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Strategies & Market Trends : The Residential Real Estate Crash Index
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To: Paul Senior who wrote (5718)10/1/2002 1:24:10 AM
From: Elroy JetsonRead Replies (2) of 306849
 
Why do many people not correctly perceive their returns on real estate?

1.) Real estate prices are not listed every day in the newspaper like stocks. This permits each property owner a great deal of fantasy regarding the actual value of their property. It also hides the volatility of real estate prices. In Los Angeles prices typically peak in July and reach lows in March. Situations like Sept 11 can cause sudden declines of 10% to 15% in real estate value, but because they're not listed daily most don't realize it.

2.) When it comes time to sell a property, very, very few people could give you an accurate total of: their maintenance costs; taxes; capital improvements; mortgage and insurance costs; and in the case of a rental property, the total rents over their period of ownership. People's estimates of the tax benefits routinely exceed their true savings by a wide margin. People do not easily recall the unpleasant and exaggerate the delightful.

3.) People don't understand the concept of compounding. If I make a 100% gain over a ten year period some would think this is a 10% return per year. Compounded it is a 7.18% return. Likewise many don't understand the time value of money. This is why many routinely pay big money (points) up front to "get a lower mortgage rate". Where the costs fall is significant.

4.) People don't consider opportunity costs. A corollary to #3, the 28.9% gain over 12 years seems significant, especially in dollar terms until compounding is taken into account. Comparison with alternate investments is too much for most to bear. It doesn't seem real to most people that over this same 12 year period they could have made 178.8% on a US treasury bond, plus as it turns out an additional 45% in capital gains on the face value of the bond as interest rates decline over the past 12 years.

5.) Sugar plums. Before the investment is made people can dream lots of sugar plum fanatasies about how lucrative the real estate investment will be. Many real estate agents, like your local crack dealer, will feed these delusions with incorrect comparisons and fuzzy logic. THe whole key is to keep people happy, not informed.
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