Here’s an article specifically designed to push people’s buttons: Why Your Home Is Not the Investment You Think It Is from the Wall Street Journal. It questions the plan of many people to use their home as part of their retirement strategy, and points to economic studies that show that houses often (1) cost more than most people make when they sell and (2) rarely match the long-term returns of stocks or other investments.
Did you know:
- If you bought a house in Los Angeles in 1990, just as the real-estate market turned downward, you would have had to wait a decade for your home’s value to return to what you paid.
- If you bought in Rochester, N.Y., in 1980, you would have seen only a mediocre 4% annual growth for the next 25 years.
- If you bought in Dallas in 1986, as the oil boom went bust, your home wouldn’t have appreciated at all before 1998.
Some other excepts:
When most homeowners figure their returns, they don’t do much more than subtract the price they paid from the price they received. Then they come up with a really big return because they paid only a 10% or 20% down payment. So they figure they made a huge “profit.”
But they didn’t. That’s because the costs of owning a home — buying it with a long-term mortgage and then paying taxes on it, insuring it, repairing it, renovating it — sap most of what most homeowners think they make in price appreciation.
I can agree with this. This overestimation of returns happens all the time in all forms of investing.
Boom market or bust, home buying has so many extra costs — from upfront “points” paid to a lender to title insurance and appraisal fees — that over the first five to seven years, a renter who invests the equivalent of a down payment in stocks could easily do better overall than a house buyer. Compounding that problem: Most homeowners move within seven years.
As the ownership timeline stretches out to 15, 20 or 30 years, however, the buyer will almost certainly do better than the renter, especially given the tax benefits of paying mortgage interest over traditional rent and the big rebate when the owner finally sells.
There is always a break-even point. Recently, it has been as little as one year, but now it may be 5 – 10 years. This will vary by location, as some areas are still going up, while other are well on their way down.
Whether you come out ahead depends on where and when you buy. Even cash buyers might be surprised to see that they can’t be assured of making a profit.
“The Costs of Home Ownership” table is a simplified rundown on a typical single-family home — a house that was bought for $50,000 in 1977 — based on national appreciation rates as reported by the Office of Federal Housing Enterprise Oversight (OFHEO). Included are modest estimates of other home-owning costs (not adjusted for inflation). To keep things simple, there are no transaction costs, no additional borrowing to finance improvements and no refinancing costs, all of which would drive the expenses even higher. It’s not a pretty picture.
I’m sorry, but this analysis seems a bit biased. Let me count the ways:
- The interest rate is at 8.72%. While it may have started out that high, there’s no way they wouldn’t have refinanced within those 30 years and significantly lower their rates.
- $3,000 a year for taxes and insurance my be reasonable, but still feels on the high side for a house that went from $50k to $300k. That 6% to 1% annually, with an average of about 4% due to exponential growth. Maybe if they lived in Texas.
- $150,000 for “major repairs” on top of $1,800 every year in “maintenance costs”? My parents have lived in their house for almost twenty years and have replaced their heater once. That’s it. What costs $150k to fix on a $300k house?
While their point is made that you need to take in all housing costs, if you take out the $150,000 bombshell, both scenarios made a decent profit.
In the end, I think it’s good that people take a critical look at some of their housing assumptions. Maybe they are a worse investment than some people think. As for me, my basic opinions remain the same:
Regarding buy-vs-rent, I think people should run several different possible scenarios and make a decision based on their specific geographic location and potential need to move. You may need to stay in the house for 5-10 years to making buying profitable. Most calculators rely on several hard-to-predict factors, including the annual appreciation of the property, the annual rising of rent, and the assumed return on the money that is not put towards a mortgage, i.e. when you “rent and invest the difference.” Keep in mind that you’ll need a 10+ year horizon to guarantee that you’ll get 8% or whatever in stocks. If you’ll need the money sooner, you should probably keep it in more conservative investments and lower your projections. Try a bunch of different combinations of numbers to see how they affect the results.
Finally, housing prices are not as efficient as stocks. It is quite possible to negotiate with buyers and be picky in this buyer’s market. I don’t have to pull the trigger unless I see both a house and a price that I like.
