# What your house is really worth

by Philip Brewer on 15 September 2008 22 comments
Photo: Philip Brewer

There are several things you can do with a house that you own.  During the housing boom, most of the attention was focused on two of those things:  You could sell it, or you could borrow money against it.  Now that the bust has arrived, it's easy to see the limitations of that particular model.  Happily, there's a more stable, more useful way to value your house.

Until the housing boom distracted people with fantasies of easy riches, most people focused on the two other things you can do with a house you own:

• If you live in it, you don't have to pay to rent someplace else to live
• If you don't live in it, you can get paid rent to let someone else live there

Looked at this way, what is a house worth?

## The financial analysis

Purely as an example, suppose you can rent an apartment as large as a small house for around \$750 a month.  (That's what a largish apartment around here might run).

Alternatively, suppose you owned a small house about the size of that apartment.  You'd have a few expenses that the renter doesn't have:  property taxes, insurance, maintenance, water, sewer, garbage, etc.  If those add up to, let's say, \$400 a month, then owning a house is worth \$750 minus \$400:  \$350 a month.

Note that this is true whether you've got a mortgage on the house or not.  Just like having some credit card debt doesn't change the value of the clothes or TV or BBQ grill that you might have charged, the value of your house is unrelated to the structure of any debts you might have.

A financial calculator can crank out a value for a \$350 stream of income.  Depending on the value you pick as the relevant discount rate, that stream of income is worth around \$60,000 to \$65,000.  (I used 6.5% as the discount rate.  You also have to plug in a number for how long the stream of payments goes on, but the payments in the distant future are discounted away to a vanishingly small value--a stream of \$350 payments that goes on for 100 years is only worth a couple thousand dollars more than a stream that only goes on for 50 years.)

Now, around here, a house comparable to a \$750/month apartment (2 bedrooms, 1 bath, 1000 sq ft) could just about be had for \$65,000--but only if it had serious problems.  It would probably have a serious maintenance backlog or be in a bad neighborhood, or else it would cost more.  (This is a big part of the reason that I rent rather than owning a house.)

## Non-finanacial aspects

You can't write in praise of renting without getting a lot of comments from people who think that renting amounts to stuffing their money down a rathole.  You write checks month after month--possibly for years--with nothing to show for it.  On the other hand, if you buy, you end up owning something.  There's some truth to that, but it's worth being clear about what, exactly you do own.  Specifically, you own the items listed at the beginning:  You can sell it, mortgage it, live in it, or rent it out.

There are, of course, other advantages to living in a house:  You have more privacy, more control of your living environment, more options in terms of size and amenities, and so on.  But you don't own those things--those things you pay for just like rent.  That is, the money you pay this month pays for this month's privacy and control.  (Because, remember, owning a house also ties you to the neighborhood.  If a creepy guy moves into the apartment next to yours, you can always move when your lease runs out.  But if a creepy guys buys the house next to yours, you can lose a lot of privacy and control at exactly the same moment having that neighbor makes it a lot harder to sell your house.)

ARTICLE CONTINUES BELOW

being tied into your neighborhood can have an upside as well--you're in a community.  But, then, some apartment buildings have a community as well, even if most of them don't.

## Principal and interest

Note that we haven't talked about actually paying the mortgage.  As I said, that's really a separate issue.  Your house is worth the cost of the rent that you don't have to pay, adjusted for the extra expenses that fall on a homeowner.  The mortgage and interest are what you have to pay to get it.  (In the United States the interest payment is tax advantaged, which makes the effective cost a bit harder to figure out, but that's just a detail.)

If what you have to pay is less than what the house is worth, it's a good deal financially.  If what you have to pay is more than what the house is worth, it's a bad deal financially.  It's that simple.

## Accumulating wealth

People seem to be strongly motivated by the idea that the money that goes toward their mortgage is going to buy something that they own, whereas money that goes toward rent is just gone.  I think looking at homeownership that way just confuses people.

