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Comment by trjordan | Hacker News Reader

Big detail missing here: a standard mortgage is the only way for the average person to make an investment with 5x (or more) in leverage. For a 20% down payment, you effectively get to invest 5x your money into a real estate investment of your choice. The real estate market as a whole is certainly less value-producing than something like tech or chemicals, but Joe Salaried can't easily go out and ask his 401(k) plan to leverage him out at 5x his net worth.

It's not for everyone, and it's certainly a risk (like all leveraged investments), but it does provide an opportunity that very few other common financial instruments provide.

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Why would you want to leverage up an investment whose expected returns are barely above inflation, though? It's a fairly good bet that the appreciation on your home will be less than the interest you're paying on your mortgage, which makes this a net loss. (Particularly now, right after home prices have seen the most spectacular run-up and bubble in nearly a century.)

You'd do it because you expect that the return on this particular property at this particular time will be significantly above inflation.

I think this would be a reasonable bet in cities which have had particularly strong post-bubble deflation but which nonetheless have strong long-term growth prospects. If I had lots of spare money I think I'd be buying up five-figure houses in suburban Sacramento right now.

It's not just growth prospects, you're making a bet on the regulatory environment continuing to restrict the supply of homes. It may seem like California will never open up more land for housing, but it's not a law of nature.

Out of curiosity, why do you see Sac rebounding strongly?

Just a guess based on the vibe of the place -- it feels like a city which is going to continue to grow in population and importance, and it's come down a helluva long way since the peak of the boom. I could be wrong. If I had a really good reason for believing it then I'd be out there buying instead of talking about buying.

I'm only picking on Sacramento because I used to live there, there could be much better buying opportunities in cities I don't know so well.

It is possible that it will rise, but it seems to lack the NY/SF factors of limited supply (land) driving prices through the roof. In SF, there is only so much space, so the affluent can keep driving prices higher. Around Sac, there is plenty of farmland ripe for development.

(example: Austin, TX is a great place to live overall, but it remains cheap due to "endless" land).

Why on earth should the average person make an investment with significant leverage? The only reason, ever, to make an investment with leverage is if there is some arbitrage opportunity that requires a large amount of capital to make money from. But by definition, the average person is not going to be able to identify arbitrage opportunities in the housing market.

The real reasons to invest in housing are: a) diversification (so not everything is in bonds or stocks) b) excellent tax treatment c) excellent political protection d) interest rates that are often lower than the monetary inflation rate (by monetary inflation rate I mean growth in M*V - nominal income growth). However, at this point, all the above factors are already capitalized into the price of housing. So at this point there is not much of an economic benefit to buying housing.

The "average person" quite possibly thinks he/she is above average in terms of identifying such opportunities (cf. Lake Wobegon effect).

On top of that, there are government initiatives to "encourage home ownership" and to protect "homeowners" even if they bet completely wrong or obtained loans they couldn't possibly have qualified for if the lender had any common sense. These will tip the balance in favor of going into the housing market.

It's becoming a bit easier for the retail investor to do other kinds of leveraged investments, since a lot are now packaged up into ETFs. For example, NYSE:ROM is a 2x-leveraged basket of technology stocks, and NYSE:TNA is a 3x-leveraged derivative of the Russell 2000 small-cap index. Of course, these are not necessarily a better idea than buying a house.

These ETFs you talk about are usually leveraged through some combination of options which means they have significant time-value decay, making them an unsuitable long-term investment.

Leveraged ETFs seek to provide the expected return on a daily basis. They do not provide the returns that you might expect over periods longer than a day, and therefore are only useful for day traders.

http://www.etfbase.com/leveraged-etf-decay/

+1 for correctly stating how those investment vehicles are structured. In fact, expect not to see them much later in the future as people didn't understand how or why they performed as they did.

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