You've been misled on real estate. Real returns aren't great. But here's when real estate makes financial sense.

The data is in. Real estate is terrible at making you rich.

Real prices of US real estate increased by 48% between 1890 and 2014. That's an average of 0.3% per year. That's the net gain after accounting for inflation, taxes, agency fees, and renovation costs. That's not great.

And that's not my research. That's from Robert Shiller, Nobel prize winner in economics, in his data-packed book Irrational Exuberance (which I highly recommend by the way).

This may come as a shock to many of you, as it did to me. After all, we all have friends, colleagues, and family members buying real estate. Some do it to avoid paying rent. Others do it to make a profit. And some do it for rental income.

It seems like wherever you look, people are talking about real estate. People think it's safe and profitable. But the reality doesn't match this perspective. In this article, we'll breakdown why people have this misconception of real estate and when it makes sense to incorporate real estate into your financial plan.

Misconceptions

Whether it's peer-pressure from family or friends, it seems like everybody is pushing you to buy a home.

“Don't throw money away on rent”.

“Don't pay your landlord's mortgage”.

These are common phrases echoed in society, but most are pushed by banks and real estate agents that have an inherent financial interest in the matter. So why do so many people believe it?

For one, it's lazy financial math.

I knew someone who ran around town telling everyone how amazing real estate is. He insisted on it because he “tripled his money" on his home. You see, he bought his home for $300,000 and sold it for $900,000. In his mind he tripled his money. But he didn't do the math properly, and conveniently forgot all of the expenses associated to it.

For starters, he didn't buy his house with cash. He got a bank loan. Even if he got a good interest rate of 3.8% (he definetely didn't), it means his $300,000 house actually cost him $503,000 ($300,000 for the house + $203,000 in interest over 30 years). This means that he didn't triple his money. He only made 78% over 30 years. I say “only” because it averages to 2.6% in annual gains (which is about the same as historical inflation). So if anything, he's breaking even.

Unfortunately, he's not. Let's not forget about the agency fees, taxes, and renovation costs paid over time and at the time of sale.

Calculate everything together and this person was probably losing money. Yet he was running around town insisting he tripled his money. When this financial propaganda runs rampant through society, it's easy to see why people are duped.

That said, it doesn't mean he got a bad deal. Sure, he has a net loss from the property, but at least he didn't have to pay rent for 30 years, and that's still a financial win (it might even be better than renting).

Another reason for the misconception around real estate is that people tend to focus on the winners. We hear about how amazing the real estate returns have been in California, New York, or Boston, so we assume it's the same everywhere. It's not. In fact, the net return of real estate in Spain and Italy was negative over the last decade. Talk to anyone in these European villages "left behind" by urbanization, and you'll quickly realize that not all have been lucky. That's why in rural Italy, you can find properties for sale for 1 euro (I'm not kidding, look it up! There are hundreds of them).

This cherry-picking on the winners is harmful and misleading. Imagine if I tried to sell you tech stocks because Tesla delivered 10x returns in 3 years. You'd laugh me out the door and call me delusional. You'd point out how this is the exception to the rule and how the average market hasn't performed that well. You'd be right. Yet this exact cherry picking is happening with real estate.

Buying a house is often a good financial decision, but it's rarely a great investment and here's why.

2. When to buy real estate

The data is clear: on average real estate isn't great for capital appreciation. Don't expect to get rich by buying and selling your house. But that doesn't mean it's all bad.

That's because real estate can alleviate a different problem in personal finance: cash flow.

You see, the goal of any financial plan is not to 10x your money (it will, but that's not the goal). The goal is not capital appreciation. Because even if you have a ton of money, you can still run out of money.

That's why the goal of any financial plan is cashflow. The ability to deliver consistent passive income over time. That's income you earn in your sleep. One day, this income will be enough to cover your expenses and you'll be financially independent. Some people also call this retirement.

That's why financial advisors insist on investing your money in the stock market. We invest in stocks not because it delivers good returns, but because you can consistently withdraw a fixed amount of money from your portfolio and, in theory, never run out of money. It's a proven and back-tested method to get passive income.

Here are two ways where real estate makes financial sense:

First, real estate can save you money. Buying your own home may actually cost you less than renting. Because eventually, you'd have paid off your mortgage, and won't have to pay any rent. It's not passive income, but it will reduce your monthly expenses in 30 years, right about the time you retire. Right when you need it.

One of my favorite sayings in personal finance is “a penny saved is a penny earned”.

Buying your own home can save you money over the long term (compared to the alternative of renting) AND can lower your expenses once your mortgage is paid off. This means you need less passive income. It alleviates your cashflow problem of running out of money.

So don't expect to get rich with real estate. But do expect to optimize your cashflow with it.

Second, real estate can bring you rental income. You can buy an apartment, rent it out, and receive rental income. It won't be amazing income (the average rental yield is about 4% in Europe (and less than 3% in most of Germany)) but it's still something. After accounting for taxes, you really don't have much left and it makes you wonder if it's worth your time. After all, the opportunity cost of buying a rental property is not investing in stock market index funds, which historically delivered far better returns.

But I still think real estate has a place in your portfolio, but not for the reason you're thinking of.

You see, the top purpose of a financial plan is financial security; the confidence of knowing everything will be alright no matter what happens. This is mostly achieved through a portfolio of stocks and bonds, but can be reinforced through real estate. Real estate isn't too correlated with financial markets so it can add a bit more stability to your portfolio. This can help you weather out crises. But the biggest reason is this:

Foreign real estate is protection from your government, something that stocks & bonds don't do.

There's a reason the Russian and Chinese citizens are buying tons of property in Dubai and Singapore. It's not so much about rental yield (it's actually pretty good). It's about security. The security of knowing that your government can't seize your money.

This applies to Westerners too. And this isn't a conspiracy theory. Following the 2008 financial crisis, and given how close we came to financial Armageddon, France has enacted laws which allow the governments to freeze your life insurance accounts. This means, if the government triggers it, you can't withdraw any money from it. This is done to insure the solvency of insurance providers in times of severe crisis. And over half of the French adults have a life insurance contract.

We point fingers at Russia and it's capital restrictions on its citizens, but the exact same thing could happen to us. It's already written law.

Now you may think that this is fine because financial crises don't happen very often. But here's the thing: a financial crisis is precisely the moment you need access to your money. That's when it matters most. Freezing these funds defeats the purpose.

It's like if you could only use your air conditioning in the winter; it defeats the purpose.

And that's why foreign real estate is important. It's another line of defense in your financial plan. Should all else fails, you have assets in jurisdictions that can't be touched. This gives you time to sell them, and live off the proceeds while waiting for the situation to sort itself out.

In that sense, foreign real estate isn't just an extra line of defense, it's a lifeline.

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