Is Your Home an Investment?
This is the second in a series of posts that aim to dispel or reinforce common personal finance cliches. The first looked at the commonly used phrase, “A penny saved is a penny earned.”. Today, we’ll venture into the wonderful world of home ownership cliches.
Home Values Always Go Up… Right?
“Go out and mortgage as much home as you could afford, because housing values always go up.” I was given this advice realtors, friends, and other peers when I looked for my first home in 2007.
History proved them mostly correct. Until 2008. Over 10 million foreclosures and roughly a 30% drop in home values later (with no signs of a rebound in the near future), the “get as big of a house as you can afford” theory has been blamed for being the cause of the housing bubble and ensuing collapse.
Despite the history lesson unfolding in front of our eyes, I still hear from peers that they view their home as an investment vehicle. After all, many in their parents (the boomer) generation are counting on their home as being their primary source of retirement funds, so it’s no wonder where they got this idea from.
Other than during the most recent housing boom (pre-bubble burst), home values tend to return to around the rate of inflation over time. Check out the Case Shiller 100-year home price chart for more on that.
Would you invest in the market with the goal of simply hitting inflation so that the real value of your money never went up? Probably not. So why is it OK to accept that from a home?
Buying Vs. Renting
In reality, homes can be a huge drain on resources. When you look at mortgage costs, interest over 15-30 years, property taxes, upkeep, realtor fees when selling, and energy costs, buying a home can result in a lower return on investment than renting a home or apartment and investing the difference saved.
When deciding whether to buy or rent, I’d recommend taking a look at the price-rent ratio, which can be calculated by taking the total price of a home and dividing it by the annual rent in that geography for a similar dwelling. The lower the ratio (10-15), the more it makes sense to buy in that geography. A very high ratio (20+ can indicate a housing market that has inflated prices).
With high unemployment, high foreclosure rates, slowing population growth, and this new outlook on home ownership, we may not see consistent home price appreciation for a while. And even if we do, there will likely be a number of investment vehicles that will get you a better return on your investment than a home in the coming decades.
Where Else will you Live?
The other thing to consider is that when you go to sell a home, you are left with a dilemma: you need somewhere to live! You can realize a net gain if you significantly downsize or move to a cheaper geography, otherwise, you don’t really keep your investment.
A wise person once told me that the best way to look at a home is with this phrase, “Four walls”. More and more, I am starting to see the wisdom in that statement.
Verdict: False. What once was true is no longer a given. Homes can result in a negative return over the short AND long-term these days. It’s better to look at homes for lifestyle and other benefits versus financial gains. Geography is a huge variable.
Alternative Advice? “Homes can provide a number of great benefits. But strong investment returns are likely not one of them.”
Your Home as an Investment Discussion:
- Do you think this cliche is true or false? Why?
- What are the reasons why you have or would buy a home?