A House Is a Home, Not an Investment

The Owner's Money

At the end of a visit with friends a while ago, I took a little tour through the house to count the rooms that had gone unused through the long weekend.

There was a finished game room in the basement, a kids’ playroom on the second floor, the second guest room, a sitting room and formal living and dining rooms — all unvisited for three days while the seven of us hung out in the family room and kitchen. Finishing my tour, I found four big air-conditioning units humming beside the house, each as big as the single unit that cools my own home quite nicely.

Now, our friends are very successful small-business owners, and they can afford this house. But, wow! There’s a lot of money committed to owning and maintaining this palace — money that could be invested elsewhere, put back into the business or kept in reserve in case the business hits a rough patch. Is the home really a good enough investment to justify such expense?

We often hear that the home is our “biggest investment.” But there’s a good case to be made that a home isn’t an investment at all. On a purely financial basis, owning a home is generally more profitable over the long term than renting. But I believe an expensive home is generally not as good an investment as an inexpensive one — not considering the alternatives.

The problem is our views of our homes are muddied by their dual functions, as places to live and as financial assets. If it’s pleasing to come home to, we tend to settle for a careless financial analysis.

Over a lifetime, ownership pays off because a fixed-rate mortgage freezes your principal and interest costs, while rent would rise with inflation. In normal times, owning beats renting if you expect to keep the home past a break-even period of four or five years, when appreciation would outstrip the sales commission and other selling costs.

Since these aren’t normal times, it’s prudent to stretch that period to six or seven years. At the higher end of the market — with homes costing, say, $750,000 or more, depending on where they are — the break-even period could be even longer, as this market doesn’t seem to be bottoming out as quickly as the low end.

Assuming you will stick around, and that the market will return to normal, why not buy the most expensive home you can afford? The more you invest, the more you gain from appreciation, right?

In fact, appreciation is not all that great. The Yale economist Robert J. Shiller has found that U.S. homes tend to appreciate at about 1 percentage point a year above the inflation rate. Stocks, measured by the Standard & Poor’s 500, tend to beat inflation by 6 or 7 points.

Census Bureau figures show that from 1960 to 2000 the median home price rose from $11,900 to $119,600 — about 10 times. During the same period, $1 invested in the S.&P. 500 would have grown to about $92, according to this calculator. (Neither figure is adjusted for inflation or taxes. Reinvested dividends account for more than 40 percent of S.&P. 500 returns.)

In real life, the discrepancy is even greater. In 1960, mortgage rates ran about 6 percent, close to today’s level. Interest would have doubled the cost of purchasing a home, cutting the 40-year gain in half to five times the purchase cost. And, of course, real estate taxes, homeowner’s insurance and maintenance costs would have chewed the gains further.

With an S.&P. 500 index fund, in contrast, there would be no interest charges or other ongoing costs, other than an expense ratio of less than 0.2 percent a year. Even accounting for a 15 percent capital gains tax on selling the fund shares, the home buyer in 1960 would have done far, far better with a stock-market investment, had S.&P. 500 index funds been available back then.

Money put into stocks or other securities is easily accessible with a phone call or a few clicks of a mouse. Getting money out of a house means selling, refinancing or taking out a home equity loan – and paying interest to use your own money. That should be an important consideration for a small-business owner who could need cash fast.

Certainly, you can lose money in the stock market. But one of the things we’ve learned over the past two years is that it’s easy to lose money on a home as well. Before the current crisis, even most experts felt it was virtually impossible to have a nationwide collapse in home prices. Now we all know better.

There are some tax benefits to home ownership. Mortgage interest is deductible, for instance. But it doesn’t make sense to take on a dollar of debt just to save a quarter in taxes. Gains from home appreciation are tax-free, while other long-term investments are taxed at the 15 percent capital gains rate. But that’s not enough to offset the home’s poorer long-term returns.

My advice: See a house as a home, not an investment. If a big, expensive home thrills you, and your other investments or business assets will grow enough to cover retirement, college costs and other long-term needs, get a fancy house, by all means — and consider it a luxury, an extravagance. But if you have a volatile business that could need a cash infusion, don’t tie a lot of money up in more home than you really need.

Fortunately, fashions have changed and conspicuous consumption is “out,” at least for the time being. If you need to make a show of entertaining clients, take them to a nice restaurant.

Update | 12:24 p.m. Thanks for all of the comments on this posting. The subject of house-as-investment always stirs passions.

Some readers question the 1960-2000 time period used in the analysis, pointing out that stocks were at a peak at the end of that period. That’s true, but there were some severe downturns as well, and I think 40 years is long enough to be meaningful. One could argue that just about any single decade offers a distorted picture. The current decade has had two stock crashes, and an extraordinarily unusual collapse in housing prices.

Other readers argue that leverage boosts housing gains, a longstanding view that works wonderfully on paper: If you put only 10 percent down on a house that then grows 10 percent in value, you double your money.

I see two problems with relying on leverage. First, it works the other way, too. If that home’s value falls 10 percent, the down payment is wiped out. That’s what’s happened to millions of people who bought homes in the first half of this decade.

