Should Most of Your Wealth Still Be in Real Estate?

One of the most common mistakes I see people make when building wealth is to hang on to what was the best performing asset of the last cycle. Are you doing that with your real estate? Hoping it’s going to come back?

The real estate cycle typically moves in 18 year periods and the last one finished about 4 years ago. Here’s a chart that shows what happened in the bubble and where real estate prices are now – and where they are projected to go. http://bit.ly/l9DBe4 Ouch.

The real estate bubble was so huge because so many people could get easy financing, interest rates stayed low for so long, and many people wanted two or more homes. Since the peak of the bubble, home values have dropped dramatically and there is a lot of extra supply available. We haven’t seen the entire supply come on the market as many homes are still being held by the banks and have not been foreclosed yet.

We are also bottoming in the interest rate cycle, which typically lasts about 30 years. That means interest rates will likely trend higher over the longer term. This will not be good for long-term prices of real estate. Neither will the over-supply. If you have equity and/or positive cash flow, you’re in a better position.

If you are underwater, holding on to real estate hoping it will come back to the price you paid for it, in my opinion, is not a viable strategy unless you have a really, really long time horizon or you simply enjoy living in it.

Your options are:

1. To sell a home (if you have equity).
2. Have a short sale, if the bank will forgive part of your debt (for a definition see http://en.wikipedia.org/wiki/Short_sale_(real_estate))*
3. Let it go to foreclosure (this will negatively impact your credit, but will stop good dollars going after bad).
4. Live in it
5. Hold onto it and hope it comes back

*I recommend you speak to a good real estate attorney before making a decision of #2 or #3.

A short sale will have credit ramifications, but it could be worth your while to move on so you can invest somewhere your money will grow.

Do you want to be like the stockholders of technology stocks after the year 2000, who thought tech stocks were cheap compared to past prices and bought more, and haven’t built wealth for 11 years?

Obviously, this isn’t a decision to take lightly. But if you avoid dealing with the reality of the situation – that 27% of real estate values are below the amount owed – it won’t serve you long-term.

Remember, there are only 3 parts to the wealth building formula: money, time, and interest rate earned.

If you don’t have a lot of money to invest, or a long time to grow it, then you’d best be serious about finding the best investment to grow and compound (your principal and interest earning interest) so that you can afford to retire. The opportunities to grow wealth are excellent right now as long as you’re looking ahead and see the opportunities in this cycle and not those in the rear-view mirror.

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