Pre-2007, I am not sure this topic would have even been controversial; people not only regularly utilized their home as their “primary investment”, but often, treated it as their personal piggy bank. In hindsight we can all judge others as we secretly lick our own wounds from a vicious downturn no saw coming, but that experience left a visceral taste in many mouths.
Most experts would suggest that your primary residence is not an investment. Why, you ask? First, you purchase a home based on need. Your buy and sell decisions rarely spring from analytical thinking around market timing. Instead, most times, they are rooted in your changing life needs. Second, investment strategy wages a secret war with your personal desires. For example, I want a tricked out man cave equipped with a full wet bar, bathroom and other appropriate amenities. Am I thinking about the return on my investment, or the endless joy my friends and I will have watching football on Sunday, Monday and Thursday? Sure, I will likely increase the value of my home with these upgrades, but the anemic return on investment, if any, would never be worth the money. Said differently, would you make the same upgrades to your rental property; probably not.
If it was that easy, I wouldn’t write the article.
I will start with a question. Is it easier to invest in stock or buy a house? Right now, Berkshire Hathaway Inc. (NYSE: BRK.A) trades at $128,175 per share. Its five year performance has been strikingly similar to the performance of many real estate markets. If you have a job making $50k and $7k in the bank, do you think you will ever in your lifetime own a share of Berkshire Hathaway A outside of a very lucky lotto ticket? The answer is unequivocally no. You don’t qualify for the right to buy on margin and even if you did, where would you get the 50% required to do a margin buy? And how would you live on the prison food when the margin call comes? All important questions to consider…
Now, let’s take that same fellow and put him / her into a working class neighborhood. He sees a for-sale sign and the asking price is $130k. He walks into his local bank branch gets a pre-approval letter and in 30 days, he is the proud owner of a similar $128k asset. Interesting… Are these two assets really that different? Sure, the risk profile is different, but not as different as people would have thought 4 years ago.
The real difference is access. Leaving aside the risk of foreclosure and the costs associated with credit repair, moving, etc., this person has $7,000 at risk and unlimited upside. Additionally, there is no other investment available to them with a lower risk profile or higher upside. This person probably could not even qualify for a real estate investment loan, but interestingly, they can get one chance to basically play with house money.
I would humbly submit that your primary residence is what you make of it. You can treat it like an investment, moving to an up and coming neighborhood every 4 – 7 years, investing in only the Spartan renovations that meet a certain return threshold, or you can treat it like your home, “investing” in renovations that make you smile a little bit every time you walk in the door. The choice is yours, but importantly, it is a choice. If you treat yourself as you would a tenant and you make sound investment decisions, you very well could do well with your primary investment. Given the easy access to financing, it may just be the biggest, safest investment in your portfolio. Or not, its really up to you.
Aaron Fisher says:
Nice Post,
I am a big believer in the home as an investment, it pays dividends by allowing you to live in it. You can grow your homes value by renovating plus you can rent it out.
If you play your cards right your home can be a large contributor to your retirement plan.
Raise a family, grow a home and then downsize when its time to retire. The increased equity is a welcome addition to your portfolio, now all you need to do is downsize your home and up-size your life.
Maybe retire in a low maintenance condo somewhere warm with a low cost of living.
Cheers
August 3, 2012 — 4:00 pm
Don Reedy says:
Well…a very nice (soft sell) approach to the primary as an investment. Since I’m in California, home of the most insidious run-up in prices any of us has seen, and pretty certain that we’re some five+ years away from a recovery here, I initially read your post with some skepticism.
But you are onto something that should be apparent to all of use. Take an asset, improve it with a set of criteria, and depending on what criteria you’ve selected….you’re going to have a different outcome.
In the end, your primary home IS an investment. What you expect to gain as an ROI on that investment needs to be revisited in these times and this era of one of the financial stalwarts.
Thanks Michael.
