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Your Home Is Not An Investment

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This is a Devil's Advocate post.

Farm House with Rising SunA few years ago, when the housing market was sizzling hot, everyone and their mother talked about how their home was a fantastic investment. They talked about how a home that sold ten years ago had quadrupled in value over the last five and cursed themselves for not buying more. I knew someone who owned four rental properties, all bought on ARMs, and was making a “killing” on the rents and appreciation. I knew someone else who was looking at his paper riches and marveling at how wonderful homeownership was.

Then the housing market stalled. ARMs reset. People were in rough shape. Those who overextended learned something the prudent have always understood, as much as your home is a great place, it’s not an investment.

Value of Homes Appreciate with Inflation Rate

There’s a great analysis of home appreciation versus inflation that concludes that home prices don’t appreciate faster than inflation. Michael Bluejay takes a look at historical data provided by the U.S. Census, the NAR, and the Case-Schiller index, so it’s not a guess… it’s based on hard data.

One big insight that I think many other analyses miss is the increase in the average size of a home. When you look strictly at census data, new homes increased in value an average of 5.4% a year, compared to 4.4% annual inflation over that same period (1963-2008). However, when you consider that the size of a home increased from 983 square feet to 2349 square feet, you’ll see that we’re simply buying bigger sized houses!

An investment has to beat inflation, not match it, because otherwise you’re taking a risk for no reason.

No Improvement Is Profitable

Every year, Remodeling magazine does a survey on the best home value renovations. No matter which year you look at, there is never a remodeling job that ends up being profitable. In 2007 and 2008, the best home value renovation was adding a deck and that topped out at 85.4% and 81.8%, respectively.

So as your home ages and needs major repair work, you’re immediately taking a loss on that “investment.” Our home was 25 years old when we bought it, in the last three years we’ve replaced all the windows and replaced the roof at a total cost of $12,000.

Carrying Costs

When people talk about how they bought their house for X dollars and sold it for Y dollars, they rarely talk about the interest and property taxes they’ve paid as they owned the house. It’s very exciting to hear about a home that has double or even tripled in value (or more!), but property taxes and interest are annual expenses that often get ignored when looking at the headline numbers.

Even when you account for the tax benefits, the costs can be substantial. The national average effective property tax rate (2000 census data) was 1.1127% and the national average value of a home is $158,934, so you could expect to pay $1,768 a year in property taxes. Slice off 25% for income taxes and it’s still $1,326 a year. It’s not an inconsequential amount to pay each and every year.

Transaction Fees

If you want an investment, buy a stock. You can get into and out of a stock for free at Zecco, for $2.95 at OptionsHouse, and for $4.95 at TradeKing. Want to buy or sell a house? Be prepared to fork over 4-6% of the sales price as a commission to the real estate agents involved. Can you imagine paying 4-6% of each stock transaction? No one would ever do it.

Not only are the transaction fees high, the market is illiquid. Buying or selling a home can take a long time. With a stock, you can expect it to be gone within minutes in a marketplace that has many participants. You sold it at the best price possible the moment you sold it. With a home, you can’t be sure. If you have only one buyer or you are the only buyer, you don’t know if you have good price because it was determined in an open marketplace.

Summary

There are many benefits to owning a home and I’m a huge fan of it, but don’t justify buying a home by thinking its home is an investment. It’s not.

It is, however, a place to live, a place to make your own, and a place to make yours. It’s a place to put down roots, a place to raise a family, and a place to grow old in. It’s a place to call your own, it’s just not an investment. It’s a home.

(Photo: orvaratli)

{ 54 comments, please add your thoughts now! }

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54 Responses to “Your Home Is Not An Investment”

  1. Gene says:

    Amen. I think the investment notion also takes a beating when you consider liquidity, whether through an outright sale, a temporary equity loan in today’s market, or through a reverse mortgage, if you qualify for one of those. The back of the envelope calculations I did recently, at http://kitchentablenomics.blogspot.com/2009/07/reverse-mortgages-strangling-on-life.html weren’t pretty.