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I don’t know that $150,000 is unreasonable over 30 years for repairs and improvements, both of my parents probably put that much into their homes over the years. My wife and I have been in our house for 8 years and have put over $100K in improvements over that time (and it started out new!)
The big unknown is how much those improvements add to the value of the home. Until it comes time to sell, it’s tough to know for sure.
Of course there are extra costs involved in selling a house that dramatically decrease the return. You have to pay broker’s fees. You likely have to pay a few thousand dollars in repairs that you mght otherwise have chosen not to. And at least in my county in Oregon, your property tax increases are capped. Presumably if you sell and move to a larger house, you may see a much larger spike in your property tax than if you’d stayed in your current house, even if the two houses ostensibly have the same value.
I subscribe to the ‘view your home as a home, not an investment’ school.
I think the most significant point from the article is the idea that any “profit” or “rebate” you make will just go to your next house unless you move to a lower-cost area. I think that this fact alone shows that your own house is not a good investment since you probably will never realize any gain, but will always pay out for it every month. Certainly, if you moved from CA to TX right now, then you could end up with $$$ in your pocket. But people have a tendency to want to stay where they have lived to be close to friends/family. So if you don’t ever have an opportunity to actually realize a gain from a personal home purchase, who cares if you have $X in equity. The only way to “cash it out” is to take out a loan, and then you have an additional payment obligation. The only time it ever matters is when you get to the point when you have actually paid off your entire mortgage and you no longer have any mortgage payment. Unfortunately, for most people, it would take 30 years for this to happen, and they would have moved or refinanced by then.
Their $150k amount does seem like a lot; perhaps $50-75k would be more appropriate? That could cover a new roof, a/c units, and maybe a remodel of something.
Note that the article is strictly from the standpoint of your own home – true investment property will return rental payments to you and may potentially provide positive cash flow every month, which is certainly a good investment.
I’ve totally done a 180 on buying a house; I used to want one emotionally, now that I’m more financially aware, I think they aren’t a good investment.
So bearing in mind that I have this bias, don’t dismiss the $150K number out of hand. If you are doing walk throughs of houses, try to imagine how much furniture you would need to fill the house. And what improvements you’d make, to landscaping, etc. I think replacing old windows can run tens of thousands, as can replacing a roof.
Excellent point in this post: Almost no one considers the maintenance/repairs of owning a home. Also, they don’t consider the cost of in terms of transportation (you can’t afford a home in the city). If you remove those figures, of course it’s a good investment. Renting avoids all of those cots. Let’s not even think about living in an area where housing prices decline (housing crashes, factories leak waste into the water/soil, major factory closes, etc.) Time value of money issues are also present; big down payment. Inflation hides all of this because you can’t just compare apples to oranges.
The really obvious case for renting is in the really expensive areas such as Palo Alto. An article a few weeks ago was hilighting the point with a guy renting a house for $2300 a month that would have cost $6500 to buy to cover the mortgage, taxes, insurance etc. If you’re in a locale like that renting can be a very good return on “intvestment.”
However I think the rent vs. own calculations are a bit naive. Some don’t cover the down payment cost for the residence. I haven’t seen one yet that took rent increases into account…
Paul
I also saw this article in the WSJ and can’t believe they ran this POS. You’re right on by calling out the maintenance and costs figure. In addition to you the points you make, the article assumes that the house starts at as a $50k purchase and then you put in an additional $150k in “major repairs and improvements.” If you put in 3x the original value of the house in “improvements,” then how can the author justify using the stdrd OFHEO appreciation rates? You’d have to be an idiot to invest 3x the original value of the house and not add signficant value to that property above and beyond the standard appreciation rate.
Furthermore, I believe that it is much easier to “beat the market” in real estate then it is in the stock market. In other words, I think with some basic research most people could make a pretty reliable educated guess on which locations will perform better than the average returns of real estate over the past 30 years. Certainly, I think its far easier to beat the OFHEO returns than it is to invest a next egg and beat the S&P 500.
I bought my first and only house in 2000 just before the market tanked by selling stock for a downpayment. At that time, I asked my full service broker for his advice and he sent me a similar POS article challenging the wisdom of home ownership. Thank god I ignored him, because I sold stock and got into a bungaloo in SE PDX that has appreciated almost 100% since then. Just one story but take this all with a grain of salt.