Your house is worth what it would cost you to rent an equivalent place or what you could get for it if you rented it out (adjusted for the expenses of home ownership).  That's true whether you own it outright or have it mortgaged to the hilt.  (Of course, if you have a mortgage you owe a large debt, but that doesn't affect the value of the house.)

Your apartment, of course, is worth zero.  But if it's cheaper to live in an apartment than it is to live in a house--and it often is--then the apartment dweller has surplus cash to invest, and therefore can accumulate wealth.

One thing I've left out of this calculation is "appreciation" in the value of the house.  If the price at which a house can be sold grows faster than other investments grow, then home ownership can win in a big way.  But, as is now clear, there's no good reason to assume that such outsized growth can be expected.

## No ratholes involved

Whether a house is a good deal financially or not is important, but it's not the only factor.  The non-financial aspects are also important--in fact, they are often the determining factors in people's decisions to buy a house.  If you want to buy a house because you find one you want to live in and can afford, then by all means do so.  But if you've previously been misled by the fuzzy notion that money spent on a mortgage is money "invested" but that money spent on rent is money "down a rathole," now you know how to do a valid analysis.

ShareThis

22 discussions

This test helps prevent automated spam submissions.

Many people assume that renting is worthless. For me, since I can write off my home office, I get a deduction for my taxes, while losing the home interest deduction. So as long as I pay below "market" for a house it is a wash. I think if you can find something to rent you only lose about 10% of the savings and you get the flexibility of being able to move without losing the 6% to a realtor and having to wait around for the house to sell.

Right now our mortgage payments (with ins & tax) is less than we could rent even a smaller house for in an ok neighborhood. Rent where we are is really quite high if you want to live somewhere that isn't rundown and crime ridden. So even with maintenance and other homeowner expenses we end up paying less or breaking even.

The real benefit is that if something is broken we can fix it. When we rented we had constant problems, even in nice properties, getting a landlord to fix things.

The one downside I see with owning is that people move around more than they used to. In some circumstances you end up taking a loss if you sell too early in the loan combined with house prices if you catch them on the down trend.

@Lucille:

It's certainly possible--it depends entirely on local prices in your area.  Do make sure that you're including the entire maintenance burden--each year's share of large future expenses such as a new roof, new furnace, new air conditioner, new appliances, doors, windows, painting, floor coverings,  etc.

Other values to your home (whether it is an apartment that you are renting or a single-family house that you own or have a mortgage on) that you could consider are the costs you incur or avoid based on proximity to work, entertainment, friends, family, grocery stores, exercise and recreational opportunities, and schools. (Philip covers that regularly but I thought I would mention it again.)

And for those who have children attending school, being able to attend a high quality school in the neighborhood or have public transportation to such as school is another factor that impacts cash flow (and home values), so that you can avoid paying private school tuition, outside tutoring fees, etc.

@Julie:

All good points.  Those sorts of issues--travel to work, access to shopping and entertainment, etc.--are really orthogonal to whether you own or rent.  (They're a function mainly of your address.)  In any particular place, of course, some neighborhoods will have lots of rentals a few opportunities to buy, and other neighborhoods the reverse.

In fact, that sort of selection limitation is a major issue.  Around here, for example, it's pretty easy to find an apartment that's roughly equivalent to a small house, but there are very few that would be equivalent to a large house--if you want 2000 sq ft, there aren't many apartment options.

I always find this sort of analysis useful and enlightening. One thing I will add though is that as a long-time renter, I rarely had the opportunity to be more self-sufficient by gardening and never by keeping animals, as I do now as a homeowner. Landlords don't tend to allow renters to do much with the yard, at least in the various places I lived. Right now we derive a very significant financial benefit from our property by gardening, keeping hens and from the very large old apple tree that came with the property. We're now spending much less than \$100 per month to feed two adults. This is only possible because we have the garden and the hens. I would have to figure this into our valuation of our home.

@Kate:

Exactly.  This is what I meant by "control"--the ability to make your own decisions about such things as keeping animals.    (And this is the reason I continue to think about buying a house, even though where I live, renting is cheaper.)