  2. The Other Schmitty says:

    Jim, I first read this through your RSS feed using Thunderbird, and there was nothing to indicate it’s a Devil’s Advocate post. You may want to do some formatting for your crazier advice.

    Houses may be bad investments, but they can be excellent sources of income. I’ve always liked the idea of owning rental properties – owning as in “paid for” – as part of a retirement plan. Although, REITs sure seem a lot simpler.

    • Jim says:

      I keep forgetting the image and Devil’s Advocate note aren’t in the post and are added later on the site… sorry about that. :)

  3. tom says:

    I’m not taking a side on the issue, but I do question the renovation ROIs. Labor accounts for 50% of the bill, if you do the work yourself… you come out ahead.

    Let’s take the deck example… average deck costs $10,000. You get a return of approximately 82% in my area… so a $8,200 increase in home value. An estimate of the materials is $5,000. So by doing the work yourself you have an ROI of 164%.

    Assuming labor is 50% of the bill and according to Remodeling Magazine, if you do the work yourself, you come out ahead everytime (no improvement yields less than 51% return).

    • Jim says:

      You probably want to discount the value of your own work, versus a contractor’s, unless you know you’re good at home improvement/renovation work. I would argue that the majority of homeowners are NOT in the “handyman/woman” category. But your argument has merit and you make an excellent point, if you don’t put a dollar amount cost on your own labor, you do come out financially ahead.

      • It’s true that if you don’t count the cost of your own labor you’ll come out ahead. But if we’re really going to look at the numbers, can you really say your labor is worth nothing? Unless you were going to spend that time just sitting on your butt in front of the TV, you could have been doing something useful with your time – something that would have had a value. There’s an opportunity cost to what you do with your time just as there is with your money.

        • tom says:

          Your labor is not worth “nothing”, but there is no opportunity cost because you CHOOSE to DIY. It’s your choice to do this over something else. Also, by doing the work yourself, one can argue you are “building equity”, so it is a value-added activity.

          Also, on a side note… begin rant… what is wrong with sitting on your butt in front of the the TV? It’s useful to me, as I use that time to relax. Everyday I work hard, I workout, I complete my household duties, I want something/one to entertain me. I hate it when people say “ugh, I don’t watch TV, it’s so below me”. How’s the weather up there on your pedestal looking down upon all of us “TV watchers”?… end rant.

  4. dilbert69 says:

    First of all, you can’t buy a home. You can buy a house. A home is where you live, and it’s a home because your family, your pets, and your stuff live there. Second, if it’s not an investment, why not just rent? Buying a house is silly unless you expect the value to go up substantially over the long haul.

    I realize that there are some areas in the USA where renting actually costs more than home ownership, but in the urbanized coastal areas, the opposite is typically true.

  5. Joe says:

    You may not consider a home an investment But you have to live somewhere. There are costs associated with living regardless unless you live with mom and dad.

    Your home is an asset, provided you paid a reasonable price. Once the mortgage is paid off, the asset remains.

    What do you have after you paid rent for 30 years?

    • LH says:

      You have all the money you saved on property taxes, maintenance, repairs, insurance and mortgage interest.

      • Joe says:

        I did my homework. Bought at a good price in 2003 and still have 100K value today in excess of what I paid even after the bust. Thats not the point though. The point is, assuming I stay put until time for an old folks home, I can sell my asset. What can a renter sell?

        Even after taxes, maintenance, etc. my monthly costs is close to what I would pay if I rented so you cannot convince me, that if you do your homework and buy at the right price, renting is the the better value.

        • My Journey says:

          The logical response – A renter can sell the assets (stocks, bonds, MFs, business, etc.) he bought with the difference between your home costs and his rent.

        • skarrlette says:

          What if you lose your job??? Where are you going to be then? All that money will be down the toilet when the bank takes your house in 3 mos?? You can’t guarantee anything and you have not protection.