Last I checked my rental property with a 30yr fixed 4.75% tax-deductible mortgage is paying for itself. I bought it new 9 years ago and not a dime needed in “home improvements” unless you count the 3 bucks I spent in furnace filters. Never mind the fact the house is worth 100K+ more just in appreciation alone and I’ve been renting it for oh, 200 more than than the total payment inc taxes and insurance for this time period. The renters have paid off another 300-400/mo in equity thank you.
Rent please. As a landlord I’ll happily take your money and the annuity that the home your paying off for me will provide in the future. 🙂
PDXer makes an excellent point; real estate is often far easier to value than equities. Just compare local rents vs. what it costs to buy a similar property with 20% down. Choose the cheaper option and you’ll be just fine. In the recent bubble it was far cheaper to rent in many of the hottest markets than to buy… a clear indication that property was over valued.
Where is the incalculable values of owning a house?
1) Personal gratification
2) Ability to do anything you want to your house ( or not do what you want to your house)
3) Privacy from neighbors (apartment living sucks in this aspect)
4) Ability to own an animal and not pay some outrageous “pet fee” every year.
The list goes on and on.
While home ownership is not for everyone, you cant look just at the figures. Most people can live happily in a house without spending thousands of dollars changing it every year. Where I live, rental property cost about the same as owning a house.
I always find it amusing (and also slightly annoying) when people believe that owning a home means owning a single-family house. (At least three commenters to this post did just that.) I just bought a condo in a vintage building in a great neighborhood in Chicago. I put 10% down, and my monthly payment (mortgage, taxes, assessments) is only slightly more than it would cost to rent an equivalent apartment in the same neighborhood. Back out the tax deduction for the mortgage interest and property taxes and I’m actually coming out ahead by owning, even ignoring the equity I’m building. My condo fees go towards heating and water bills, landscaping, and common area maintenance (including big-ticket items like tuckpointing and roof repair–although there’s always the possibility of a special assessment), and because I’m not living in a huge house I don’t need to buy any furniture to fill a bunch of empty space. I do share walls with neighbors, but they’re also homeowners, so it’s not like I live next to a bunch of drunken college kids or something.
I do view my home as a home and not as an investment, but in the back of my mind, I still feel I’ll come out ahead in the end.
I am in the midst of house hunting in Chicago area and believe me..it has been a frsutrating experience. I have about $300,000 and intend to buy my home outright.
Thanks to Zillow.com, I am able to see what price the previous owners have paid for their homes that they are selling on on the most part, on average, I have only seen that homes appreciate around $7000 to $10,000 a year in the Chicagoland area. Considering that you pay taxes and in some houses, assesment fees…..many of these people are just BREAKING even. (if you count the interest they have paid, they probably are losing money).
I am having a tough time justifying home ownership in this part of the country. I am at crossroads and dont know what to do. To make matters worst, many of the homes we have seen have been on the market for over 200 days.
Can you guys imagine that you can buy a 1 bedroom condo right on Michigan Avenue (Magnificient Mile) for about $250K… Thats it!! This is Chicago.
I’m just sad they used Rochester for their example. It hurts my civic pride!
Not true for us … bought our first house in 1996 in Hawaii for $80K, sold it ourselves 5 years later for $120K (put about $10K in repairs, etc.). Then bought a much nicer house in Oregon for $175K, sold it 3 years later for $225 (again, ourselves, no real estate commission). Put about $2K into that one. Then bought a nicer house on 24 acres for $259K, sold off 19 acres for $115K. Have put about $15K into this house, but it is now worth $400K due to real esate boom in our area, and is $6500 from being paid off.
We wouldn’t have made near that much by investing our initial $20K and adding $15K a year, even at 10% return. Not even counting the loss of $1500 a month it would have cost to rent equivalent houses.
And now it doesn’t matter to us what the real estate market does. If it crashes, we will own outright a very nice house. If we have to sell, an equivalent house will also be a lower price. Same if the market goes up again.
Bob wrote:
Rent please. As a landlord I?ll happily take your money and the annuity that the home your paying off for me will provide in the future.
Bob, if you bought that same house today, would you be able to rent it for the same and make a profit? It’s all in the timing huh?
