Your House is Not an Investment

We’ve been spending the month exploring economics and investing.

Not once in any of that exploration have I mentioned housing. Even when discussing what we should be investing in.

Why? Did I forget to include it? Isn’t buying a house a great investment?

In short: No.

Caveat

Before we dive in, let me be clear that I am not saying you should never buy a house.

There are plenty of reasons you could want to buy a house. Maybe you want more of a sense of permanence than you can get from an apartment. Maybe you want to remodel without dealing with a landlord. Maybe you want something larger than you can find on the rental market.

That’s all fine. None of it means your house is a good investment.

The Returns

When determining whether something is a good investment, the first thing we look at is the returns. How much will you make on your investment?

If your investment is a house, you are likely to make slightly more than nothing.

Okay, let’s be fair: Slightly more than nothing after accounting for inflation.

Home prices since 1890 have barely beaten inflation. That means your home provides a better return than the cash in your savings account, but not much else.

Leverage

“But what about the leverage?” you might be thinking. The value of your whole house is going up, but you only put in the down payment and a few mortgage payments!

True. And if you bought a house in 1997 and sold it sometime before 2008, then you made a lot of money off of that leverage.

If you bought a house shortly before 2008 and wanted to sell it after, that leverage destroyed you. In November 2009, 23% of all mortgages in the US were under water. Some places were even worse. 65% in Nevada. 48% in Arizona.

As with any investment, leverage increases the risk and increases the potential reward. The difference with a house is that it is both an investment and a place to live. As James Altucher has said, “Leveraging up 400% in an illiquid investment with no diversification is a scary concept to me and should be to any rational person.”

People talk about the stock market as if it is risky. It’s nothing compared to the housing market.

Flexibility

A related problem is liquidity and flexibility.

If the stock market crashes and you lose your job, you can get a new job in another city if you need to and take your stock with you. If your house loses value and you lose your job (and large layoffs in one area can cause home prices to drop there, so there is a good chance these things will happen at the same time) then you are forced to sell low and lose money in order to move to a new job.

And that’s if you’re able to sell at all! If you’re underwater or if the market has dried up, you could end up stuck there and your job prospects will be limited to whatever is within driving distance of your house.

In this way, your house can lead you to take a lower-paying job, suffer a longer period of unemployment, or both.

Liquidity

On top of that, a house is also very hard to sell on short notice in the best of markets. If I need cash and have stocks to sell, I can sell my stocks and have the money in my bank account within a few days.

If I need to sell my house, it’s not quite so easy. It can take weeks or months. There are lawyers and agents and piles of paperwork.

If I need to move before the house sells I may need to do a lot of traveling back and forth. That’s not so bad if I move a few towns over, but if I need to move to another state this can become quite problematic.

Besides that, I’ll need to keep paying the mortgage while paying the mortgage or rent at my new place.

I don’t know of any other investment that makes me pay double for living expenses.

Fees

On a related note, buying and selling a home involves quite a few transaction costs.

You need to pay your real estate agent. You need to pay for title insurance. You need to pay for home inspections, loan origination fees, attorney fees, and transfer taxes. There are a lot of costs involved in purchasing or liquidating this investment. There are no costs at all to set up a Vanguard account and buy VTSAX.

There are also all sorts of ongoing costs to homeownership that don’t exist for renters. These are important to remember for the “But renting is throwing away money!” crowd.

Throwing Away Money

When paying rent, you are buying shelter without building up any equity in the property. This is why people will argue that renting is throwing money away.

Ignoring the fact that buying shelter, one of the basic necessities of life, is certainly not a waste of money, this rationale would also suggest that much of homeownership involves throwing money away.

Part of what you spend on your home goes towards equity. But you’re also spending much more than that. You’re paying mortgage interest, property tax, maintenance and repair costs, homeowner’s insurance, and potentially PMI. Add these to all of the transaction costs that you incur when you buy or sell a home and you’re throwing away quite a lot of cash.

Diversification

Another concern when it comes to investments is diversification.

The average American has over 75% of their net worth in home equity.

That deserves repeating. More than 75% of the average American’s money is in their home. 75%!

No reasonable investor would put 75% of their money in Netflix stock. Why is putting that much of your livelihood into your home any better? Instead of betting on a single company, you are betting on a single house in a single neighborhood in a single town in a single state.

If anything happens to any of those, the entirety of the wealth you’ve spent your whole life building is at risk.

If a factory shuts down and lays off thousands of people, your home value and your net worth could drop drastically. Your town raises real estate taxes and you are stuck with increased costs that you didn’t budget for. Your state finally follows through on its threats to secede. A natural disaster wipes out your neighborhood. Termites destroy parts of your home.

Any number of risks could completely sink your financial well-being.

Opportunity Cost

Another concern when looking at investments is opportunity cost. When you spend money on one thing, you can’t spend it on something else.

If I spend money on a new couch, I can’t spend it on a vacation. If I spend money on a vacation, I can’t invest it. If I invest it in bonds, I can’t invest it in stocks. If I spend it on a house, I can’t spend it on index funds.

You generally need a large down payment when you buy a house. This down payment comes with an opportunity cost.

Let’s take a situation where all other costs between renting and buying are exactly the same and the only difference is the down payment. If you put a $50,000 down payment on your house, it will likely keep up with inflation and be worth right around $50,000 in real terms at the end of your 30-year mortgage.

If you continue renting instead (with the same monthly expenditures) and put that $50,000 in the stock market, it will potentially be worth right around $360,000 after the same 30 years (using a return of 6.8% after inflation, the average long-term return on stocks according to Stocks for the Long Run).

Obviously you will never end up in a situation where the monthly costs of renting and buying are exactly the same, but the opportunity cost of passing up other investments is a very real thing that you need to consider.

Reasons to Buy

Maybe where you live it is cheaper to buy than to rent.

Maybe the cost of the mortgage, tax, insurance, and expected maintenance costs combine to be less than the cost of renting. Maybe the opportunity costs of the down payment are bearable and minimal.

There may certainly be financial arguments in favor of buying in some areas.

But even then, it isn’t because your house is a good investment. It’s because it is cheaper to buy than rent in that area at that time.

There are plenty of reasons it may make sense for you to buy a home. It’s value as an investment should not be one of them.

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