Philip, I largely agree with you. There is one important aspect you didn't touch on: inflation.

I just bought a house. Even though I got a good price and a good interest rate on my loan, I still pay substanitally more each month than I would to rent a equivalent house.

However -- and this is the important part -- rent tends to increase each year. My mortgage payment will not. So 10 years from now, I expect my mortgage payment will be lower than the rent on a similar house. 20 years from now, I expect my mortgage plus home-upkeep expenses will be lower than the rent on a similar house.

@Guest
It's true that your mortgage payment stays fixed (assuming a fixed-rate mortgage), but that doesn't mean your total housing costs are fixed. Property taxes, utilities, and maintenance costs continue to rise with inflation. In my case, my property taxes have almost doubled in the 20+ years I've owned my house. Water, power, garbage hauling, insurance, and other costs have risen at least as much. My housing costs increase every year, even though my mortgage doesn't.

From my point of view I always look at the debate in terms of retirment planning. I am currently thirty and I should (all being well) be mortgage free in about 15 years at the most. This means that for the following 15 years I'll be able to put considerable sums away for my retirement (or more likely, enter a long period of semi-retirment straight away). On the other hand, if I were to rent, this period of reduced outgoings will never arrive.

The UK has been a very pro-ownership culture for the last 50 years, and I don't really see that changing much.

Awesome post, as usual.

Another point is that buying a house adds to your diversity. If I had rented I would have been able to save more money each month (even now, after 12 years with a fixed-interest loan, surprisingly). But where would I have saved it? The same places I'm saving all my other money: stock funds, REITs, CDs/high-interest checking accounts. I like that if my taxes get too high for me, because my house has become too valuable, then if I have to move, at least I get a big pile of money (from selling my extremely pricy house).

I usually suspect I would have been better off renting and saving the extra money, though. Especially as the things that I don't like about my house start to drive me nuts. When you move all the time, the annoyances change. But now I want to renovate to fix those annoyances. (I want a dishwasher. And a dryer. And shaded parking that's off the street, for both cars. Even though no one really needed these things back in the 1950s when my house was built.)

Which leads me to another issue: decorating costs. People usually spend way more decorating something they own than something they rent (which they are usually not allowed to paint, etc., anyway). Ideally, moving less, I'd buy less furniture, because I'd always have stuff for the place I'm in, but if you keep switching roommates, or you keep buying more stuff, your needs change anyway.

Good analysis. I would suspect for most people the financial aspect of owning vs. renting is secondary, however.

This is an interesting analysis of home ownership for short-term financial planning, but I think it's overly simplistic when taking a long-term view. Most seniors squeak by on their social security checks and retirement savings only because they purchased modest homes 30-50 years ago and paid off the mortgage. Yes, they must pay property taxes, insurance, and do maintenance, but those usually cost far less than renting. Sure, renting may be cheaper in the short term, but how many people are -really- disciplined enough to put the extra savings aside and invest it wisely so it grows through bull markets and bear?

Furthermore, with all the corruption coming to light in the financial markets, what's to stop those "safe" investments you made while renting from imploding along with the rest of the market and leaving you out on the street? Or evaporating from runaway inflation? Who can guarantee social security will be there (or keep up with inflation) when you 30-somethings retire as Congress has been borrowing against the social security trust for decades to provide tax breaks to the wealthy?

If you live in a real estate "bubble" area where housing bears no relationship to salaries (such as San Francisco Bay area), then renting may be attractive. Otherwise, I'll take home ownership any day. Home ownership may not be glamorous once you eliminate buzz about long-term capital gains deductions and "house flipping" for profit, but at least you can live in it, plant a garden, raise hens, and clean up deadwood to burn in a wood stove for heat (things a landlord would never permit) and trade home-grown veggies to pay your property tax bill while the rest of the economy implodes.

This, of course, assumes you buy a -modest- home and pay it off as soon as you are able and not a McMansion with an exotic mortgage...

I miss renting. I'm such a bad house-keeper and maintainer than I long for the days when I didn't have to lug garbage cans to the curb (mind you, my curb is pretty close), pay a separate water bill, or fix appliances when they break. I do love being able to paint my home whatever color I want, but sometimes, I would relish having less responsibility and more disposable income.

Plus, my mortgage is pretty hefty.

@Kevin:  It's fine to buy houses for the non-financal advantages of home ownership.  A lot of people, though, having decided that they'd rather live in a house they owned than rent, then try to justify their decision with a faulty financial analysis.  I say, do a proper financial analysis, and if you still want to go with the less-advantageous choice for non-financial reasons, that's perfectly fine.  It's the "fooling yourself" aspect that bugs me.

@Anna_esq:  I suspect that the people whose home ownership spending is really "far" less than the cost of renting are probably skimping on something.  I've seen more than a few homes owned by elderly people on fixed incomes with a lot of deferred maintenance.  (It's actually worth acknowledging that as a plus for home ownership.  Unlike a renter, who will be evicted if he stops paying his rent for even a few months, a home owner in financial trouble can suspend payment of a large fraction of the costs of home ownership--potentially for years--and still have a place to live.  Of course, its value as an investment will decline rapidly, and someone will eventually have to make up all those missed payments.)

Two things to consider:
1) I think families can benefit from the non-financial aspects of home-ownership.

2) I've seen time and again where an income-based analysis of home values encourages owning dilapidated properties. That's where personal values have to kick in.

Well As Robert Kiyosaki says it's not an asset unless it's bringing in money..
i guess with the melt down in the states we really found that out.

Something that make it unnecessary to spend money (the way owning a house makes it unnecessary to pay money for rent) is also an asset.  But it's only worth the avoided expense.  A house that avoids \$1000 in rent but that costs you \$1100 in ownership-related expenses is no asset.

We live in a suburb outside of New Orleans. Our market is very different from anyplace else in the country now. I was an apartment dweller until I married 10 years ago. We purchased a huge estate sale fixer upper. That became a five year project. I insisted that we sell at that point: you haven't made the money until you sell the asset, right? We did make about \$80K after expenses were taken out.

We rolled that into a property in a better neighborhood in January '05. Along came Katrina in August of that year. We didn't have any flooding or house damage, just fence damage. Despite this, our insurance co. dropped us after raising our rates. We are now paying double for homeowner's insurance.

Many, many houses have been on the market for a year or more. It's different here - it's not foreclosure, these are people trying to get out of the catastrophe zone.

Despite this, the property tax assessment for our home has gone up \$40K. We're going to pay an extra \$800 in taxes this year. I'd like them to send the buyer on over that would pay anything like the assessment; they can have it!

It's like being nibbled to death by ducks.

I'm wishing I was still a renter right about now.

The large house where I grew up 20 years ago saw its property tax increase from about \$3,000 to over \$12,000 in the last 20 years.

Mom sold it for \$550,000 back then, and it recently sold for \$1.1 million.

I'd hate to think what property taxes will be on it 20 years from now.

One factor you didn't bring into your discussion was that the portion of your housing costs comprised by your mortgage payment is fixed for the term of the mortgage, whereas your lease is subject to annual increases. Maybe you could do an analysis of that using a present value analysis. (I won't do it right now because I'm too busy with other stuff)

Thanks for the interesting article.

to the poster in the "katrina" zone who wrote:

"Despite this, the property tax assessment for our home has gone up \$40K. We're going to pay an extra \$800 in taxes this year. I'd like them to send the buyer on over that would pay anything like the assessment; they can have it!"

That's when you have to demand a reduction in assessment. Find out the legally admissable methods of assessing your property for tax purposes, both on the local and state level. If the city doesn't adhere to them in your case, bring a suit at the state leve. If you don't want to do this as an individual, consider forming a citizens' committee to sue the city in your state's land court. Generally, cities get away with this kind of stuff because most citizens will "roll" and won't attempt to hold the city to the letter of the law.

The lawsuit may cost you 10,000 dollars, but if you get a group of citizens together and file it as a class action suit the cost goes way down.