The main reason I bought a house is because when I pay off my home in my 50’s, I will have no housing payment for the rest of my life. It’s hard to beat the peace of mind that comes with that.
I think this article is incomplete and misleading. Maybe it’s trying to be devil’s advocate. In a single-family, no-rental-income situation, the only pertinent aspect of this discussion is the cost of owning versus the cost of renting.
Even with the disputed $150k home improvement cost (which is not out of the question given the 30 year time frame), the $103,500 total cost of having had a roof over your head is $287.50/month.
While you are still “spending” $287.50/month, you are “earning” the difference you would incur in any other living situation, the quality of the living situation and it’s ability to accomodate your needs (plenty of room for adjustment with 150k), and the lower-cost financial leverage a house provides. A dollar in a savings account technically will equal multiple dollars in the same timeframe, but this dollar provides no service beyond the interest it accumulates.
Also, I think worrying about the length of time you will be living at a specific residence is a recipe for paralysis. If you plan on being alive for the next 30+ years, chances are you will want to have a roof over your head, so your in housing for the long-term. The financial implications of moving a few times is not much different than remaining in one house. Once you are in the housing market, the price of your house will rise and fall with the cost of the next house you buy. Either way you look at it, you will have spent around $287.50/month to live.
Its always easy to find someone that bought at the worst time and then took years to recover. Name the risk and you can find an example. Stock, house, franchise, etc.
If you took a house that was completely an investment (no living in it), then you could reasonably compare it to other investments in regards to return. But if you live in house, you can’t. I’ve never lived in a stock certificate.
The 150K must assume some major renovations over the years. While some people do that, you can assume every who owns a 30 year old home has done that.
While I doubt someone in that situation wouldn’t have refinanced at some point, maybe its possible. By the time the rates were down, maybe it didn’t make sense to refi a house 23 years into a 30 year mortgage.
In the end, there are many many factors to determine if a house makes a profit or not.
fyi, interesting analysis in how too much home ownership can hurt the economy as it keeps people from moving to better jobs.
http://www.slate.com/id/2161834/fr/rss/
Am I missing something here? You have to live somewhere. Where does the fact that you would pay rent if not owning come into play in this calculation?
I too, always find it amusing (and also slightly annoying) when people believe that renting means renting an apt. (At least three commenters to this post did just that.)
Where is the incalculable values of renting a house?
1) Personal gratification (I can move in only a single month as i’m now month-to-month in this townhouse)
2) Ability to do anything you want to your house ( or not do what you want to your house). (my landlord doesnt care, in fact he’s delighted we painted it all the colors we did and planting the garden in the back, he also didnt mind replacing the sliding glass door, garbage disposal and part of the hardwood floors)
3) Privacy from neighbors (apartment living sucks in this aspect), (sure does, that’s why smart renters rent houses.)
4) Ability to own an animal and not pay some outrageous ?pet fee? every year. (my landlord is an animal lover, his words were “i dont dare charge a pet fee”. my dog loves the place.)
all this within the dc beltway, renting for $500 less than owning cost. thank you landlords!
Big problem with this theory–it does not take into account the money you save from not paying rent.
Because I bought during a serious boom cycle, I’ve increased my networth significantly. Even when you consider home improvements, taxes etc, I’m still ahead by an easy $150K.
The other variable that I haven’t seen discussed much is the sweat equity you gain. Most homeowners that I know do some of the work themselves (and enjoy it). By doing some of the work yourself, you can minimize the lifetime improvement costs significantly.
As an “investment”, homes are pretty horrible. Say you went to a financial advisor and he offered the following option to you:
50K initial contribution
15K/year contributions for the next 30
3% frontend load
6% backend load
3% expense ratio
expense ratio can randomly increase to 10% 5 years out of 30
3.5% annual return, 5% pro-rated for taxes
Who in their right mind would pick this option? I’d have a hard time finding a variable annuity with worse terms than this.
Luckily homeownership does have other benefits — and when considered as housing, it is a good deal during historic buy:rent ratios.
that’s pretty good mossy. though i think the backend load is really only 3% if you count the frontend.
but your example is only if the house sits empty. hopefully you have 20k/year return to offset the 15k/yr contributions
I was going to point out rent, but they were pretty specific to title it “Cost of Homeownership”.
