Pundits have recently been slapping the “bubble” label on the real estate market. Should you be worried? Creative Planning’s Peter Mallouk and Jonathan Clements discuss how real estate is part consumption and part investment, and the roles it can play within your overall financial picture. Also, Peter describes the motivation behind Creative Planning’s new financial education center, Pathway Financial Education.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education for Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Today’s topic: real estate. The word “bubble,” which pundits seem to apply to pretty much everything these days; it’s now getting slapped on the real estate market. But should we be worried? According to the National Association of Realtors, the median sale price of an existing single-family home climbed almost 24% over the 12 months through May to a record high of $350,000. Affordability, which takes into account things like the typical home price, typical family income, and average 30-year mortgage rate has deteriorated sharply this year. On the other hand, affordability is still substantially better than it was in the early 1990s or at the peak of the 2006 housing bubble, thanks in large part to today’s low, low mortgage rates.
Moreover, according to S&P data, while home prices are up 86% since the market bottomed in 2012, that is the housing market, prices are up just 35% since the 2006 housing market peak. That 35% is a tiny gain for a 15-year period. So, what’s your take, Peter? Are we in a bubble?
Peter Mallouk: So, I don’t think it’s a bubble. I think the reality is that every time we get a new generation since the Baby Boomers, we get this narrative that this new generation isn’t going to live in houses and they’re just going to live in the cities and they’re not going to have families and all this stuff, and it’s just always wrong, always wrong. And I don’t know how this narrative gets going and gained steam and the media feeds it. And it is true that young people have kids later now. And I do believe that 30 is the new 21 in many different ways, but the reality is people eventually want a little bit of space and a lot of people get married and have kids and want to move out of the city. And so, we had this very big pent-up demand for millennials and soon Generation X of needing housing.
And there were a lot of people in real estate that saw that disconnect. I have a few clients that are developers that said, “Hey, look, there’s not enough houses for these people whenever they come around.” So I think we have had a little bit of that. Second, ‘08 or ‘09 might seem very distant to some people, but it was not that long ago to people that were in the real estate market. This aggressive building kind of really came to a dead halt. I mean, it took a long time for construction to come back after ‘08, ‘09, for lenders to come back after ‘08, ‘09. And you started to see steady build-outs, but you did not see a lot of supply. So, there wasn’t really room for a sudden shock.
And you layer on top of that what happened during the pandemic where people suddenly all of a sudden wanted to look at water or some people wanted to be in a gated community, or some people just wanted to be in a house that had more than one room, and didn’t want to be trapped in a small space, and wanted a yard and saw that they could live there, and this ability to work remotely and not have to be one building away from your office in downtown San Francisco, all of that stuff also encouraged people, drove demand in the housing market. So, you have pieces of this that are shocks to the system that will be absorbed and part of it’s generational.
Jonathan: But in the end here, we don’t buy the national housing market. We buy one home. If a couple came to you today, Peter, and said, “Should I be buying a home today?” What would you say? What would you ask them? What are the criteria they should be considering?
Peter: The first thing I talk to people about is you should have a home if you want a home, right? A home, people say it’s a good investment, or it’s not a good investment. It’s not a good investment. So, if you’re building your net worth statement, you have to look at your net worth statement. All assets are not created equal. So, there are assets that bring money to you. Those are great assets from an investment standpoint and from a building wealth standpoint. There are assets that take money away from you. Or, if we’re lucky, we may break even. In the former, you would have real estate like a rental home. You buy a home, you rent it to other people. That’s an asset that brings money to you, or you rent a duplex or an apartment complex or an office building. If you buy a house, the house takes money away from you.
I have a house. I love my house. I don’t buy it because I think it’s a great investment. Now, when I bought my house, is it worth more today? I’ll use an example. I have a small condo that I bought for 200 and something thousand dollars in the ‘08, ‘09 crisis. Today, maybe it’s worth $400,000. Somebody might say, “Well, Peter, that works great. You made money.” Well, it went up about a hundred or so thousand dollars, but I’ve paid more than that in taxes, maintenance, and insurance over that time. My net return is negative. Had I just put my money in the S&P 500 at the same time, my $300,000 would be well over a million dollars today. So, by putting it in something that takes money away from me, it was not a great investment. But, I got to enjoy it.