        • Adam says:

          Yeah but your house appreciated based on a fradulent bubble. That is not the norm.

      • NiceComeback says:

        Sweet – nice one… not to mention the compounding effect of all that savings…

  6. Geoff says:

    Timely article since my wife and I are looking at homes now and my father in law told us yesterday that we should look for something bigger an at the high end of our range because a house is a great investment. Personally, I”m going to buy what I feel comfortable with and if I miss out on some huge gains on a larger house I don’t need, oh well.

  7. MichaelM says:

    “Unless you were going to spend that time just sitting on your butt in front of the TV.”

    We just bought a foreclosure that needs some TLC (funny how “Tender Loving Care” tends to involve pry bars, claw hammers and a plumbing torch…).

    We’ve decided to leave our TV in its moving box in the basement until we have remodeled and repaired the things we want to.

    Every project we get done both makes me glad the TV is put away, and makes me want to get it out and take a lazy rest day.

  8. Jim–brilliant post, especially since the current housing market is finally forcing people to reconsider the way they think about the family homestead.

    This whole concept of a house as an investment is at least partially to blame for the mortgage mess, the real estate decline and the millions of foreclosures and bankruptcies since.

    If you think of your house as an investment first and foremost, you’ll leverage it to the hilt and give little consideration to the importance of shielding it from risk. So here we are.

    Dilbert69, good catch on home vs. house. Not too many years ago, you bought a ‘house’, but after one of the more recent downturns, the real estate community changed the nomenclature to ‘home’. You’re looking at HOMES, you’re buying a HOME, you building a HOME, the HOME has, the HOME is.

    Logically, it’s only a home if you live there, but the word ‘home’ sounds warm and fuzzy, and implies you’re already there. ‘House’ sounds too much like a commodity, even though that’s really what it is. A home can be a house you own in the suburbs, an apartment you rent, or a trailer you live in out in the woods. But that consideration of the term doesn’t do as good a job of marketing houses.

  9. Sorry, in the second part of my comment I addressed Joe–it was actually Dilbert69. (Sorry Joe!)

  10. Jim, I disagree. There is one way the home you occupy can be an investment and improvements are profitable . . . if you have professional grade skills and make the improvements yourself with materials at cost.

    Problem is that most folks need to develop the skills . . .

    • Jim says:

      True, but I think it’s dangerous to enter the scenario thinking you can make it an investment. A lot of people think they have professional grade skills and don’t. :)

  11. DDFD–I agree with Jim completely. You shouldn’t go into a house with the idea of it as an investment, but rather with an idea as to how you intend to pay off the mortgage in less than the scheduled time.

    Up until the perma-inflation of the 1970s, that was how people realized their “investment” in their houses, by paying them off. You don’t hear much about mortgage burning parties anymore, because most people roll them over every few years, creating permanent debt. It’s the “good debt” justification taken to an absurd degree.

    • Jim says:

      I wonder what percentage of people refinance (roll them over) versus. sell and move on.

      • No idea on the breakdown of refi’s vs. sales and actual payoffs, but according to industry sources, mortgages are paid off on average every 5.7 years, the majority being refinanced.

        Not too many years ago, refi’s were mainly the result of lower rates, but now they’re sort of built into the homeowner experience, being used to raise capital for home improvements, debt consolidations, outside investments–all activities that were considered to put a house at risk a generation ago.

        That’s why I think the point of your post is right on the money! If more people did what you’re saying to do, there’d be a lot fewer of them in trouble.

  12. @Kevin

    I choose my words very carefully. If you re-read my early post, you will see I agree with Jim too. However, in keeping with the spirit of the Devil’s Advocate, there is one way to approach your home as an investment– qualified as it may be . . .

    • DDFD–I see what you’re saying, I glossed over your qualification about having the skills to do the improvements yourself. I appologize, my mistake!