Secondly, gains due to leverage are trimmed by the mortgage interest cost. If you borrow 90 percent of the purchase price and pay 6 percent a year on the loan, the house has to appreciate by more than 5 percent a year just to offset the interest. If interest is not taken into account, a 5 percent gain looks like a 50 percent return on the down payment.

Also, the leverage diminishes over the years as the monthly mortgage payments reduce loan principal.

Some other readers have made very good points about the dangers of having many eggs in a single basket — a very expensive home.

Comments are no longer being accepted.

I wish that conspicuous consumption would remain “out” of our national character forever. Given the recent bonus payments on Wall Street, I don’t think those at the top get it.

Why didn’t anyone say the same thing during the go-go years of ’04-’06? So many silly people sunk all their savings (and a horrendous amount of Monopoly money) into their palaces. I still remember when people w/ not such lucrative jobs were going after million dollar homes replete with with wine cellars and gift-wrapping rooms… Can’t help but wonder what they think now.

Fast forward 30 years when you retire – if you purchased a home, you now have a shelter that you own outright, you can live in retirement there and pay property taxes and hazard insurance. If you rented a house for 30 years, you still have to pay for rent throughout your retirement. Depending on where you live, it is usually cheaper to rent an apartment, than pay a mortgage on a condo or a house. But if you have a family and must rent a house, it’s usually about the same net cost to buy a house and pay a mortgage. I’m in favor of buying, but not he $750k McMansion with unused rooms, I’m in favor of buying the $250k house (but I live in a lower cost housing market than NYC).

The other downside not mentioned here of owning a home is “concentration risk.” A home is a huge, “lumpy” investment, whereas a portfolio of stocks, bonds, TIPs, cash, commodities and other holdings consist of smaller, somewhat diversified investments. When some go down, others can go up.

As a de-diversifying investment, the value of your home is also particularly connected to (correlated to) to the fortunes of your town/city/area. Generally speaking, your employment and income prospects are similarly connected to the fortunes of your town/city/area. When one gets hit, odds are that the other is more likely to get hit at the same time. Homeowners in Detroit may have seen the value of their homes get walloped just as they lost auto-related jobs. Apartment owners in New York may have seen the value of their apartments smacked just as they were laid off by the bank they worked at.

From a diversification standpoint, buying a home with a large share of your savings is roughly as smart as putting your life savings into the stock of your employer.

Can’t live in a stock… But you’re right, buying more house than you need is imprudent.

Same applies to owning land or any other real estate

My husband and I often look at the ginormous houses around us and think “why?” Why would anyone want to live in a house with that much excess space that has to be heated/cooled, furnished, window-treated (a surprisingly expensive proposition), cleaned, etc.

We are one of the lucky ones. We bought our house in Northern Virginia 12 years ago, long before the big run-up in home prices. We have an ordinary house in an ordinary neighborhood. Very comfortable but nothing special. The best part is our wooded yard where the deer eat everything in sight. We wouldn’t move for anything.

We need to get wise to the fact that more money is not a good enough reason to buy more house. Your CARBON FOOTPRINT is what really matters in life. Taking up valuable resources just because you can is a sorry excuse for consumption, and really says what a person thinks about being part of this modern world.

dont stay in the kitchen and family room
go to the beach
life is a zero sum game
let the sun dry the salt water in your hair
dig toes into sand while working on a snow cone
lie in surf let waves run up to chest
repeat

I have rented in downtown Jersey City for 11 years. Starting rent $1,050…current rent after a move 2 years ago $1,077. I can tell you for a fact that the homeowners in JC have had far larger property tax hike than I have experienced in rent hikes.

It isn’t entirely your friends fault. We as a society have done a really poor job of rethinking the traditional family home and retooling it for the way we live today. Gracious center entrance homes with grand 2-story foyers and formal living and dining spaces came to popularity 100 or more years ago when the typical well-off family had several servants and regular sit down formal dinners for guests and relatives. We simply don’t live that way any more, but our concept of the dream home has not changed much since then.

I doubt many people living in such houses actively thought “I want all this unused space as a good investment”. It is more like “well to have a proper home and be grown up like our parents we need to have all these traditional rooms” Home builders and architects (of which I am one) have done homeowners few favors so far in this area. We need to counsel our clients better. Density needs to increase and small homes need to be as well designed and appointed as large homes, just as compact cars now range from affordable to luxurious.

Mr Brown’s financial analysis is enlightening, but misses one key factor. We HAVE to live somewhere, and we can’t live in an S+P 500 stock fund.

Your analysis takes the year 2000 as an end benchmark for the S&P, that would be like saying the benchmark for housing values is 2005. Your analysis would be radically different if you took, say 1999 – 2009 data, don’t you think?

Well said. I live in San Diego, and I think our entire perspective of finance and saving was skewed by the real estate “boom” here.

As breezy as this article is, I think it succinctly summarizes the misperception people have about the proper relationship with a house. To think if this simple advice were listened to 5 to 10 years ago.!

