How Firm a foundation?

The example has been used in the past—as a way of illustrating the need for a strong investment foundation—of the Biblical story of the wise man who built his house upon solid rock. The rain came down, the streams rose, and the winds blew and beat against that house, but it did not fall because it had a firm foundation. Conversely, the foolish man built his house on sand. When the rain came, the streams rose, and the winds blew and beat against that house, it fell with a great crash.

As the country’s fascination with real estate continues to rise, the story could be used more directly to warn those putting their investment dollars in the housing market to be sure their money is sitting on a firm foundation (particularly given the regional nature of such an investment). The numbers serve as a vivid illustration of the recent real-estate frenzy.

• 23% of all home purchases in 2004 were made for investment purposes; 36% of second homes purchased were investments.

• 27 communities saw average home prices increase more than 20% in 2004. In 13 communities, prices have doubled in the past 5 years.

• 177 real estate investment clubs now exist, a fourfold increase over the past three years.

• Home resale prices rose more than 15% during the 12-month period ending April 2005, the sharpest one-year rise since 1980.

• Average home prices rose 12.5% between the first quarter of 2004 and the first quarter of 2005. During the past 5 years, prices have increased more than 50%.

Adding to the craze is the fact that banks and mortgage companies are taking advantage of the trend by offering more adjustable rate mortgages and interest-only loans, making it easier to buy a home quickly, with less (or no) money down and many times, get more house than can really be afforded.

So why not join the crowd and put money you currently have in the market into real estate instead? It certainly seems as though people buying houses are making more money more quickly than those buying stocks. The truth is, they are. But the difference is the foundation upon which they’re building. The man with the house on the sand, if he were building today, would no doubt be proud of the extra money he was putting in his pocket by not building on rock or another sturdy foundation. However, over time, as the recent landslides in California taught us, things change: What once was sure and steady became shifty and shaky.

You’ve no doubt heard mention or speculation that we’re in the middle of a housing bubble. The term "bubble" is used in reference to something, in this case the housing market, that grows too large for the economy and the market to sustain it. Ultimately, the bubble pops. The ground shifts. However you want to put it, it’s not the strong foundation investors should be building on with most of their investment dollars.

For something that has remained sure and steady throughout history, invest in the market, the whole market (using a Market Return™ approach), and you won’t have to watch for storm clouds—or landslides—on the horizon.

 

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