      But I agree with Jim that most people don’t have those skills and lose money making improvements. I’ve experienced this first hand in the mortgage business where someone pays $50,000 to finish a basement or upgrade a kitchen, but it only adds $15-25,000 to the value. Disturbingly common, I’m afraid.

  13. jim says:

    I agree with the premise in general. People should not be thinking of their home as an investment. Its a home first and foremost.

    But, whether or not a house will be a good long term investment depends much on where the house is. As they say: location, location, location. The US housing market isn’t a single homogenous market but is many different distinct regional markets that all behave differently. Houses on the West coast have appreciated 4-6% annually from the case-shiller index which is up to double the rate of inflation. Thats even including the housing bust. On the other hand the Midwest, Northeast and South have grown at rates closer to inflation. Or the worst major market Detroit has failed to keep pace with inflation. So thats a wide range from 1% in Detroit to 5-6% growth in Seattle & Portland.

  14. JoeTaxpayer says:

    Given the “size growth” you cite, size inflation was 1.95% per year. If you normalize home pricing to cost per square foot, housing has lagged inflation over these 45 years by nearly 1% per year.

    Joe

  15. Lord says:

    It can be a valuable hedge against rental increases in large urban areas. These can significantly outpace general inflation depending on location. This can make it an investment, but only in certain places and at certain times.

  16. lostAnnfound says:

    Jim, your summary is so true. It doesn’t matter where you live – as long as you’re family is with you it is your “home.”

    We don’t look at our house as an investment. We have to pay to live somewhere. Rent vs mortgage payment would be about the same for where we are. If we can sell our house (when the time comes) for the price we paid for it, we would consider ourselves ahead of the game. The rest (taxes, insurance, maintenance, interest, etc.) is part of the cost of owning a house and living where we want to.

  17. eric says:

    Judging from the comments, I think this Devil’s Advocate post succeeded in stirring up talk! :)

    Personally I would never consider my primary residence an “investment,” at least in the same sense as I do my retirement accounts or taxable accounts. A house is just too illiquid and doesn’t appreciate all that much over the long run.

  18. mbhunter says:

    “Then the housing market stalled.”

    It’s still stalling.

    “ARMs reset.”

    They’re still resetting. And will for another few years.

    “People were in rough shape.”

    And it’s getting worse.

  19. I wouldn’t say the sky is falling. It’s better considered a return to a sane market, which has the look and feel of a painful slide at the moment.

    I think when the market hits bottom and stabilizes, we’ll be looking back at the past couple of decades and asked the cliche question ‘what were we thinking???’.

  20. My Journey says:

    Jim,

    Great Post, but I have to know – How do you really feel? Your Devil Advocate posts usually run against “common knowledge” but don’t indicate your true feelings.

    Personally, I agree with your DA post your main home is not an investment. You just put way to much into it without receiving much out.

    • Jim says:

      In this case I agree with the Devil’s Advocate, I don’t think you should buy your home expecting to turn a profit, big or small, between the price you sell and the price you bought it. I didn’t buy the house we currently live in because I thought it would be a good investment, I bought it because I thought it was a good home.

  21. It was a great read that didn’t an even better job of stirring up controversy. I couldn’t agree with you more and am amazed at how people believe what is marketed to them. Times are changing and people need to stay open minded and change too.
    I’m interested in your opinion of your home as leverage? I think you’re right that your home is not an investment but what about it being an opportunity or leverage to an investment? As a side note, I am not, I repeat not using investment as it pertains to stock market risks/rewards. Couldn’t people manage their home, the asset/liability relationship of their home better and reap the rewards for doing so?

  22. Neil says:

    Carrying costs are generally not a factor in home ownership because those are unavoidable costs. If you weren’t paying them on your own home, you’d be paying someone else’s through rent.

    I agree with your premise, though. If homes were a (good) investment we’d be in big trouble because each progressive generation would be increasingly unable to afford a place to live. We saw this problem in all its glory during the recent bubble. Imagine if there was a real appreciation in housing of 3-4% per year over the course of a couple generations. Wage growth hasn’t outstripped inflation for at least 30 years, so there’d be no way to keep up.

