Compared with stocks, a house has advantages

By Tom Kelly

April 15, 2007

This article has been reprinted with the author’s permission.

Purists believe that, by definition, a second home is one bought with the intention of keeping it forever. Anything less – including the plan to sell it one day – makes it an investment, not a second home.

The value of the “second home,” based on purists’ definition, is that it becomes part of the kids’ inheritance and that the owners get to enjoy it – the sunset over the lake, cocktails by the seventh fairway, a breathtaking mountain view just a short walk up the road.

The problem is, most potential shoppers can’t afford to consider only the pleasure component – they are in need of a larger total package, namely an investment.

So how does buying a second home compare to investing in common stocks?

Conventional wisdom still holds that, over time, common stocks offer the best returns. Measuring cash on cash return, this may be true, but when one looks at total return, the picture changes. The ownership of real estate offers four distinct advantages over stocks:

* Real estate prices are less volatile in most areas. As we have seen in the opening years of this century, stocks can move a great deal in both directions. This can make ownership of stock a crapshoot, with profit often dependent on timing.

Someone who cashed out in December 1999 saw huge return. Someone else who waited a year probably lost a great deal. Since then, it’s been up and down.

House prices fluctuate, but to a lesser range. If real estate prices don’t shoot up the way stock prices do in a bull market, real estate markets don’t crash the way stocks do when the bull runs out of steam. In short, it’s a less risky investment.

* Real estate is a leveraged investment. One can own a second home with an equity investment (down payment) of no more than 20%. In fact, there are many programs that let people buy with a lot less.

Most investors can’t do this with stock. They need to pay the entire price of the stock.

Because of this difference, when the price of a stock rises 5%, the investor makes 5% on his or her money. If real estate purchased with 20% down rises by 5% in value, the return is upward of 25%.

* Real estate is tax-advantaged. Any interest incurred for the financing of a second home is deductible from ordinary income for tax purposes. If a second home becomes an investment property, tax can be deferred and sometimes eliminated.

The stock investor, on the other hand, pays capital gains tax and can’t deduct the interest on any debt incurred for the purchase of financial assets.

* And finally, here’s the only return that drives the purists’ camp: An investor can live in real estate. Stock certificates are pretty, with great colors, cool writing and embossed letters. Unfortunately, the stock investor can’t go to sleep in them or stand on them to watch the sunset over the lake, or hold a party for your friends and family in them. They just – hopefully – make money. Real estate provides many kinds of satisfaction that money can’t.

A second home has long-term wealth-building powers. In a nutshell, if the owner thinks a house is good enough to live in and enjoy, someone else will too, and they’ll pay for the privilege to rent it.

The ownership of an investment home, particularly a property the homeowner can personally enjoy, pays dividends on a variety of levels and can be a very profitable road.

Tom Kelly has been a professional journalist for 36 years. He served The Seattle Times for 20 years, many as Real Estate Editor. Tom's weekly real estate column, now being syndicated nationally, is featured in The Los Angeles Times, St. Louis Post Dispatch, Miami Herald, Houston Chronicle, Rocky Mountain News, Louisville Courier, Tacoma News Tribune, Portland Oregonian, Reno Gazette-Journal and dozens of other newspapers. The column typically focuses on residential mortgage and tax options for Baby Boomers and Retirees, providing consumer tips and helpful hints as well as explaining concepts and terms in a friendly, understandable style.   Tom has also co-authored a book called “How a Second Home Can Be Your Best Investment” (McGraw Hill Trade).  For more information, please visit Tom’s website at:  http://www.tomkelly.com