So, the way to look at a home is the same way to look at in many ways as a car, that that home is something for you to enjoy, that you need, you need a place to live. You need a car to drive, but we can’t look at this and say, this is a fantastic investment even if we expect it to go up.
Now today, should somebody buy a home? Well, you have the advantage of very low rates. And if you’re smart, you get a fixed rate. And even if the housing market’s a little high, maybe it goes higher. But even if it’s high, if you’ve got a fixed rate and we’re in this home for 15 to 30 years, it’s going to work out. Now, to your point, we buy one home. We don’t buy the housing market. So, from a macro standpoint, which means looking at everything, low interest rates, keeping that fixed, buying a home, probably going to work out nationally. Now where it is, different story, right? There are different pockets. And so, if you’re overpaying for a home in a small town where you’re the only doctor in that town, well, that’s problematic. You’re probably never going to get your money back. If you’re buying it in a town that has net inflow of population, this is probably going to work out for you over the long run. I wouldn’t get hung up on where the housing market is day to day.
Jonathan: So, go back to your point, Peter, every home is really part consumption and part investment. And the biggest part is the consumption part. So, we all need to live somewhere and if we didn’t live somewhere, we’d have to rent. So essentially when we buy a home, we’re renting it to ourselves. We consume this imputed rent. And unfortunately, when you buy a piece of property for your own use, the biggest part of the return to you is that imputed rent. It’s a nice thing to have. It’s great to live in your own home, but it’s immediately consumed. So, as you put it, it is taking money away from you.
Peter: Yeah. I mean, this is an excellent distinction and I’m glad you bring this up because I don’t think I was perfectly clear about it. There are people who go, I’m going to buy a second home instead of a rental property or instead of stocks or instead of private equity or whatever. That’s not a real good comparison if the second home is for personal use, the investments will probably do better. Now, if you’re comparing, I need to live somewhere, so I’ve got to buy or rent. Yes. You know, buying better than renting. So, when I talk about it not being an investment, I mean, if somebody buys something going, “I think this is something that’s the same thing as buying the stock market or publicly traded real estate.” That’s not the same thing there, but certainly it has an investment component that should turn out better for almost all of us than renting.
Jonathan: Right. I think when I talk to people about the virtues of owning real estate, I don’t focus on the price appreciation, which we know historically has been de minimis. Housing prices historically worsen about one percentage point a year, faster than inflation.
Instead, what I say to people is there are really two great advantages. One is if you buy a house, you lock in your housing costs. Your mortgage payment on a fixed rate mortgage this year, it’s going to be the same next year and the year after that. You may pay a little bit more in homeowners insurance, a little bit more in property taxes each year. But in terms of that core mortgage payment, it’s going to stay the same. You’ve locked in your housing costs. And the other thing is with every one of those mortgage payments, you build home equity. You pay down the principal balance. And after 30 years, you have yourself a valuable asset, which may turn into a little bit of extra cash. Your nest egg, if you retire and downsize. Or, if you decide to go that route, tap into using a reverse mortgage.
So, it’s really the forced savings and locking your housing costs, the two big advantages of buying your own home. The other thing we haven’t mentioned here, which I think is important, is you do also need to think about your time horizon. And the best scenario, you should have at least a seven-year holding period if you’re going to buy a house because the costs of buying, owning and selling real estate is so expensive that if you don’t have that sort of holding period, it’s very easy to come away with less than you put into the house initially and over the years. So just one last question on this before we move on. You mentioned rental properties, Peter. I mean, for many everyday Americans buying rental properties and becoming a landlord, it has been a road to riches. I mean, it’s not my choice. I don’t want to deal with tenants, but a lot of people do do it. What do you think of that as a strategy?
