Buying home can still yield huge return

Nation's housing

January 28, 2001|By KENNETH HARNEY

In what is widely acknowledged to be a slowing economy, what will the house you now own - or plan to buy - be worth at the end of 2001?

Will your invested home equity dollars work as hard for you this year as they did in 2000, when the typical American home appreciated in value by 7 percent to 8 percent, and many did far better?

Will 2000's double-digit, overachiever markets in California, Massachusetts, New York, Colorado and metropolitan Washington be anywhere near as profitable in the coming months?

Put those questions to some of the country's top economists specializing in the housing and mortgage markets and you get surprisingly consistent predictions.

Most of them forecast a moderate decrease in housing appreciation this year, between 4 percent and 6.5 percent nationwide. But they still expect a big year for new and existing-home sales - close to record levels, in fact. And, thanks to low mortgage rates, they believe your home-equity growth will be at least double the rate of inflation this year.

When Freddie Mac economist Frank Nothaft projects 6.5 percent housing value appreciation nationally for 2001, your initial reaction may be, well, that's OK but it's no better than what I'm making on some of my mutual funds, or that certificate of deposit I bought last year. Ditto for Mortgage Bankers Association chief economist Doug Duncan's prediction of 4 percent home appreciation.

My home equity, you might conclude, is yielding a return, but is hardly an outstanding investment performer. But a more accurate way of looking at 6.5 percent - or 4 percent - is your return on the dollars you have invested. In other words: What am I making on the money I have actually sunk into this house, i.e., the down payment I made, the closing costs, commissions, etc.?

For a simplified example, take the case of new-home buyers who put 10 percent down on a $200,000 house. If the house appreciates 6 percent between now and February 2002, it will have a resale value of $212,000. Did the buyers gain 6 percent on their investment? No, the house as a whole gained 6 percent. But on the buyers' out-of-pocket investment of $20,000, they racked up a gain of $12,000 - a 60 percent return.

If the house appreciated another 5 percent in 2002, then buyers effectively would have more than doubled their equity investment in two years, turning $20,000 into more than $42,000 in 24 months.

Now this example doesn't factor in the costs of turning that equity into cash, either through refinancing or a sale. But it does illustrate the basic concept: Don't look at home gains the same way you look at other investments. Your home investment typically is highly leveraged. You put down just a fraction of the value of the asset - 5 percent to 20 percent - but the asset itself produces gains on its total market value.

Leverage can turn relatively small investments into big ones rapidly.

Take the experience of thousands of buyers and owners in nearly 30 major housing markets last year who, according to federal estimates, experienced average gains of 1 percent or more per month. Houses in 16 of those markets appreciated at 15 percent or higher during the year.

What's the return on a leveraged equity investment in a 15 percent market? Say you put down 10 percent on a $300,000 new home in 1999. The property jumped 15 percent in resale value and was worth $345,000 at the end of 2000. Your return on your invested dollars? A stunning 150 percent - a $45,000 increase from a $30,000 investment. Your equity is now $75,000, instead of the $30,000 you started with in 1999.

Compare that with your certificates of deposit or even your dot-com high-fliers at their zenith. Then compare your home equity returns on an after-tax basis. Your home gains are likely to be 100 percent tax-free.

On everything else but retirement funds, you at least pay capital-gains taxes.

So when you hear economic forecasts of a decrease in home appreciation to 4 percent or 5 percent, don't confuse that number with the actual financial benefits you're likely to reap from your home investment.

In a tax-free, leveraged investment setting, 5 percent on a new house isn't modest - it's hot. Plus, it's an investment you get to live in and enjoy, unlike stocks, bonds and dot-coms.

A soft landing at 5 percent? Think of it as a cushy landing.

Kenneth R. Harney is a syndicated columnist. Send letters in care of the Washington Post Writers Group, 1150 15th St. N.W., Washington D.C. 20071.

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