Recently I received a question from somebody looking into self-directed IRA/401(k) investment for themselves. They said, “I ran this by my financial planner in New York who said to roll over my IRA to put some of its money into my home is illegal.” This statement is technically correct. Putting IRA money into his primary residence would be a prohibited transaction. The disturbing thing about the situation is that these three people (a person, their realtor, and their financial planner) could all be on the same page about something so fundamentally ridiculous.

The misconception

In the past 10 years, many people think “real estate investing” equals “putting money into my home”. Their home can’t be an investment in the first place because they are paying for it rather than having it paid for by a renter.

When somebody wants to help people rationalize buying the stuff they sell, they often call it an “investment”. Bill Clinton started changing the way people thought about government spending (when he was increasing it) by calling it an investment.

An investment or a consumer product?

Selling a primary residence to a home buyer is selling a consumer product. It’s for their use. They can buy what they really need. Or they could get extravagant and buy the Lexus/Mercedes version of a home and spend more. Either way, it’s a consumer product if they are paying for it and using it themselves.

But realtors followed Clinton’s spin move and started calling home buying an investment. This really caught on once Fannie Mae, Freddie Mac, and the Fed all took actions to artificially inflate home prices in order to defer the recession of 2002. Once you could buy this consumer product (the home) and then have it rapidly increase in value (supposedly) and realize this value by selling it or doing a refinance cash out, then the talk about the home being an investment seemed to make sense.

Today, the bubble is over, and the illusion that your home is an investment should be easy to correct. If it was an investment, then somebody else would be paying the mortgage. If somebody else was paying the mortgage, they’d probably live in it instead of you.

It’s not to say that buying a home is a stupid thing to do. That can only be decided on a case-by-case scenario that depends on the buyer and the home in question. Buying a home can be a financially beneficial thing to do in some cases, but it hardly could be truthfully classified as “real estate investing”.

Back to basics: real estate investing means buying properties that produce income. And, yes, real estate investing can be done inside an IRA or 401(k).  

One of the reasons that everyone seems to act so surprised at the “economic meltdown” is because we measure everything in U.S. Dollars while paying little attention to the value of the dollar itself. The dollar is a floating currency. The amount of dollars in circulation can dramatically increase or decrease in any given period of time as seen fit by the central bank, the Fed. An increase in the money supply will push prices up, while a decrease in the money supply pushes prices downward. Therefore, an asset’s true value can remain constant while it’s dollar denominated value can fluctuate – and vice versa.

Looking at statistics or charts denominated in U.S. Dollars can be very deceiving, and if that’s what you’ve been doing, then you were blindsided by the recent collapse of various markets and institutions. If during the past decade you were looking at real prices (as measured in grams of gold) it would have been quite apparent that housing prices were experiencing erratic growth that was likely unsustainable. Gold has been the real currency used by humans since the dawn of time, and even after Nixon took us off the gold standard in 1971, all markets continue to follow logical boundaries of movement as priced in gold.

The good news is that we can now look at this type of data to more comfortably estimate where the bottom is. Warren Buffett commonly perpetuated the addage attributed to Baron Rothschild: “Buy when there’s blood in the streets.” This means that you should be buying (greedy) when most everyone else is selling (fearful) and be selling (fearful) when most everyone else is buying (greedy).

That said, the charts over at www.pricedingold.com show the Case-Shiller Home Price Index as returned to 1997 levels (top). The chart for U.S. Median Home Prices (below), however, tells a less clear story:

To me, this all translates to a crystal ball that says housing is near its bottom, but median home prices may fall a bit more. This would support investment into inexpensive housing. Keen real estate investors will be diverging from trendy lofts and luxury homes in order to focus on where the real money will be found – affordable housing. Many American families will be financially destroyed by the acts of Wall Street and our central banking system. They will need to start over. At the very least, many American families will start living within their means… which they will find to be much more modest than previously thought.

The housing prices that should remain strong will be those at the lower end of the spectrum. In today’s chaotic marketplace, buying an $80k home for a 50% discount should be a solid bargain. On the other hand, buying U.S. real estate for cash flow may be a confusing (often losing) game in years to come because I suspect rent raises will be unlikely to follow inflation beyond 15%.

All in all, my perspective for wealth preservation in the next few years can be summarized in a few points:

1. Anything that is bought and sold in U.S. dollars shouldn’t be held for the long term due to monetary instability.
2. Demand for affordable housing will continue to grow while demand for luxury housing will continue to shrink.
3. If you can find a bargain (at least 50% under fair market value) on an affordable-priced home, buy it because you should feel confident that its market value is fairly solid. Buy it if you feel like you can liquidate it for its market value in one year or less.
4. Stay away from cash flow real estate if it is bought, sold, and rented in U.S. Dollars or any currency pegged to the U.S. Dollar.
5. Stay away from investing in mortgage notes or trust deeds whose return is paid in U.S. Dollars.

Once you start checking your assumptions against prices in gold, you gain an understandable, logical, and predictable viewpoint.

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### Update ###

The five guidelines above are for a person who is interested in growing wealth. If wealth growth is not high in your priorities, long term ownership of affordable-priced U.S. real estate should still provide a good hedge against inflation. This means you will likely experience double digit price appreciation, although this will be accompanied by double digit costs of living increases. That can be an effective means of wealth preservation.