While home prices generally only increase at an average of 5-6% per year, the stock market generally sees returns of 10% or higher. Yet real estate is often still looked at as a better investment.

Why is this?

It all comes down to leverage. While a home may be valued at $100,000, the owners generally only start out with 20% equity ($20,000). When the market goes up 5%, the value increases by $5,000, which is 25% of the total that you actually have invested in the home.

So a $20,000 investment nets a 25% return (minus costs). This is much better than the stock market traditionally does, and so is considered a better investment.

But as your property value grows, and your mortgage shrinks, you’re actually getting a lower return on the money that you’ve invested.

As your leverage decreases, you may be better off selling your current investment and purchasing a different property that gives you a better return on the money that you’ve actually put into the place (not just the overall property value).

Click here for an article from EquityScout that explains this in much more detail, and includes graphs that further reinforce the point.

Via the Carnival of Real Estate #70