Why Ramit is wrong about buying a house

8:53 AM James 0 Comments

Ramit Sethi is one of the voices of the millennial generation. He sounds more like a cocky guy you’d pound shots with at a party rather than a buttoned-up financial guru or a career coach. It’s the fact that he doesn’t sound like your traditional financial advisor that makes him appealing. Instead, he rebels against anything that sounds like it would come from your parents. (Frugality? Don’t waste your time. Focus on earning more!) Ramit also urges readers to learn the facts about so-called Invisible Scripts - standard life advice that may be obsolete - and do what’s right for you.


So I’m surprised (and a bit disappointed) that he’s so religiously against owning real estate. He may be right about a lot of things, but in this area, he’s substantially wrong.
Here’s a breakdown of one of his blogs on the subject, Surprising Real Estate Investing Myths. Here's the video:


The video's main points are:
  1. Return is zero after inflation
  2. When you own, you pay for repairs, and a $290k home becomes a $1M home
  3. There are 50% in hidden monthly costs in addition to your mortgage payment
  4. Stock market returns decimate real estate returns


Let me address these one by one.


  1. “Return is zero after inflation”


NOPE. just saying it doesn't make it true.


Ramit quotes a study by Shiller of average home values over a 100 year period. This is a super macro view. Forget that home prices started picking up in the 70s with the wider availability of credit. This super macro metric may confirm his anti-real estate bias, but it’s irrelevant for a couple reasons.

Real estate is highly local, and is also cyclical. How is the 100-year metric relevant to us? Is our investment time horizon 100 years? No way. Then why should that be the metric we use to gauge return? We should use metrics that are in line with our own time horizon. Since the typical homeowner owns a home for 6-10 years, and I've been investing in real estate for a little under 5 years, I'm going to choose a time horizon more in line with that. To be clear, real estate is not necessarily a long-term investment. It can be, but the vast majority buy and sell long before the 100 year period. (Most of us will be dead by then.)

The real estate market is also inefficient, meaning that individual investors can still find good deals when they know the areas well and know how to fix up a home. My annualized return on the 3 homes we’ve bought and sold have been 63%, 42%, and 11.5%. Adjusting for inflation, which has been around 1% over the last few years, that’s still about 62%, 40%, and 10.5%, respectively.


  1. “When you own, you pay for repairs, and a $290k home becomes a $1M home”

He’s right - home ownership has significant costs. I found an article on Angie’s List that tallies the total cost of owning a home. For a $300k home, the 30-year cost of ownership is $708k. What that statement fails to take into account is what you’d pay as a renter. I did some calculations myself, and as long as rents are sufficient for landlords to make their monthly payments, renters would pay the exact same amount!


You have to think about this from a landlord’s perspective: they’re going to pass on their costs to the tenant whenever possible, and they usually do. If rent wouldn’t cover my home costs, I’d get out of that business. But the great thing is, it does for me. Even if you’re only “breaking even” (covering your monthly costs with no extra gross profit), the tax savings means you could save $152k over 30 years as a landlord, before even considering the equity you’re building over time, or depreciation. Being able to deduct mortgage interest, maintenance, and repair costs, as well as depreciation, is a pretty sweet deal. (After 30 years, you’d have your home paid off, so you’d actually be $452k ahead of a renter, plus any depreciation savings.)


Don’t want to be a landlord? That’s fine, you’ll still save money - about $68k before accounting for equity increases, and $368k including those.


Don’t have 30 years to wait around? Let’s use a smaller timeframe. On a monthly basis, because of tax savings, you should be profitable. My $300k home example gives $214/month ($2,572/year) net income after taxes the first year. But the good things for landlords is that rents have increased at double the rate of inflation over the last 15 years nationwide - about 2.7% (and in LA, 4-8%). Price in those increases, that you’ll make $252/month ($3,035/year) the next year, increasing roughly $500-600 each year after. Again, this calc ignores equity, which makes this an even better deal for you.


Saying that buying a home costs you more than renting is kind of like saying buying a car costs you more than leasing. That’s pretty easy to refute. Renting / leasing’s advantage isn’t saving money, it’s flexibility. Whether you want or need that flexibility is up to you.


Calculate your own situation using this handy rental property calculator. Take a home you’re interested in. I like looking for homes on Redfin and checking rents on Zillow. See how the numbers come out for you. It only takes a minute.


  1. “There are 50% in hidden monthly costs in addition to your mortgage payment”

You can’t say costs are hidden when they’re listed on Redin. Here’s a breakdown for a $600k home (close to the median in Los Angeles County):
With a 4.5% interest loan, Principal and Interest are $2,432. Property taxes are $635. HOA dues are $300 (for this property). Insurance is $110, for a total of $3,477. In this case, non-”mortgage” component is 42% of the “mortgage” component, but you’re still pricing all the payments into your total monthly payment. Lenders routinely ask if you want to include these in your monthly payment. If the total monthly payment is too high, you know before you even make the offer. That’s hardly a “gotcha” by any stretch of the imagination.


