The Fallacy of Homeownership as a Sound Investment
Homeownership is ingrained in the American psyche. Beyond that, the idea of owning a home has become a moral imperative in the United States. Presidents from Herbert Hoover to George W. Bush have extolled the virtues of homeownership as a symbol of American freedoms and values. "No man who owns his own house and lot can be a Communist," the preeminent 20th century builder William Levitt famously said.
Owning a home has become inextricably linked to the American dream, as much a part of the social fabric as baseball and apple pie. But the reality is that most Americans would be better off buying shares of Apple instead of trying to use homeownership as a vehicle for wealth creation.
The contention flies in the face of maxims and political mantras that millions of Americans have accepted as Gospel truth. But the numbers, the economists and the historical patterns lead to the same general conclusion: Homeownership is not a wise investment.
A Dearth of Diversity
There's a cliché about eggs and baskets that's rather apropos here. In most cases, investors would shudder at the thought of pumping a majority of their capital into a single stock, no matter how blue the chip. But that's exactly what most homeowners are doing. And it can have devastating long-term consequences given the unpredictable, fluctuating nature of the housing market. Just ask the thousands of near-retirees nationwide who've been forced to hold off on retirement because of the one-two punch of diminished stock portfolios and plummeting home values.
"You're supposed to diversify as much as possible — put your money into stocks, bonds, many different geographies — and then use the income to rent whatever you like, which allows for greater flexibility, as well as efficiencies," Robert Schiller, a professor of economics at Yale University, wrote in an October 2008 issue of Newsweek. "The popular argument that renting is throwing money down the drain is really fallacious, since if one rents one can invest the money one would have put in the home in other investments, and so offset the rent with the dividends from the investments."
Homeownership can become a black hole for income that could otherwise be redirected into investments with more stable, proven returns. Isn't the stock market risky? Sure, it certainly can prove tumultuous, especially looking at the last two years. But for most homeowners interested in maximizing return on investment, history is not on your side...
History is Not on Your Side
It doesn't square with the American mantra of homeownership, but there are numerous studies from economists, real estate experts, sociologists and others that continually lead to the same conclusion: Homeowners are lucky to break even when using their home as an investment. The reality is that, in most cases, historical returns are much more favorable for the stock market and other forms of business and even real-estate investment.
For example, the average appreciation for U.S. homes was 5.6 percent from 1987 to 2006, according to the S&P National Home Price Index. Adjusted for inflation, that's more in the ballpark of a 3- to 5-percent return. Factor in the 2 percent expense ratio of owning a home (the cost of ownership as a percentage of its value over the course of a year, as defined by The Motley Fool) and those margins shrink even further. At the same time, there are proven, big-time companies whose returns have far outstripped market averages for decades.
Economists also point to the Case-Shiller index, a composite of 10 major cities. The return on homes is a mere 1.14 percent a year over inflation since 1987. Since 1994, the figure has increased slightly to an annual return of 4.7 percent. But factor in inflation during that span (about 2.5 percent) and you're still looking at thin margins — around 2.2 percent annually above inflation. As the Wall Street Journal recently noted, investors routinely perform better with government bonds.
Buying a House is Just Renting Anyway
Speaking of mantras and clichés, there's one in particular that tends to dominate the buy v. rent discussion: Paying rent is simply throwing away money every month. But how many homeowners get back their mortgage interest payments, or their property taxes, or their monthly maintenance expenses?
Homebuyers spend a good 20 years paying mortgage interest before their monthly payment starts scratching away at more of the principal than the remaining interest. In essence, homeowners are renting money from their commercial lender. Compounding that is, well, the compounding. Homebuyers will typically pay for the cost of their home again just in interest payments. Factor in two or three decades of property taxes, insurance, maintenance and improvements and a $300,000 home quite easily becomes a $1 million purchase.
Here's an example with some numbers:
You want to buy a $200,000 house. You put down $40,000 (at 20 percent you avoid mortgage insurance) and finance the remaining $140,000 at 5.25 percent on a 30-year mortgage. A decade later, you decide to sell your "investment" for $300,000.
It's here that some homeowners are tempted to proclaim they made a cool $100,000 profit on their home investment. Ah, but not so fast...
The Fallacies of Cashing Out
With homeownership, appearance and reality are two very different things. Let's keep that same example. After the first 10 years of payments, you will have spent about $100,000, with more than $75,000 going solely toward mortgage interest. Include the $40,000 down payment and that's about $146,000 during the first decade.
At the time of sale, you can subtract the remaining mortgage balance and sale proceeds. You're left with a whopping $22,684 return.
But that doesn't include the money you've shelled out during the last 10 years in property taxes, insurance, maintenance and improvements. Taxes and insurance over the last decade could easily total another $35,000 to $40,000. Now you're losing money — big time. And we're not even worrying about inflation.
Tax deductions could offset some of the pain during that decade, but certainly not enough to ease the pain.
Homeowners can easily overlook the mountain of money they've spent during the course of owning a home when the time comes to sell. There's something about holding a six-figure check that somehow disables the brain's ability to do simple math.
The costs of homeownership rarely meet up with price appreciation. Homeowners who bought in the Dallas area in 1986 didn't see home appreciation until 1998. In 2000, Los Angeles homebuyers finally saw home values return to what they been in 1990. Beyond that, money spent on upgrades and improvements don't generally translate into extra dollars in your pocket come closing day.
Whatever "profit" emerges upon selling your home, chances are you've already spent most of it on taxes, mortgage interest and upkeep. Besides, that "profit" is usually short-lived anyway. Many people turn around days later and pour those funds into a new mortgage.
It's a Lifestyle, Not an Investment
Despite the political pronouncements and moral imperatives, homeownership is not a wise investment. But it's an important cornerstone of American society — one that people still hold tightly to despite boom and bust cycles and the overall grim economic picture. A Rasmussen Report in September 2008 showed two-thirds of Americans believe home buying is the best investment families can make.
While that notion is a complete fallacy, its pervasiveness speaks to how deeply rooted the concept remains, despite mounting evidence to the contrary. For many Americans, homeownership is a right that brings an autonomy and self-fulfillment that renting will never inspire. If owning a home suits your lifestyle, find a trusted lender and the home of your dreams.
But don't view your home as anything other than a place to hang your hat. Grand visions of home ownership as the path to wealth creation will likely leave you hanging your head.
This is a guest post by Brandon Laughridge. Brandon is the editor of the Mortgage Loan Place blog. MLP focuses on providing free mortgage tools and educating consumers about all types of government mortgage loans.