I’ve been working with clients for over 22 years, and one issue that has been popping up more and more is residential real estate. Naturally, some clients are merely seeking advice about one of the most significant financial decisions of their lives. For them, purchasing a home is about finding a place to put down roots and raise a family.
For others, however, the motivations are a bit different – they believe this sector could give a boost to their portfolio of investments. And on the surface, it’s easy to see why.
For one, with interest rates remaining historically low and inventory constrained, home prices in some of the hottest markets around the country have spiked and are showing few signs of slowing down. Also, there’s the unsettled equity market environment. Yes, indexes are still flirting with record highs, but valuations are full and corporate earnings growth has slowed, with even stalwarts like Apple showing cracks in recent quarters. These dual trends lead some to believe that residential real estate could be a good alternative or, at the very least, a complement to equities.
Whether you’re looking for an investment opportunity or just a place to live, there are some very important variables about buying and selling a home that most real estate agents won’t tell you. Consider the following:
1. Your home is not an investment. Let’s dispel this myth now: A home is a place to live, not an investment. Without question, healthy home ownership rates support the overall economy, driving home equity lending and, thus, more spending by the average consumer. That tends to help large companies like Disney (family vacations) and Home Depot (home improvements), but the notion that home ownership produces long-term investment gains is mostly a fallacy. What you’re essentially buying is a piece of land, because the structure is a depreciating asset that over the course of a few decades could require hundreds of thousands of dollars in upgrades and repairs. So even if you bought your home today for $250,000 and sell it 20 years from now for $500,000, the return won’t be nearly as significant as you might think due to upkeep costs and inflation. Real estate investors rarely factor in such considerations. On the contrary, they make it seem like owning a home is the equivalent of being an early buy-and-hold investor in Facebook or Google. It’s much harder than most people realize to generate meaningful returns on residential real estate.
2. Sale contracts do not offer ironclad protections. Every house, unless it’s brand new, has material defects (Sometimes even brand new ones do too!). And while such defects are typically disclosed and reflected in the sale price, the standard language included in most real estate contracts gives buyers far too much leeway to use the mediation process to pry more money out of sellers well after deals have been finalized. To be clear, buyers have every right to perform the proper due diligence to ensure they don’t end up with a lemon. But at some point, the concept of caveat emptor has to reign. If you are selling a home, have a real estate lawyer add an addendum to the purchase contract that will protect you against future attempts to claw back money. Otherwise, it could turn into a never-ending legal battle and financial drain, and in those instances only the lawyers win.
3. Home inspectors are not always impartial. Most home inspections fail to reflect the actual cost of needed repairs. The reason is simple: Many real estate agents don’t want those costs known. A thorough review of a depreciating asset, like an existing home, will inevitably reveal flaws – which, of course, could kill or delay a sale. That’s why real estate agents use home inspectors who are incentivized not to make their jobs more challenging. Because of this, buyers should hire not only their own home inspector but also a contractor to provide an estimate for everything that appears in the inspection report. Often, real estate agents will offer buyers a seemingly generous lump sum to cover any required maintenance, but it’s almost never enough.
4. Commissions are negotiable. In today’s landscape, where some attractive listings receive multiple cash offers almost instantly, it borders on insanity for a seller to pay a real estate agent a commission of 5 – 6%. The median sales price for a home in Los Angeles is approaching $700,000, according to Trulia. That means a real estate agent’s take could be as high as $40,000. While I’m not trying to put anyone out of business, there seems to be a fundamental disconnect between that level of compensation and the amount of work required to close a sale – especially given that online portals such as Zillow are making this process much easier than ever before. The problem is that the Multiple Listing Service (MLS) system, which ostensibly is intended to make real estate transactions more efficient for all the relevant parties, is essentially a monopoly. Indeed, it supports agents who use the same outdated compensation structure and freezes out services like Redfin that charge discounted rates like. I negotiated down commissions when I sold my home recently, and so should you.
5. You may hate your neighbors. Everyone knows that the three most important things about real estate are location, location, location. But what about neighbors, neighbors, neighbors? I’ve been through the home-buying process a few times, and never has a real estate agent said to me, ‘Hey, take a look around and meet your potential neighbors.’ Why? Because they knew I may not have liked what I found. Neighbors are an especially important consideration if you are thinking about buying a condo. Those walls can be paper thin. It would be disastrous to plow a bunch of money into a place only to have an antagonistic relationship with someone who is only feet away from you. Spend some time to figure out who will be living next door. And while you are at it, find out if they have any plans for construction. That’s another headache you’ll want to avoid. Remember, peace of mind is part of the return.
The fundamental conflicts of interest that are inherent to buying and selling a home are pretty clear. That’s not to say that all real estate agents are bad. They’re not. Unlike the regulatory requirements in my world, however, real estate agents have no legal obligation to do what is best for their clients. They are not fiduciaries.
Work with an agent who is experienced and has a good track record. That will give you the best chance to find a great place to live. With some luck and good timing, you might make some money in the process. But don’t count on it.
By Ross Gerber
Ross Gerber is CEO and president of Santa Monica, Calif-based Gerber Kawasaki, a registered investment advisor with approximately $460 million in assets under advisement. Clients and employees of Gerber Kawasaki own positions in Apple, Disney, Google, Facebook and Home Depot.