Wednesday, September 8, 2010

Why Buying a House is a Poor Investment. And Why Buying a Home is Not

For many of us, the current real estate market represents the greatest property buying opportunity of our lifetimes.  Interest rates are at lows not seen since the 1950’s.  Housing prices have finally fallen from the sky high levels seen in the past decade.  But even in this environment, buying a house is a poor investment.

A house is an asset, this much is true.  It will grow your wealth over time by increasing in value, unlike a liability, which will cost you money up front, and lose value over it’s useful life.  But not all things that increase in value are worthwhile investments. 

Many people (mostly the ones trying to sell you one) will try and tell you that a house is a good investment.  Well, it’s not.  This is why.  Lets say you buy a house today, and because you put down 20% and have good credit, your interest rate is a very low 4.25%. Using house prices near me as a base, let’s say your house costs $250,000. Using the estimated insurance and taxes for this price house in my area, and the general maintenance estimate of 1% of the purchase price per year, this is how it all works out.

                        Down Payment                                                $50,000
                        Mortgage                                                          $200,000 30 yrs @ 4.25%
                        Insurance and Taxes                                         $3744.00 a year
                        Maintenance                                                     $2500 a year

Total After 30 years

                        Down Payment                                                $50,000
                        Mortgage                                                          $354,196.69
                        Insurance and Taxes                                         $112,320
                        Maintenance                                                     $75,000 
                        Total Paid                                                         $591,516.69
                        House Value                                                    $614,211.00

                        Real Return                                                      $22,694.31

This calculation assumes you pay off your mortgage at the minimum payments, and that your taxes, insurance, and maintenance costs remain stable for 30 years, which is impossible.  All these costs will increase over time. 

It also assumes that your house will increase at 3% a year, the historical real return of houses.  Please note, when I say real return I do not mean equity.  You have $614,211 in equity, since you own the house.  Your real return is the amount you have gained as a result of the $591,516.69 you have invested. 

This puts your 30 year return at 3.8%.  As if this were not enough to show you this house was a poor investment, here are a few more reasons

1.     That equity in your house is only available through a line of credit (debt) or selling the home (realtors, closing fees, haggling, taxes)
2.     Your house provides you with no real, usable income
3.     Your maintenance costs will increase each year as the house and appliances age
4.     Your taxes are based on the market value of the house, not on your buying price, so at this point your taxes alone may be more than you can afford.  

Now, let’s flip this situation and take a look at what you would have if you invested your down payment in the stock market, in a Vanguad Total Stock Market Indexed ETF with an expense ratio of 0.07%, assuming a stock market real return of 7%, the historical average 

                        Initial investment                                                $50,000
                        Expense Ratio                                                      0.07%
                        Total @ 30 years                                                $372,700

That return is about $350,000 more than your house returned in the same time period.  And it never required a replacement water heater, new carpeting or shovelling snow from the driveway.  It’s also much more liquid than a house.  And since renting is almost always cheaper than owning, you could probably add to this amount over the years, furthing increasing your return.  

So which is the better investment?  I think that is pretty obvious. 

Of course, these calculations are rather simple, and follow historical averages for their basis.  They do not include improvements, upgrades, paying your mortgage early, doing the work yourself, major stock crashes, etc.  But you get the picture; houses are NOT good investments.  But a Home is a great investment, and here’s why. 

You will always need someplace to live.  When you buy a home, you are not just buying a roof with four walls, you are building a comfortable space in which you can experience all the joys and heartaches of life.  You can return to it’s comforts after a hard day at work. You can welcome your first child to the world there. You can spend time with family and friends there. You can invest in your neighborhood and make it a great place to live.  You can be your own landlord, and you can change up the place however you want.  It’s yours.  It is your home, and maybe it wasn’t the best investment financially. But emotionally, it beats the stock market any day. 

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