By contrast, for our first primary residence, we got a way better value than when we were renting. We went from $1,750/month for a 1-bedroom to $1,300/month for a 2-bedroom. In our case, buying was a way better value, and gave us a much lower monthly payment.


  1. “Stock market returns decimate real estate returns”


Not the case for me (see my answer to #1). Stocks have done 7-8% year over year, and that’s taxable, so the real pre-tax return is 5-6% year over year, if you think of taxes as a large management fee that the government compels you to pay. We used to benchmark stock market growth at 10% year over year, but we’ve learned in the last decade that it might not be sustainable. On the other hand, my real estate deals have done 11.5-63% year over year. Not even close.


To use Ramit’s words, in the last 5 years, real estate returns have decimated stock market returns.


Now what about the risk factor? Sure, with enough volatility, you can get a high upswing. What about the inherent downswings? My answer is to pay attention to market trends. In real estate, that’s not hard to do. The information is publicly available in the number of transactions, median home prices, time on market, Case-Shiller Index, etc. What’s more, the rate of volatility isn’t fast - it’s slow, because real estate transactions are slow, and reports are relatively low-frequency compared to the instantaneous stock ticker updates. Effectively, that market inefficiency is the equivalent of you having one of the fastest fiber-optic trading computers that Wall Street brokers use to buy at the best prices. Putting in a strong offer quickly is just as effective. If you pay attention to your market, great deals are completely within your grasp.


Dissention Within IWT


The interesting this is, even when you read the blogs on Ramit’s site, IWT, you see conflicting statements. This guest post, The Real Scoop On Real Estate, is a telling example. It starts out by saying “Real estate can be one of the most rewarding investments that you can make”.


Hold on, isn’t that a complete 180 from what Ramit originally said? Yup.


Here are the main points, and I actually agree with all of them.


1. Starting to invest in real estate takes time.
2. Real estate is a very local business.
3. It’s hard to make serious money without serious leverage.
4. Real estate can be very illiquid.
5. Real estate can be real time consuming.
6. You are in control.


My general response to these points is “Yes, of course! Please learn about real estate and your local market. That’s how you become successful.”


Later, the post says "Real estate is a great investment for some and a horrible investment for others. If you think it might be for you, or if you don’t know which category you fall into, continue down the rabbit hole and follow your gut." So while Ramit talks a good game, he’s hedging his bets with this guest blog post.


Things To Remember


Calculations about appreciation are misleading, unless you have 100% equity. If your house goes up 3%/year, and you have 25% equity, your investment goes up 3%/25% = 12%/year. This is basic leverage math. Ramit’s correct that leverage goes both ways - that’s how people get underwater on their mortgages. So do your research and if you feel something’s overvalued, don’t buy it. Also, don’t count on insane amounts of price appreciation.


Remember, Ramit doesn’t invest in real estate, and his target audience probably doesn’t either, so he can get away without using actual investment metrics like IRR, NOI, and cap rate. Make it simple: use an ROI calculation and compare for yourself. I included a rental property calculator I like to use. There are others online. Just search for them.


Ramit is correct that there are fees when buying and selling. Home transaction costs might be 5-7% of the sales price when selling. Hopefully, you’re either selling because you’ve made enough money to offset the fees, either through price appreciation (renovating, flipping, or riding the market up), or rental income. Many people say that in real estate, you make money when you buy, by purchasing at a good price. Keep that in mind, and don’t overpay. Also, look at ways to save taxes when you sell. Two common ways are the 1031 exchange, where you can defer taxes and pay no taxes if you’re selling one home to buy another; and the 2-year rule, where you pay no capital gains tax if you’ve lived in the home for at least 2 years. Hopefully, these will far outweigh any transaction fees you have to pay.


When is real estate worth investing in?
  1. When the market’s not too hot
  2. When you’re willing to own for at least 2 years
  3. When you’re willing to learn about your market


Final Thoughts


Real estate has been good for me. I’m not even that good at it - others are much better - but my wife and I have made 6 figures so far. So have thousands of other people. If you’re looking for a community of people like this, BiggerPockets has tons of tools, content, inspiration, and systems to help you. I’ve only been reading and listening to them casually for a couple months, but I’m enjoying their content and learning a few things along the way.


While Ramit’s opinions on real estate investing are highly suspect, his writings on systems applies to investing too. Ramit’s focused on investing in yourself and starting lifestyle businesses. That’s great! You should always invest in yourself. I have a post about the ROI of my MBA. 4 years after I began, it’s paid off at about 40% per year.


Just keep in mind that your ventures doesn’t have to look like anything Ramit talks about. Real estate hasn’t been good to Ramit, which I’m assuming since he’s never mentioned buying or selling any property. That’s fine for his lifestyle, but remember that it biases him. With his affinity for psychology, he would be aware of this.


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Ramit’s done incredibly well for himself over the last decade. He’s set himself up as an iconoclast - the songbird of a generation, if you will. You can count on him to present his views strongly and unapologetically. He’s all about contradicting traditional advice and letting his unique voice be heard. That’s fine. He says not to blindly follow society’s advice about buying a house. If you agree with his point, you should approach these decisions with critical thinking. Don’t blindly follow his advice here.

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