The reason they buy is because on a very large scale, their investment is negligible relative to leverage. It's all about the delta for them...

Ben Leybovich · Answer

Andrew - the inefficiency of the RE market is covered by the 1st item on my list. And I completely agree on the leverage component :)

Larry Turowski · Answer

No doubt much wealth is preserved in real estate.  But real estate is generally illiquid and not a common place to park money.  And people who are parking money are not leveraging it.

Does Real Estate Create Wealth...really?

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