I like Mossy’s summation above. As a pure investment, houses are a horrible investment when compared with other alternatives.
Adding rent saved does make the picture much rosier.
A point I think the article is missing is that most American’s are NOT good savers and they ARE bad investors. If you combine those two factors, a person’s house becomes there BEST and sometimes only investment.
Most people who read this blog are good savers and investors. You are neither the majority nor the average – you live in your house/condo because you LIKE it, not because you think it’s an awesome investment.
Think about the average Joe who can’t afford much else besides his mortgage payment. When he hits 65, his house IS his major asset, and it returned, annualy, anywhere from 3% to 6% depending what statistic you choose te believe. That kind of steady return is pretty darn good over 30 or 40 years. One day then the mortgage is paid off average Joe is pretty darn happy with his investment.
-Wes
I am in the market here on the North Shore of Boston.
Am currently renting for $530/mo plus elec.
I am looking at condos and even with $30,000 down a decent, modern condo (2br) here is close to $289,000.00. 20 miles outside Boston…
So do I keep renting? If I buy, i’ll have roomate income of about 500/mo. my payments (including taxes and condo fees) will be about $1800/month. So thats 800/month on me, additional. Total. I can afford it, but is it worth it?
I forgot to mention it is new and would have excellent saleability when it is time.
Based on our forecast Americans have to be prepared that housing won’t finance their retirement anymore. Globalisation will force Americans to recognize that US is not anymore the place where you really want to be. Globalisation is a huge chance but a danger to the developed world markets. We are not anymore the place where emigrants will just come and will stay forever. Even though Students might come most of them will return to their home countries which will be able to give them a better chance to work or make a future.
Is an apartment an investment? No, but we live there. We must either live in a house we own, or pay rent to another owner to lease their living space. So when considering buying a house, the comparison shouldn’t be made with investments like stocks, bonds, other marketable securities, that is NOT the purpose of owning a home…at least not the first home.
That said, even if home prices only remained on par with inflation, paying off that house in 30 years means that after 30 years,
1. You own the property outright, now worth 100’s of thousands,
2. You have given far less to Uncle Sam than you would otherwise…meaning that money you wouldn’t keep actually went to paying off the property that you are keeping.
There are of course many more benefits of owning a home (and then some drawbacks too, of course) but i think those two points alone are enough to skew the argument in favor of homeownership for most intelligent folks who also posess the wherewithall to own.
I think that this analysis misses an important point.
***you have to live somewhere***
Your home isn’t just an investment, like a stock or a bond. It’s a physical thing that provides you with a service. So yes, you gotta pour some money into it so that it gives you something back – a happy home to raise your family (or whatever).
A better comparrison would be with an investment property, and the numbers would come out better. Why? Because an investment property pays you in monthly $$$, as opposed to paying you in the convenience of not having to sleep under a bridge in the rain.
Another way of looking at it would be to add back the saved opportunity cost of not having to pay rent.
Don’t forget to add in the value of a good school system where your house is located. If you had to pay for a private school, it could run you from $5K-10K++ per kid per year for 13 years. That’s 65K-130K per kid. Of course, in other ways, I agree that homes are a money pit and only if you buy right before the boom do you feel smart. Homes require money, work and worry. And, like they say, in reality, no one really “owns” anything, especially when you have to pay taxes and maintenance every year.
The house you live in is NOT an investment and should never be viewed as such!
Commentor “bob” has the right answer – his rental property is an investment; if you want to look at housing as an investment, buy a rental property!
Exactly – and my investment has kicked major butt in the 8 years I’ve owned it. Even with the recent downturn.
I want to reiterate – thank you renters for making me rich. Okay – not rich – the friends of mine in the rental property business for the past 20 years who own outright over 10 quality properties each thanks to tenants.
Don’t get me wrong – there are times when you’ll have a bad tenant – which is why you always run credit report, and treat your good tenants like gold – because they are gold.
I think this is a wonderful article. The greatest point in the article (which some of you apparently need to read first) is that when you buy a house with a huge mortgage…you’re still renting. A couple of comments about saving on rent are missing this major point in the article. When you buy a house for hundreds of thousands of dollars that you don’t have, you “rent” the money to buy it.
