Real estate myth 2

This is the continuation of a feature inspired by a conversation with an acquaintance who revealed a good deal of ignorance about the real estate profession. I think an educated market benefits everyone, so I intend to debunk as many myths as possible, one myth at a time. I hope you find this information useful. Please feel free to comment!

You'll hear many of these myths at the neighborhood barbecue.

Myth #2 'We made a ton of money on the place'

Has your house been a good investment? To get an answer, many folks simply look at how much they put down on their house, think about how much they might net after paying off the mortgage and then figure out the difference.

But this calculation leaves out all kinds of complicating issues, such as the intervening monthly payments that whittled down your mortgage debt and the home improvements that bolstered your home's value.

The calculation also ignores the continuing costs of home ownership, including property taxes, home insurance and maintenance expenses, as well as the costs of buying and selling the property. Maintenance costs might run to 2% of a home's value each year, while selling usually means forking over a brokerage commission equal to 6% of your home's value.

The calculation's real downfall, however, is that it looks at the wrong thing. As with many other investments, your home's total return includes both income and capital gains.

Over the past 25 years, homes have appreciated at one percentage point a year above inflation.

Thus, if inflation runs at 3% a year, your home might appreciate at 4% annually. Disappointed? Don't be. You don't just benefit from your home's appreciation. You also get to live in the place. How much is this worth? Think about how much you could collect each year if you rented out your house.

Suppose this annual rent is equal to 8% of your home's value. Add that to the 4% appreciation and your home's total return might be 12% a year, before costs. After expenses, your home's long-run performance probably won't rival stocks, but you should outpace the bond market.

Thanks to Jonathan Clements of The Wall Street Journal