Peter: Well, I think it’s a very broad space, so there’s where you can invest with a third party who’s managing properties and dealing with everything. You have a lower expected return cause you pay all those costs. You don’t deal with the hassles you were just talking about. I think what most people do is what you’re talking about. They buy a home or a duplex or a small apartment complex or whatever, and they put it in a limited liability company and they go lease the space out and they deal with the tenants and the plumber calling and the turnover and so on. And it’s kind of like a mini business. And it is a nice side hustle in terms of having another income source that’s coming to you because you’re adding something to your balance sheet, to your net worth statement that brings money to you.
And so in exchange for dealing with finding a location, getting it leased, dealing with the problems and all of those things, we expect that property to appreciate a little bit over time. But in the meantime, the tenants are paying the mortgage for you and building your net worth for you. There’s ways to do that passively through real estate investments that are publicly traded. And if you’re willing to get your hands dirty, spend a little bit of time on this kind of thing – it’s definitely worked out for people. Now, what I’ve noticed, there’s a lot of people that are into that. They’re on the sidelines now. It’s very hard in this market to go buy a home and rent it out because home prices have soared so much, whereas the cost of renting has not.
So, whereas before you could go buy a home and you could rent it out and you could get hopefully your high-single-digit rate of return or, if things are great, you get a double-digit rate of return. Now, you go buy that home and you rent it at market rate. You can’t make it cash flow, at least in most markets. And so you’ve really seen the investment side of this dry up, while this massive residential demand has started to flood the marketplace.
Jonathan: So Peter, before we get to our usual tip of the month, I want to have a quick digression here. Credit Planning a few months ago launched a financial education effort in Kansas City called Pathway Financial Education. There are a lot of folks focused on financial education these days. What was your motivation, Peter, in launching Pathway? And what is it doing that you feel is somewhat different from these other efforts that are out there?
Peter: I think when we were looking at what was going on through the pandemic, all the social issues and political issues, we said, “What can we do that I think universally everyone agrees would be positive”, right? That we could make a difference here. And as an organization at Creative Planning going all the way back to 2004, our charitable giving has been centered on the opposite of our client base. So, our client base is doing pretty well, right? It’s top 1% or 10%. And we have always focused our giving when we have our events as a firm that require our time or the millions of dollars we’ve given away a year, it’s always been focused on the bottom 10% of the people that need a break that are trying to pull themselves out of poverty, break the cycle of poverty.
But what we’d never done is financial education. And here we are with all of these lawyers, CPAs, financial planners, and money managers. That’s what we all do for a living is help people with their finances. We said, “How do we take these resources and direct it to that community?” There’s a district in Kansas City. It’s the 18th and Vine District is a historical jazz district. Unfortunately, an extremely high crime area that’s blighted. We’re trying to turn it around here in the city. And I have confidence that that’s going to happen.
We secured a location right on the corner there. We raised the money, I think in 24 hours. I mean, people want to help. If they hear a good idea, people want to help. And we put our team in there to do the education and we’re focused on three groups. One group is people that want to start businesses or are business owners that are in that community. The other was adults that want education around finance, debt management, and so on. And the third is teenagers and young adults trying to get financial education. We just completed our first course, which is I think a 14-week course for business owners. I got to teach that last course. It was absolutely incredible to see just a room full of people that are trying to break that cycle and make a change. And so I’m really proud of everybody at Creative Planning that put together the education, that has gone up there to teach. Ultimately, we want to get this stabilized and turn over to the community where people from all different law firms, financial firms, and so on, go help provide the education.
Hopefully, we can replicate it in other cities, but it’s off to a great start and inspiring start. I think the people here that have been involved in it are getting just as much out of it as the people that we’re trying to help.
Jonathan: So, just a quick question on this. I just know from my own writing efforts, when you’re writing for what is a pretty affluent community, and then you turn around and write for people who are struggling financially, it’s a totally different conversation. So, if you take your high-end estate planning lawyers and your financial planners are used to dealing with people with seven figure portfolios, and you put them in a classroom with people who are trying to get their lives going in the right direction, it must be a bit of a struggle for them to figure out what level to have that conversation at and what they should be saying.
