The 1990s gave birth to hundreds of Internet-based companies, popularly known as dotcoms. Some dotcoms had good ideas and matured into strong, successful companies. But many didn’t. In too many cases, the business plan was simply to start a company and sell it to someone else—which could be immensely profitable if delusional investors could be found, but a disaster otherwise. The tech-heavy NASDAQ index increased by more than 40% a year between 1995 and 2000. Dotcom entrepreneurs and shareholders were getting rich, and they wanted to believe that it would never end. But end it did, with the NASDAQ falling by 75% between 2000 and 2003 and the Internet Index falling by almost 95%. That was a bubble.
Before dotcom stocks, people paid hundreds of dollars for stuffed animals known as Beanie Babies. Did they think that their children would have $500 worth of fun playing with a Beanie Baby? No, they thought they would get rich by "investing" in Beanie Babies. But they weren’t really investing. They were speculating—speculating that they would be able to sell a $500 Beanie Baby for $1,000. This is the "Greater Fool" theory: You buy something at an inflated price, hoping to sell it to an even bigger fool than you for a still higher price. Today, for less than $5 you can buy Beanie Babies that once sold for hundreds of dollars. That was a bubble.
The Housing Market Is Quite Different
When real investors such as Warren Buffett buy something, it’s not because they expect the price to be higher tomorrow than it is today, but rather because they expect the income from their investment to provide a good return. If you can buy a stock for $100 that pays a $10 dividend every year, forever, you don’t have to sell the stock for $200 for this to be a good investment. Beanie Babies and flimsy dotcom stocks were bad investments because there was no income at all.
What is the income from your home? If you’re a landlord who rents a home to someone else, the income is obvious—the rent check you get each month from your tenants. If you own a home and live in it, your income is the rent check you don’t have to give to someone else. When you write a rent check for $1,500, the money goes out of your bank account and into your landlord’s bank account. If you own your home, however, the $1,500 doesn’t leave your bank account. This isn’t an abstract theoretical $1,500: It’s real money that you can invest or use for food, clothing, entertainment, and so on. This $1,500 is income from your home.
Of course, you derive other financial benefits from home ownership (including tax deductibility of your interest payments and property taxes), and some expenses are associated with owning a home (including mortgage payments, property taxes, and maintenance). The point is that the investment value of a home depends on its income—the rent savings and other benefits net of the mortgage payment and other expenses. Because this income is as real as the dividends from a stock portfolio, we call it your home dividend.
An Indianapolis resident told us that he didn’t think Indianapolis was a good place to buy a home because real estate prices there go up by only 2% to 3% a year. He’s wrong. Indianapolis can be a great place to buy a home even if prices don’t go up at all. His mistake—and it’s a common one—is to focus on the price appreciation and ignore the home dividends. If you buy a home, buy it for the home dividends. A home can be a great investment because of the great dividends.
All real estate is local. In some places, home prices are too high relative to home dividends. But in most places, now is a good time to own a home. If you already own a home, congratulations! If you don’t yet own a home, you should think about buying one. Twenty years from now, you’ll probably look back and say that this was the best purchase you ever made. We can confidently make that statement even though we don’t know what your home’s price will be 20 years from now.
Over long horizons, the income you get from owning your home—your home dividend—usually will be much more important than wiggles in home prices. Once you focus on years and years of home dividends, a home is not as risky an investment as you might think. While buying a home might seem risky, not buying is also risky. If you wait too long to buy, you might get priced out of the housing market and have to pay rent for the rest of your life. Think of it this way: You don’t have to buy stocks. But you do need a place to live—which you can pay for with rent or with mortgage payments. Which do you think is riskier—making mortgage payments that are constant, or making rent payments that can change every year? (If you have an adjustable rate mortgage, your mortgage payments may change every year, but that’s another issue.)
Home prices won’t ever collapse the way the prices of Beanie Babies and dotcom stock plummeted, because homes are fundamentally different from Beanie Babies and dotcom stocks. Homes have a substantial income—home dividends—that Beanie Babies and flimsy dotcom stocks never had. When the prices of Beanie Babies and dotcom stocks started falling, there was no longer any reason to buy them. If home prices fell dramatically, you would have a very good reason to buy a home—to get the home dividends! You want to be a homeowner because it’s emotionally satisfying and because the home dividends provide an attractive financial return. If home prices fell significantly, the argument for homeownership would be even more compelling. Like many a great investor has said, if you like a stock at $50, you will love it at $40. If you like a home at $300,000, you will love it at $200,000.
The proverbial bottom line is that you should think of your home as an investment. First and foremost, this means that you shouldn’t think like a speculator. Don’t buy a home because you think you’ll be able to sell it for a profit. Buy a home because you think that the income from your home will provide a good return on your investment. Don’t try to time the stock market or the real estate market. Just keep your eye on the home dividends.
We’re convinced that real estate continues to be one of the most appealing ways for you to achieve financial security, and, along the way, to enjoy—even love—your investment in ways that you could never love stocks, bonds, and bank accounts. You don’t need to be a home flipper or a landlord to be a wise and successful real estate investor. You don’t have to pay unconscionable sums to motivational speakers who will try to persuade you to risk your life savings on speculative real estate gambles. You can simply be a sensible homeowner who enjoys living in a home and the financial rewards that go with homeownership.
Build up equity in your home and invest your home dividends wisely. If you do, your home will be the best investment you will ever make.