I agree! But the missing piece here is that people don’t just buy a home, they buy a neighborhood and a school district. Because developers make more money from McMansions than from a reasonably-sized house, they focus on McMansions. Schools, and often the safety of a neighborhood, are tied to the property tax value of houses in that area. The higher the tax valuation on the houses, the more money to fund schools, police, parks, and general quality of life things. If you want a decent education for your children, and a peer group that doesn’t consist of gangs and dropouts, even though you’d be happy with a modest house and ordinary neighborhood, you’re pretty stuck with going to the high end. Most modest neighborhoods tend to be on their way down, and most people are afraid of getting “stuck” when a neighborhood turns bad. so they buy far far far more house than they could ever possibly want or need.

Change the way we fund schools and municipal services, and watch home buying habits change. And that is just what the developers don’t want to see happen!

For an even better comparison, what if, instead of investing $1 in the S&P 500 in 1960, you had borrowed $10,000 at 6%. After 40 years, your portfolio would be worth $920,000. Subtract the original $10k plus $24k interest (which would actually be less assuming you amortized the loan balance), and you’ve got nearly $900k, compared to appreciation minus after-tax interest netting you well under $100k on a $10k house.
In this century, long-term gains in both U.S. housing and stocks may be more modest. But if you’re so inclined, you can chase better returns in overseas stocks from the comfort of your (owned or rented) home. Not so simple to speculate in global real estate.

Distinguishing between the housing and investment functions of home-buying is useful, but I’d appreciate it if the analysis included a couple of other points… (These points may have been factored into Dr. Schiller’s analysis. If so, I’d appreciate it if that was noted.)

First, as almost all home purchases are made with borrowed money, leverage increases the returns (as well as the risk) that individuals can reap on their investment. How does the increased leverage affect the average homeowner’s ROI?

Second, the value of a house as shelter is not a separate issue from its financial value. Sure, putting money in the stock market instead of a house may yield higher returns, but if you’re putting the money in the stock market, you’ll be spending more on rent. I assume the rent you save should be included in any comprehensive financial analysis.

We closed on a new house in late spring after renting for a year. We love the house and picked it because we would live in EVERY inch of it (houses around here either are huge or small) and got in in time to pick the finishing to our taste. We were lucky because the house is well within our affordability range and we have no other debt. We have the traditional loan – 20% down, 30 year fixed. I was hesitant until I realized that with interest rates low, we pay LESS for mortgage, taxes and insurance than we were renting for. This made me feel a LITTLE better but I was still ABSOLUTELY anxious about losing money on our “investment”. Then I realized I needed a house much like I needed a car. We all know that when we drive a new car off of a lot, it depreciates – but we still buy cars. We needed a house and every cent of our downpayment came from the sale of our other house that we bought with nothing down. I’m less anxious now and will just go on enjoying our home.

To paraphrase a sailboat-owning friend of mine, a house is a hole in the ground into which you throw your money.

well said SG

my points exactly.

Leverage in the market has only been 50% and you could get a margin call if values go down.
Leverage in real estate is 80-90% and no margin calls make buying a home and living in it one of the best decisions you can make. But it should not be bought as an investment.
Once real estate is purchased as an investment, it becomes an active as opposed to a passive investment. The two returns are quite difficult to compare.

Like all analysis of investment values, picking your dates and markets carefully can change the outcome. Stock market analysis can be misleading because most backward looking studies don’t include companies that went bankrupt or were delisted. That said, it does appear that a lot of people (some I know, some are strangers) buy more house than they need, want, or use. I remember somebody asking me why I didn’t buy a larger house and they were shocked when I told them I didn’t have time to clean another 1000sqft and would have to hire a second house cleaner if I had more space and more bathrooms.

This piece is trying to tackle two issues at once– financial planning and excessive consumption… while they are related issues, I found the author didn’t really make a coherent statement or a statement that followed from his financial reasoning. Of course, we’ve got tons of people with investment accounts and credit card debt– though those investment accounts will never make the 25-35+% effective rate that is charged on the credit card debt, people will hold onto their investments instead of paying off their debts. Telling people to be prudent with their expenses is like trying to stop the wind from blowing.

Buying a home allows access to large-scale loans, and therefore leverage. I can buy a $500,000 home but I cannot buy $500,000 of stock.

If you are putting 10% down, $50,000 gets you that $500,000 house. That rises to $5,000,0000 over the 40 years.

Of course (tax-deductable) interest must be paid and the original $450,000 principle. But I would think is that this still tops putting this money and the original $50,000 in the S&P and paying taxes on dividends each year.

Did the analysis take these factors into account?

I sold my big house in the country 10 years ago and moved to an affordable condominium. I have been able to save thousands of dollars each month and I will retire early in three years. I have more time for leisure now because of little or no maintenance, and no mowing the lawn. Big houses are a wast of time and money. Live simply, live well. Life is too short to do otherwise.

Condos maintenance costs are pure waste as well.

In NYC they range from $500-5000/month…..

and that is money right out the window as it goes to pay condo boards, doormen, trash, lobby x-mas trees….no tex deduct there.