Don't Bet Your Retirement on Real Estate Investment

Conventional wisdom says you can't go wrong with real estate as a long-term investment. But a high-interest savings account might give you a better return with lower risk.

It's a common bit of conventional wisdom that investing in real estate won't steer you wrong over the long term. The housing bubble of the early 2000s aside, home prices do tend to gradually and steadily rise. Buy a house now, sell it in 40 years, and you'd expect to get your money back plus a tidy profit.

So real estate must be a great place to put a big chunk of your retirement savings, right? Wrong. As it turns out, a high interest savings account might give you a better long-term rate of return than a real estate investment, with far fewer hassles along the way.

Sleep at home, invest in the stock market

As the New York Times put it, smart investors sleep at home and invest in the stock market. Yes, some homeowners who sell their houses decades after buying them often walk away with a lot of cash, perhaps even hundreds of thousands of dollars.

But the return on their initial investment, when adjusted for inflation, is a lot less than the average return on a similar investment in stocks. This was true in 2005, at the height of the real estate bubble, and it is certainly true now in the wake of the real estate bust.

Owning your home has a lot of advantages: it gives you a substantial asset, security and stability in your residence, and the freedom to paint the walls any color you like. Homeownership does pay off for most people. Owning a home establishes you as credit-worthy for other ventures, and as you pay down your mortgage your home equity will become a tidy nest egg over time.

Overall, most financial experts advise eventually buying your primary residence. The New York Times says buying is better than renting if you're going to stay in one place longer than six years.

Whether buying costs more or less than renting a comparable apartment varies year to year depending on where you live and what the real estate market is doing. But over time, you will earn a small return on the investment you make in your home. You'll also enjoy the intangible benefits of homeownership, like pride in your home and the security of knowing you always have somewhere to hang your hat.

The true cost of a real estate investment

Owning a home has costs, too, as any homeowner can tell you. You need to pay for upkeep and renovations yourself. The property tax bills arrive with your name on them, as do all the utilities. The Wall Street Journal estimates that real estate often costs 2 percent or more a year in condo fees, insurance, maintenance and taxes. That's a pretty big chunk of your eventual returns on the money you put in.

Unless you're the rare person who can buy your real estate in cash, you need to also factor in the cost of mortgage interest. Add in the thousands of dollars in realtor fees you pay to buy or sell a house, and your investment returns start to vanish pretty rapidly.

That's before you adjust your profits for inflation. The forces that push home prices up are the same ones that increase your salary and the cost of a gallon of milk. Everything costs more, thanks to inflation. The dollars you walk away with from your real estate sale are worth less than the dollars you used to make your down payment.

The real return on real estate

Once you've made the necessary adjustments to compare apples to apples in a real estate deal, the profits turn out to be pretty modest. It's better than stashing cash in your mattress, but not by much. There arebetter ways to save money.

Citing the Case-Shiller index of ten major cities, the Wall Street Journal reports that real estate has produced an average real return of just 1.5 percent since 1987. Inflation-protected government bonds routinely beat that figure, as do many high-interest savings accounts. CD rates, money market accounts are also low-risk, long-term success stories.

That's a time period which includes the biggest real estate boom in U.S. history. Think a longer picture would favor real estate more? Think again. According to J.D. Roth of GetRichSlowly.org, in his book Your Money: The Missing Manual, which compares the growth of housing prices to stock prices over the last 100 years, the real return on real estate has never been better than 2 percent, while stocks offer long-term returns around 10 percent.

Home ownership is still usually a worthwhile investment for your own home. But before you succumb to the temptation to buy a second home as an investment, take a good look at the numbers. Odds are, depending on your personal situation and tolerance for risk, you're betting off putting your money in the stock market, or a savings account. You'll be spared the headaches and expense of property management and building maintenance, and you may even get a better rate of return on your investment.

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