Why Your Nest Is Not Your Nest Egg
by Jonathan Clements
Wednesday, February 13, 2008
provided by wsj.com


A house isn't a stock.

To be sure, you probably don't regularly confuse the bricks and mortar you occupy with the investments listed on your brokerage statement.

Yet thinking about the differences between the two helps explain why folks love owning real estate -- but also why some homeowners are in such trouble today. Here are five key ways that homes differ from stocks and stock mutual funds.

1. You don't know the price until you sell.

With a few minutes of spare time and an Internet connection, you can find out the share price of every stock and stock fund you own. But you don't really know what your house is worth until a buyer makes an offer.

This leaves ample room for mental mischief. You can happily imagine that your house is a wonderfully stable investment, because -- unlike your stocks -- you aren't receiving continuous price updates. You can also happily imagine that your home sports some grand valuation.

But if you are a seller in today's rocky housing market, a happy imagination can be a big drawback. If you insist on getting a lofty price, you likely won't find a buyer. Indeed, if you have already moved and your house is sitting empty, your stubbornness could cost you big bucks.

2. The expense ratio is huge.

What big bucks? Think of your home as a stock fund with an exorbitant expense ratio. Each year, between maintenance costs, property taxes and homeowners insurance, you might be paying a sum equal to 3% or 3.5% of your home's value.

In addition, you will have utilities and probably mortgage payments. These costs don't seem so dreadful if you're getting good use from your home. But if you have an unoccupied house you are aiming to unload, these costs mean you're bleeding money every month that goes by without a buyer.

3. You will pay a hefty commission to sell.

Real estate isn't just costly to hold. It's also moderately expensive to buy -- and horribly expensive to sell.

Purchasing a property can involve home-inspection costs, lawyers' fees, title insurance, moving costs and mortgage-application fees. Selling can also mean moving costs and lawyers' fees. But the big hit is the real-estate commission, which might snag 5% or 6% of your home's selling price.

Trading stocks, on the other hand, is fairly cheap if you use a discount broker.

In fact, you can avoid all trading costs if you favor no-load mutual funds and deal directly with the fund companies involved.

4. You can't get a margin call.

It's common to take out a mortgage to buy a house, while only aggressive investors use a margin account to buy stocks. This isn't a big surprise. Buying real estate with borrowed money is a whole lot safer than buying stocks with borrowed money.

How so? If the stock market plunges and you own shares on margin, you could receive a margin call from your broker, asking that you add more cash or securities to your account. If you don't pony up, part or all of your holdings will be sold, locking in your losses.

By contrast, as long as you make your mortgage payments, your neighborhood mortgage banker can't force you to cough up more cash or sell your home, no matter how far your home's price plunges. This ensures you won't be bulldozed into a snap decision. Still, because homeowners don't receive margin calls, it makes it easier to procrastinate over selling and to entertain fanciful ideas about your home's value.

5. The dividend is impressive -- but it isn't in cash.

If you buy a collection of U.S. stocks today, you might notch a 2% dividend yield. Clearly, the hope is that you will do far better than that, thanks to handsome share-price gains.

Meanwhile, with a home, you shouldn't expect much in home-price appreciation. According to home-finance corporation Freddie Mac, home prices have climbed at less than 6% a year over the past 30 years, versus 4% for inflation.

Moreover, even if you notch this sort of price gain, much of it will be offset by the 3% or 3.5% "expense ratio" mentioned above.

Instead, with real estate, the biggest part of your gain should come from the dividend, which is the rent you receive. Most of us, of course, don't have tenants. Rather, we live in our own homes and effectively rent to ourselves.

The good news is, this "imputed" rent is pretty valuable. If you rented out your house, you might collect rent equal to 7% of your home's value each year. That's an indication of how much value you're getting from living in your own home.

An added bonus: It's tax efficient to rent to yourself, because you don't have to pay tax on this imputed rent.

So what's the bad news? You may be getting real value from your home -- but you aren't getting your dividend in cash.

The implication: You want to own a home that's the right size for you and your family, but no bigger. What if you purchase a house that's much larger than you really need? It's like renting a mansion -- and living in just two rooms.

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