    Mostly the value in owning a home is the forced savings plan and inflation protection. Provided you do take out a mortgage that will be paid off by retirement, that’s a good chunk of your income that you won’t need in your golden years. On top of that, once you buy, the bulk of your housing costs don’t increase with inflation. If you’ve owned for 20 years now, you’re still paying your “rent” in 1989 dollars, which is pretty awesome.

  23. Wes says:

    This post is so timely! I am being pressured by my job to relocate from the mid-west to CA. For a “poor” young mid-westerner it is quite a shock to the finances when I look at going from median house values of $150k to $800k. My boss keeps telling me that I am going to make so much money by purchasing a home in CA and that I should count on this money as my “big raise.” I had the same dialogue with him, as what Jim stated. I commented that any potential money I made on a house would not weigh in on my decision, as I did not consider my home an investment – it was simply another expense and a place to live. I might as well have been speaking Greek, because he and I had to finally agree to disagree.

    I believe one of the reasons that people think that they can make money off of their home is due the power of leverage. I can not really think of many other investments that a bank would allow me to leverage myself 20:1 (OK, maybe not these days…..). But if I bought a home for $600k and put 20% down (5:1 leverage) and it appreciated at 4% a year for three years you would have an increase in the homes value of just under $75k. If you put down 20% ($120k) and made your monthly mortgage payments (about an extra $100k) then you would have a return of about $35k (subtracting 6% commission) on an investment over three year of about $220k. I didn’t do the math, but I can tell the return is actually higher than the 4% appreciation. This would only increase the if you could actually buy the house for even less money down.

    Obviously, this is not magic, it is just the power of leverage. However, the item that everyone forgot about over the past 5-10 years, is that leverage………drum roll please……………..works both ways!

    Good post, Jim. I can’t wait until this wonderful “investment” I am living in, is finally paid off.

    Wes

  24. Bobster says:

    There’s a logic problem here. If a home is not a good investment, then why are there homes that you rent-fanboys are going to rent? Why would someone rent out a home unless they are making a profit?

    • Jim says:

      I didn’t say a home wasn’t a good investment, I said you can’t go into it expecting it to be a good investment and you can’t approach it as if it were an investment. There are plenty of empty houses. Houses that people won’t rent for whatever reason. If being a landlord and renting out a home were such a win-win, these places wouldn’t exist, right?

      • Bobster says:

        Lot’s of investments aren’t sure things. Heck, if you put more than $250K in an FDIC insured account and the bank went under, you’d lose money. So are we really just talking a matter of odds? Every investment needs to be evaluated before you plop down the cash. I would say that long term, buying a house is almost certainly a good investment.

      • Bobster says:

        OK, perhaps I’m fighting an argument that you aren’t actually making. I guess whenever I hear the rent vs buy arguments I get rankled. Buying instead of renting was one of the best financial decisions I ever made. My mortgage was less than the rent I was paying for half the space. Of course, I bought in a buyers market, but here we are again in a buyers market.

  25. @Bobster
    How about on an investment property (for renting) you put at most 20% down. Then your property hopefully to more than cover the expenses (mortgage, taxes, insurance). So it generates income from the beginning and then you get the added bonus of appreciation (if any). When you live in the house, there is no income derived from it. You are really only on appreciation that can only be realized with a banks permission or the sale of the house. As the article points out, it isn’t usually as good a rate of return as you think.

    • Okay it’s late and there are some bad typos in that. I meant to saying hopefully it generates more than enough income to cover expenses. Then I wanted to say that you are only relying on appreciation. Sorry about that.

    • Bobster says:

      The money you have saved in rent is part of your return. Imagine buying food that never runs out or a car that never needs to be replaced. When I buy a house I provide for my housing needs AND the value of the asset (usually) appreciates.


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