Is Your Home Really an Investment?
Real estate agents, loan officers, and your parents have probably all told you that buying a home is a great investment that will lead to returns later in life.
But the reality is that your profits from selling your primary residence are likely to be fairly small—if they materialize at all.
Real Estate Appreciation and Inflation
The first thing to consider is home appreciation in context of inflation. You might be surprised to realize that the appreciation of your home can be offset by inflation. This is especially true if you don’t live in a hot real estate market. We hear dramatic stories of appreciation in certain areas of the country, but most people buy homes in areas where annual appreciation probably won’t beat out inflation by much.
In September 2007, according to the Federal Reserve Bank of St. Louis, the median sales price for new homes sold in the United States was $240,300. In September 2017, that number was up to $319,700. However, when you run some numbers using the U.S. Inflation Calculator, some of that appreciation disappears. Rather than seeing $79,400 in appreciation, the actual value of that appreciation is closer to $33,648.
That still doesn’t seem too bad. After all, your home’s value has increased by more than $30,000. But let’s not forget about costs.
Owning a Home Comes With Additional Costs
Next, you need to subtract the costs of homeownership from your gains. Let’s say you get a mortgage for $250,000 at an interest rate of 3.92 percent. Over the course of 30 years, according to Google’s mortgage calculator, you will pay $175,533 in interest. Even if your home appreciates by an inflation-adjusted $30,000 every 10 years (totaling $90,000), that’s still not enough to offset the interest you pay on the loan.
And the interest you pay isn’t the only cost you face. Remember that you pay property taxes in most states. Student Loan Hero’s mortgage calculator includes a property tax calculation. If your property tax amounts to 1.5 percent a year, you could see a total tax payment of $117,000 over the course of 30 years. And that assumes no property tax increases—as your home appreciates in value, so do your property taxes.
It’s true that you can deduct some of your costs on your tax return, but a deduction doesn’t have the same value as a credit. It can lower your income and your tax liability, but not on a dollar-for-dollar basis. Besides, according to the Tax Foundation, only about 30 percent of households itemize. Unless you’re among those who itemize, you won’t see any tax benefit related to your mortgage.
Other costs related to homeownership include maintenance and repairs, as well as homeowners insurance. You might also have to pay mortgage insurance if your down payment is less than 20 percent. By the time you factor in decades of these costs, added to your mortgage interest and property taxes, the chances of even breaking even are fairly small—even if your home does appreciate in value over time.
What If You End Up Selling Unexpectedly?
We like to think that the real estate market will always go up. However, as we saw between 2007 and 2009, real estate can form a bubble like any other asset. The bursting of the real estate bubble created a situation in which thousands of people ended up losing a lot of money. If you can ride out a price decline, you might not lose as much.
However, if you are forced to sell during a real estate market crash, there’s not much you can do to salvage the situation. You could end up losing money on your home, on top of what you’ve already paid in interest, taxes, and other costs.
What About Renting?
Of course, as imperfect an investment as buying can be, it’s possible to point out that renting might not be the solution. After all, when you make mortgage payments, you at least build equity in your home. When you rent, you’re helping your landlord build equity.
However, that doesn’t mean that renting should be avoided at all costs. Depending on your market, renting can be a good choice, even if that means you aren’t building equity.
That’s especially true If you live in an area with high home prices, and you can rent for less than the monthly aggregate costs of mortgage, maintenance, and other costs. Not only are you saving money on a monthly basis, but you can then invest the difference in the market and potentially realize a greater appreciation than you would have gotten from your home investment.
Between November 2007 and November 2017, the S&P 500 had an annualized return of 9.672 percent, adjusted for inflation. Let’s say it would have cost you $1,100 a month to own a home during that period, but instead you lived in an apartment with a monthly rent of $700. If you invested the $400 difference between renting and buying each month over those 10 years, the value of your investment would be $83,587.81.
There’s also the fact that renting means you don’t lose a bunch of money if you’re forced to sell your home during a downturn. On the other hand, if you manage to stay in your home and ride out market events and real estate downturns, you can build enough equity in your home that it can be used during retirement. Even if you only break even (or even if you lose overall) on the home, it can be a forced-savings vehicle that has the potential to provide you with a large amount of capital when you sell.
It can also be a place to live rent-free in your retirement years (you might still need to pay property taxes, however), or you can use a reverse mortgage to access the equity in order to close a retirement income gap. You won’t see those options when you rent.
When Buying a Home Is an Investment
Rather than viewing your primary residence as an investment, consider other reasons to buy. Perhaps you want a place to call your own, build equity, and put down roots in a community. These are all good reasons to buy! Conversely, if you think you will have a more mobile lifestyle, it can make more sense to rent, even if you aren’t building equity. As long as you make other provisions for planning for your future, renting can be a viable option, depending on the local market and your long-term lifestyle goals.
Finally, if you want to turn your home into a true investment, you need to do something other than live in it. Renting it out after you move or using it to make money via Airbnb can be ways to actually see a return on your home purchase.
But if you’re just living there, don’t count on it providing big investment returns.