Peter: It is. And you know what? I’ll tell you this, it’s harder to advise people that don’t have money. So, if you’ve got somebody that goes, “Hey, I’ve got a college degree or I’ve got a business and I’m making $150,000 a year and I’ve got a couple million dollars.” I mean, look, what we do all day long, you have somebody who says, “Look, I’m trying to pay off my student loans. I’m trying to break into a job. How do I switch from this apartment to that apartment? And how do I get out of this credit card debt?” I mean, this is way more complicated. And I think that it’s people don’t appreciate that with money. They assume, “Oh, I have more money. My situation’s more complicated.” No, it’s not. It gets easier the more money that you have to start to do this kind of planning.
So, this is something that we were aware of going in. And we really made sure that everything that we were doing was relatable and impactful. So as an example, with our clients, we might be talking about margin loans and pledged asset loans and so on. With this community, we brought in micro lenders. And said, “Hey, how do we get you a really small loan so you can go from one barbershop to two,” which was a real example there. And so we’re really trying to find out, well, how do we really help these people in a way that can make a difference for them? We want our advice to be actionable. And so, that’s why we started with business owners. We really wanted to have time one-on-one to really help them move to the next level, instead of just have a course and be done with it. So there’s a lot of one-on-one that’s happening afterwards to make sure that we can really customize this to their situation.
Jonathan: All right, Peter. Well, it’s that time of the month, your tip for the month ahead. What would you suggest that people think about for July?
Peter: Look at the debt side of your balance sheet, of your net worth statement. And if you’ve got variable loans that can move up and down with interest rates, try to get all of those over to fixed loans where we’re going to be locked in at the same rate. You’ve bought a house, interest rates are really low. You’re going to live there for 20 years. Lock in that really low rate. Be very careful about the amount of leverage that you have. People really feel like we’re living in a risk-free world. Again, leverage is basically debt. And so you want there to be significantly more assets than the money that you’re borrowing. A lot of people are borrowing more money against their investment accounts, more money against their real estate. And this is really one of the number one or two causes of bankruptcies is having a lot of leverage. And then when the net worth drops, these debts get called in and you find yourself in a hard moment.
We are not immune from recessions. And you know, one wonderful thing about being American is we have such short memories. So it’s an incredible coping mechanism, but with investing, it’s not the greatest thing in the world. There will be another recession. There’ll be another bear market. Your account is going to go down. The real estate property market eventually will go down. It will. It’s called an economic cycle for a reason. There’s an expansion followed by a contraction, then rinse and repeat. And so make sure you don’t let the leverage get carried away. The good times may roll, but they won’t roll for forever.
Jonathan: So, for my tip of the month, Peter, one of my pet peeves is that people don’t talk enough about money, and particularly families don’t talk enough about money. If you have children, if you have parents, we are each other’s greatest asset and each other’s greatest liability, and you want to make the most of that relationship. So, one thing I would say to folks, kids are getting out of school now. There’s a little break in the action. This is a great time to have family conversations about money and particularly about paying for college. How much can you afford to pay towards your kids’ college education? What should they reasonably think about going? What sort of debt can they take on given the sort of careers they’re talking about? And this is a conversation, not just that you should be having with your kids, but also you might be wanting to have with your parents if they’re going to be able to contribute financially.
So, take the time, have that family conversation about money and about college funding. And that way, when the kids start to think about college, and you should be having this conversation when they’re early in their teenage years on an ongoing basis, not just before they become seniors. Because at that point, they may already have colleges in mind they want to go to, that they’re going to discover as well through this conversation are unaffordable. So have this ongoing conversation about money, about how much you can afford to pay for college. Preferably start it when they’re 12, 13 so that their expectations are well set by the time they get to that senior year in high school.
Peter: Good advice.
Jonathan: So that’s it for this month, Peter. This is Jonathan Clements, Director of Financial Education. With me is Peter Mallouk, President of the firm. And we are Down the Middle.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed