Home Ownership: Good Financial Decision; Horrible Investment

Is home ownership a good investment? I guess it comes down how you define an investment. If an investment is something you put money into hoping to get more money out of it, then no. It's probably one of the worst investments you can make. However, it is still a pretty damn good use of your money if you can swing it. This probably calls for some explanation.

Compare home ownership to stocks. Stock purchases should be among the coldest, most rational decisions you make. Run the numbers and make some estimates. Buy the stock if you think it will appreciate over the timeline you're considering. If events prove your assumptions were wrong, sell that sucker. The worst thing you can do is become emotionally attached to a stock. Some people buy Apple because they think it's a money maker. Some buy it because, gosh darn it, they just like the company. Good luck making money off warm feelings. Letting your emotions take over your stock investment strategy will be the death of it.

This illustrates the first difference between home ownership and stocks. Note that I'm talking about your primary residence, the only home most people will ever own. If you're a house flipper or a real estate magnate, then buying and selling homes is your business and it works like any other business. Personal residences, however, are much messier. For starters, making money isn't and can't be the first thing on a home buyer's list. You want a nice neighborhood with good schools. You want convenience to amenities. You want a decent commute to work. All of these things are of course of value to real estate investors, but solely in terms of the effect on rental or resale values. If you live in your home, then it's your kids and your work that matter and you might be willing to give up some resale value in exchange for something that works better meeting the non-monetary needs of the here and now. 

And then there is the emotional attachment to the home itself. A true investor who isn't going to live in the home will buy a house built next to a hog rendering plant if he or she things some money can be made out of it. You, on the other hand, don't just want a house. You want a home. It's impossible for that to really work as an investment in a traditional sense. That's okay.

Houses also pose a liquidity problem. In the financial world, an asset is more or less liquid depending on how easy it is to buy and sell. Cash is the most liquid thing of all. Real estate tends to be on the other end of the spectrum. Even for those who make it their business to buy and sell real estate, exchanging properties takes a lot more time than buy and selling just about anything else besides whole companies. This situation becomes even more complicated if you're living in the place. As I mentioned above, if an asset is truly an investment, then you have to be ready to sell it as soon as the conditions call for it. Can you really do that with a house? What about the kids? Where will you move to? You get the idea. Houses aren't liquid, especially for those who live in them.

Finally, we have to ask what kind of investment return we should expect to get on a house. Perhaps we should start by asking, who would you expect ANY investment to give you more money back than you put into it. Who's giving you that money? Well, in the case of a company stock, the basic idea is that the company gets some money and uses that generate new value by selling more crap or whatever. You get a share of the proceeds. There are lots of other complexities, but that's the notion that drives the system we call capitalism, right? A house, however, just sits there and grows old. It only generates value on its own if you rent it out or if you make some improvements, though in the latter case the value you get from home improvements is rarely more than break-even with the cost of doing the improvements unless you do it yourself. Another alternative would be running a business out of your home. 

Why do home values increase, then? Like everyone's uncle says, they aren't making any more land. Population goes up and those kids need a place to live. Certain areas become more desirable and squeeze the available housing stock. These are important things to consider when buying a home, but it's also important to remember that they have nothing to do with the house itself and are largely out of our control. Hoping to make a profit off the changing market conditions around the house is speculation, not investment. There's nothing wrong with that and real estate developers do it all the time. But they know how to do it and are willing to cut their losses and pull out when reality turns out to be different. 

Also, there is the little problem of home loans. In order to really make money off of real estate, you either have to pay cash or get value in excess of the loan rate. I think a lot of homeowners forget this. They see their value go up 5% and think they just made a 5% rate of return. Factoring in the 4.5% interest rate of the home loan, however, more or less erases any real returns. It is a very lucky person indeed that experiences home values going up a fast enough to make serious cash once the loan is taken into effect. Most people who come out on top are those who sell long after they've repaid the loan. And with that statement we get to our turning point.

This all sounds bad. Why would anyone buy a house? For starters, you've got live some place. I once read an article by someone who argued that if they took the amount of money they would've spent on a mortgage and put it into stocks, they'd make a lot more in return. Duh, but where are you living dude? Maybe he thought he'd just stay in his mom's basement. It all comes down to comparing apples to apples. Don't compare home ownership to investments, compare it to the other options for living space. Home ownership usually beats the pants off renting in the long term. The apartment I rented in Brookline for $1600 a month twenty years ago probably goes for $3000 a month or more now. If I'd been able to buy it with a $1600 a month mortgage, I'd be paying the same today, of course. And once it's paid for, I'd be living there for free.

My point is that an increase in home values usually don't MAKE you money, but it does usually SAVE you money in the long run, given that finding a place to live is a fact or life. I had a co-worker who bought a place in Woburn for about $184K in 1982. That place is worth over $700K now. That's pretty good. But we have to take into account inflation, which makes $184K in 1982 dollars $487K in today's dollars. Her initial loan rate was 14%, which is astronomical in today's world but pretty standard back then. I'm sure she refinanced to a better rate, but there were still some years at that high rate. Oh and let's no forget nearly 40 years of home improvements totaling to over $100K... you get it.

Nonetheless, her house was paid for. Renting that house in Woburn would probably cost four or five thousand dollars a month. Or more. I can't even begin to guess, really.

I think this simplifies things considerably. It allows us to breathe a bit easier. Rather than trying to figure out resale value on our homes, we should find a place we like in a good neighborhood and rest assured that so long as the home value keeps pace with inflation and the home loan rate, we'll be okay. Even if all we do after 20 or 30 years is break even, we're still better off in most cases with that fixed monthly mortgage rate than leaving ourselves to the whim of ever rising rental markets over the same time period.