Houses have long enjoyed the reputation of being a good investment. Many people consider their home to be their first - and probably their biggest - investment of their lives, and many young couples (and, increasingly, individuals) spend the first several years of their career "saving for a down payment." There is a societal push toward owning a home, and having a mortgage under your belt brings with it a new status (that of a "home owner" rather than a "renter," with the former being superior to the latter) and the promise of having landed for yourself a "good investment."
But the truth is that, from a purely financial perspective, a home is generally anything but a good investment. And when we're dealing with dollar amounts that demand a third of our paychecks, it pays to look at the thing through personal finance lens, and understand why they're not great investment vehicles:
Appreciation Equals Inflation
Outside of the housing boom of the late 1990's and early 2000's, houses really don't earn their owners that much. And though homes may have made people a lot of money during the housing boom, they caused tremendous losses for their owners during the subsequent housing bust in the last few years. This collapse of house values was actually thought to be impossible by the same people who have historically pushed home ownership as a good investment. Homes, in their entire history, barely outpace inflation. (By contrast, in every 30-year period since 1928, the stock market's average annual return has beaten inflation by at least 4 percentage points and typically by 7.) (1)
If a house will earn you inflation, it's essentially a savings account. It seems that mortgages may have been attractive to people and encouraged by society because they act as a "forced savings." However, you don't need a mortgage to build equity - in fact, if you have the discipline to allocate a third of each paycheck to better investments (that don't have contractual obligations), you could build the same $300,000 in equity in fewer years - and buy a house for cash faster than you'll own a mortgaged one outright.
Non-diversified
If you allocate the "recommended" third of your paycheck to your mortgage, you've signed over a third of your income over 30 years to one single investment vehicle. So what happens to 30 cents of every dollar you earn for thirty years, and how much you make from it, will be tied to the performance of just one asset. Would you ever allocate that much of your money to a single stock?
Illiquid
When you've decided to sell some stocks or bonds, it takes less than ten minutes - even if it's $300,000 worth. When you decide to sell your home, however, it will never, ever happen that fast - unless you're willing to take a loss. When you're ready to sell your house, it takes months to find a willing buyer. And though this is largely accepted as the way real estate market works, it becomes an issue if people ever need to relocate - or simply get their money out - quickly. In this situations, homeowners will often be forced to take a hit.
Transaction Costs
Not only can we sell that $300,000 of stocks in less than ten minutes, it only takes $7-30 to do the transaction. You could never expect to get through buying or selling a home that cheaply. After inspections, legal fees, application fees, land transfer costs, movers and the myriad of other charges, buyers end up paying far more for their home than is ever discussed. In fact, according to a study, "buyers who sold within four years of purchase on average paid 19 percent more as owners than they would have paid as renters. For these short-term owners, transaction costs averaged 23 percent of their total costs of owning." (2)
Opportunity Costs
This is obvious and goes without explanation for those that recall the concept from economics courses: if you're allocating a third of your paycheck to your mortgage, you can't invest it in other (and potentially more lucrative) opportunities. So even if you hear about a great stock, your money is already tied up in your mortgage. You can't change course and switch strategy from month to month or even year to year as the economy evolves to offer new opportunities.
So Why Buy?
Because home is where the heart is! A home will forever inspire in us, as a society, emotions of security, comfort, and consistency. We recall our own childhoods; summers spent at Grandma's, playing horses in our fathers' carefully manicured lawns. We will never stray far from the tradition of home ownership; mortgages represent "building a life" and becoming adults. Home ownership still yields the same status over renters, and does still help us build a little equity as we age.
But, this is my hope: though we are understandably reluctant to dissect our connotation of home ownership and separate our emotions from the financial aspect, if we take a moment to consider it from a strictly "personal finance" perspective, we might collectively come to admit that houses are, ultimately, not a good investment. And that while many of us will continue to own homes in order to build our lives and raise our children, we might do so by allocating a little less to our mortgage and a bit more to other - better - investments.
