Your home isn’t an investment. Before you start emailing me your Zestimate® and talking about all your “gains”, I’ll concede that 2008 would’ve been a better time to make this argument. After all, the index that tracks national home prices (Case-Shiller) is pushing all time highs. There’s a guy in Austin, TX who offered to buy the seller’s next house. A $275,000 fixer-upper in DC had 88 offers in four days, 76 of which, were all cash. The state of the housing market is about as crazy as the AMC CEO offering his Robinhood investors free popcorn through the summer. You’d be forgiven for asking yourself, “what is going on!?!”
Despite the state of the real estate market, I still maintain that your home isn’t an investment. Notice I didn’t say real estate, but your home. Hear me out.
Real estate has been one of the best performing asset classes so far this year (through the end of July). Which is why it is important to differentiate between broad real estate investing and your primary residence. There are two ways to look at this: the math and the motive. Let’s start with the math.
Assume you bought a house for $500,000. After five years, the home value increased to $590,000 (20-year average annual increase at 3.4%). Let’s also remember that the growth rate is worse when you factor in inflation. But you might think to yourself, “wow, I made $90,000”. Except you forgot that your equity is based on the value of your home minus the mortgage balance.
After five years, your mortgage balance would be around $359,000 (assuming 20% down-payment on a 3.5% 30Y fixed rate mortgage). Now you might be thinking, “wow I made $231,000”. But in the words of College Football Analyst Lee Corso, “uh uh uh, not so fast my friend.” What about all the money poured into that house over the years? Let us count the ways:
• Down payment | $100,000
• Mortgage payments | $108,000
• Property Taxes | $23,000
• Maintenance | $27,000
• Insurance | $16,000
• Total | $274,000
• Not having to deal with shared apartment walls | Priceless
All in all, you spent $274,000 over 5 years to “make” $231,000”. For those of you who bought Pets.com stock in the early 2000s or held onto Bitcoin through 2018, this isn’t too bad. You could have done worse.
This isn’t meant to dissuade you from homeownership. My wife and I bought our first home in 2015. Sometimes it isn’t great. I’m not a fan of replacing water heaters or dealing with groundhogs digging holes under the fence. As the saying goes, “the grass isn’t always greener on the other side” (humble brag, my grass is definitely greener than our neighbors). But, we love being homeowners and there are definitely more positives than negatives. The point is that the math doesn’t look too favorable for considering your home as an investment. But that’s okay, because it shouldn’t be. Since the math doesn’t work, let’s consider motive.
The single biggest reason why a home isn’t an investment, is that the primary purpose of a home isn’t to appreciate in value, but to provide shelter. On its face, it doesn’t sound like that big of a deal, but one of the more important elements that defines an investment is the timing and purpose of ownership. In most cases, you buy a house when it is needed for shelter, then sell when it no longer serves that purpose.
It is true that homes generally increase in value, but tapping into that value isn’t exactly easy. The easiest way would be to sell your house, but then you’re stuck with finding another house (see shelter rationale above). If you don’t wish to sell, you could set up a line of credit based on the equity. But you’re not really tapping into the equity, just borrowing against it. A third option is a cash-out refinance, but you’re effectively refinancing a mortgage (and assuming all the expenses that come with it) just to get access to the equity. Not terribly efficient.
I’ll wrap up my argument by revisiting our earlier example. The carrying costs of your home are simply too high for it to be considered an investment. Property taxes, insurance, utilities, mortgage insurance (sometimes), and routine maintenance all eat away at the perceived “gains”. Investments don’t typically require that kind of cash outlay. You can always rationalize that the above-mentioned outlays are necessary because the house provides shelter. But then we’ve just come full circle – a home provides you shelter and should not really be considered an investment.
I can’t remember the Charles Dickens quote exactly, but I think it was something like “it was the bubbliest of times, it was the frothiest of times, it was the age of sub-3% mortgage rates, it was the age of foolishness…” The real estate market certainly has felt this way over the last couple of years. If considering a real estate investment, all of the above carrying costs should be considered in addition to other investment rules of thumb (namely, diversification). Rather than investing in a single condo, house, or lot, typically you can better manage the risk and expenses, and improve returns, through other avenues.
Real Estate Investment Trusts (REITs) are excellent vehicles for a diversified real estate exposure that covers a variety of types of real estate (commercial, industrial, retail, cell towers, data centers, etc.) and geography.
If you’d like to learn more about diversified real estate opportunities, feel free to reach out to our offices. We’re grateful for you and the opportunity to serve as your wealth manager.