But mortgage interest is deductible! That means buying a house is always better! The deductibility is nice but if you don’t itemize it doesn’t mean anything. Plus, this point of deductibility is ridiculously overrated. In effect, if you’re in the 25% tax bracket, you are pouring $1,000 down a drain to pick up $250 downstream. Yeah, that’s a great investment.
I agree wholeheartedly that your primary residence is NOT an investment. Great article.
Thanks for the great post!
reading this article also useful before buying.
While many people do think of homes as an investment, this probably isn’t the way to think about it, and therefore it’s not a good way to determine whether you will rent or buy.
The way to decide is which option causes you to LOSE THE LEAST money. Either way, you’re paying for a roof over your head, and it’s not unreasonable that you’ll come out behind, just like when you buy groceries, clothes, or a car. But renting will put you farther behind than buying will.
Consider the example above (without even factoring out the huge $150,000 in upgrades). In the worst case, the fictional homeowner has spent (lost) $103,500. However, to only spend that amount renting, this person would have to pay an average of $287.50/month or less ($103500/360 months) to rent a house of equal value. That may have been possible in 1977, but now renting a $300k house will cost significantly more than that.
So when you consider that the average rent would in fact be more than $287.50/month, the renter winds up deeper in the hole than the homeowner. And that doesn’t even consider the fact that the renter must still pay rent for the rest of his life, while the homeowner only needs to pay taxes and maintenance, which is less per month than rent.
Homeowners win in the long run.
I think there are several points from both sides to be made. Renting has its financial benefits, you are not tied down to a area, you have little financial obligation for housing cost, but that all depends on your area. Same goes for buying. If you live in a area that is a popular area and housing cost and rent are both high, you both are paying out the nose. But Homeowners get one advantage, they get to deduct some of their cost at the end of the year. Personally I think this is as unfair as the marriage tax break, just because you own a home or are married should not give you breaks on taxes.
But, the plus side to renting is, in DC if I was to buy a house of average price, even with 20% down and a fair interest rate, my mortgage would be close to $2000 a month or more. While I rent a townhome for $1500 a month, I am able to save some of that money I would have been paying. I think its like others stated, it all breaks even until the 30 year mark, then you are in the clear. You just hope your area hasn’t turned downward, or the house doesn’t start falling apart. personally I feel for any homeowner buying a newer home, they will be lucky if they last 30 years. But most people, sell their house after they pay it off, so what is the reward? Its a roof over your head, I hope to own one day, but for now renting is fine with me, and if Bob feels like he is getting rich off people like me, good for him. I just need a home to live in, if I want a investment, I will look at the market and my piggy bank, because in a worse case scenario, I would rather have cash on hand then a home that I have to rely on a strong market and someone who can afford it to cover my backside.
Even if you come out flat after 10 years, you had a place to live for 30 years rent free. That’s a profit.
The WSJ article is an “apples to oranges” comparison. As mentioned by a couple of others here, the equivalent rental value of the house is a missing factor in determining gain or loss. You will have housing costs no matter if you own or rent. The true investment value is the difference between owning versus renting.
Here’s some quick, “back of the envelope” estimates of renting this house for 30 years. The monthly rental cost of a home is roughly 1 percent of the appraised value. In 1977, the rent on the house would be $500/month. In 2007, it’s $2,900/month. The average monthly rental for the 30 year period is $1,700/month or $612,000. The cost of owning using the chart figures, is $394,000. The advantage of owning versus renting is $218,000 on an “apples to apples” basis for the 30 year period.
The first house we bought, 30 years ago, currently rents for $10,600 per year. It’s been a rent house for the past 20 years. It has no mortgage. Taxes, insurance, management fees, and maintenance allowance costs us about $5,600 per year. Our current gross profit is $5,000 or $4,000 net of income taxes. Over the past 20 years we’ve had five tenants in the house. The average unrented time between tenants has been five weeks. ‘Nuff said!
This post is important especially to first time home buyers, who often don’t know anything about buying a home. This post does a great job of pointing out some of the common pitfalls in home buying and selling. It is also good advice to compare the costs of renting as compared to buying, and you also need to know what the housing prices are trending at in your area.