(1) MSN Money - http://articles.moneycentral.msn.com/Banking/HomebuyingGuide/the-3-worst-reasons-to-buy-a-house.aspx
(1) National Multi Housing Council - http://www.nmhc.org/Content/ServeContent.cfm?ContentItemID=534
But the truth is that, from a purely financial perspective, a home is generally anything but a good investment. And when we're dealing with dollar amounts that demand a third of our paychecks, it pays to look at the thing through personal finance lens, and understand why they're not great investment vehicles:
Appreciation Equals Inflation
Outside of the housing boom of the late 1990's and early 2000's, houses really don't earn their owners that much. And though homes may have made people a lot of money during the housing boom, they caused tremendous losses for their owners during the subsequent housing bust in the last few years. This collapse of house values was actually thought to be impossible by the same people who have historically pushed home ownership as a good investment. Homes, in their entire history, barely outpace inflation. (By contrast, in every 30-year period since 1928, the stock market's average annual return has beaten inflation by at least 4 percentage points and typically by 7.) (1)
If a house will earn you inflation, it's essentially a savings account. It seems that mortgages may have been attractive to people and encouraged by society because they act as a "forced savings." However, you don't need a mortgage to build equity - in fact, if you have the discipline to allocate a third of each paycheck to better investments (that don't have contractual obligations), you could build the same $300,000 in equity in fewer years - and buy a house for cash faster than you'll own a mortgaged one outright.
Non-diversified
If you allocate the "recommended" third of your paycheck to your mortgage, you've signed over a third of your income over 30 years to one single investment vehicle. So what happens to 30 cents of every dollar you earn for thirty years, and how much you make from it, will be tied to the performance of just one asset. Would you ever allocate that much of your money to a single stock?
Illiquid
When you've decided to sell some stocks or bonds, it takes less than ten minutes - even if it's $300,000 worth. When you decide to sell your home, however, it will never, ever happen that fast - unless you're willing to take a loss. When you're ready to sell your house, it takes months to find a willing buyer. And though this is largely accepted as the way real estate market works, it becomes an issue if people ever need to relocate - or simply get their money out - quickly. In this situations, homeowners will often be forced to take a hit.
Transaction Costs
Not only can we sell that $300,000 of stocks in less than ten minutes, it only takes $7-30 to do the transaction. You could never expect to get through buying or selling a home that cheaply. After inspections, legal fees, application fees, land transfer costs, movers and the myriad of other charges, buyers end up paying far more for their home than is ever discussed. In fact, according to a study, "buyers who sold within four years of purchase on average paid 19 percent more as owners than they would have paid as renters. For these short-term owners, transaction costs averaged 23 percent of their total costs of owning." (2)
Opportunity Costs
This is obvious and goes without explanation for those that recall the concept from economics courses: if you're allocating a third of your paycheck to your mortgage, you can't invest it in other (and potentially more lucrative) opportunities. So even if you hear about a great stock, your money is already tied up in your mortgage. You can't change course and switch strategy from month to month or even year to year as the economy evolves to offer new opportunities.
So Why Buy?
Because home is where the heart is! A home will forever inspire in us, as a society, emotions of security, comfort, and consistency. We recall our own childhoods; summers spent at Grandma's, playing horses in our fathers' carefully manicured lawns. We will never stray far from the tradition of home ownership; mortgages represent "building a life" and becoming adults. Home ownership still yields the same status over renters, and does still help us build a little equity as we age.
But, this is my hope: though we are understandably reluctant to dissect our connotation of home ownership and separate our emotions from the financial aspect, if we take a moment to consider it from a strictly "personal finance" perspective, we might collectively come to admit that houses are, ultimately, not a good investment. And that while many of us will continue to own homes in order to build our lives and raise our children, we might do so by allocating a little less to our mortgage and a bit more to other - better - investments.
(1) MSN Money - http://articles.moneycentral.msn.com/Banking/HomebuyingGuide/the-3-worst-reasons-to-buy-a-house.aspx
(1) National Multi Housing Council - http://www.nmhc.org/Content/ServeContent.cfm?ContentItemID=534
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