August 3, 2012 — 11:24 pm
Josh Malone says:
I totally agree and it is unfortunate and sad to me that so many friends and family do not look at it in this way. Many say, “I feel we made a good investment” to justify their purchase, but it was not the reason they purchased the home. I think, tho it might take a little longer, one can find a great home that is also a great investment, but they have to not just settle for one of the two.
August 4, 2012 — 9:57 am
Damon Chetson says:
The problem with real estate is that we have an insane tax code that privileges taking on home loan debt. Most people, when they buy a home, are not saving or investing. They are taking on a massive amount of debt, backed by a piece of real property.
They should only do so if renting is more expensive, and if they intend to be in the home for decades.
Historically, homes have appreciated at about 4 percent, which is about 1 to 1.5 percent more than the rate of inflation. Which means the real appreciation rate of a home is about 1 to 1.5 percent.
This is not good. What makes it attractive are lending policies driven by public policy that allow people, even today, to leverage when they should not be leveraging. And favorable tax code treatment that skews “investment” into housing stock.
We Real Estate lobby in this country is far too powerful, and has created very bad public policy, leading to silly debates about whether you should own your home.
August 4, 2012 — 2:22 pm
Don Reedy says:
Damon, I’m going to disagree on a specific point, not your overall impression.
The rate of return on a home at 1 to 1.5% is on the leveraged amount of the home. Thus a $10,000 downpayment on a $200,000 home, returns 1-1.5% of the $200K ($2000-$3000) per year, a 20-30% return on the $10,000 invested.
There aren’t any other investments available to most us that can return that much. Agreed?
August 4, 2012 — 2:51 pm
Don Reedy says:
Damon, of course there are taxes and insurance, all of which (depending on that “insane tax code” you reference), decrease the actual ROI.
Again, I’m sooooo on your page about the tax code.
August 4, 2012 — 2:54 pm
Damon Chetson says:
Am I missing something?
In addition to the $10,000 you pay and taxes and insurance, plus repairs, upkeep, you are paying interest and principal throughout the 20 to 30 years. So the actual cost is not $10,000 even in the first year, but $10,000 plus all the mortgage payments (which would amount to about $10,000 a year, plus the taxes, plus the insurance.
Obviously for that you are getting some place to live, so the benefit is that you’re not paying rent, so it depends on the rental costs (as I said in my original comment).
I’m not saying there’s no benefit to owning a home. But by that I mean OWNING a home. Not leveraging to own a home, which is what you seem to be advancing as a good thing. It’s not a good thing for most people to be leveraged.
August 4, 2012 — 7:20 pm
Damon Chetson says:
There aren’t any other investments available to most us that can return that much. Agreed?
What does this even mean? In the normal investment world, most people can’t get loans of $200,000 on $10,000 down even if they promise some kind of collateral. And why? Because it’s insane to lend most people that kind of money, even if there’s some putative collateral.
The exception is residential real estate.
The reason we allow regular people to become highly leveraged in residential real estate is because of misplaced cultural values and powerful lobbies, not because residential real estate is inherently a better investment.
People should save. Maybe they should save in homes. But they should not become highly leveraged to save… that’s a recipe for disaster over and over.
It’s fine to sell people homes. It’s not fine to sell people highly leveraged positions in homes.
August 4, 2012 — 7:45 pm
cooksquared says:
“The problem with real estate is that we have an insane tax code that privileges taking on home loan debt. Most people, when they buy a home, are not saving or investing. They are taking on a massive amount of debt, backed by a piece of real property.”
I could not agree with you more; however, it would seem
“un-American” for me to look a gift horse in the mouth. Too many times, renters don’t consider all of the costs and benefits of owning a home. The interest deduction makes a very big difference in my tax payments every year. Do I want the money going to the government or to my home / investment?
August 6, 2012 — 6:46 am
cooksquared says:
“In addition to the $10,000 you pay and taxes and insurance, plus repairs, upkeep, you are paying interest and principal throughout the 20 to 30 years. So the actual cost is not $10,000 even in the first year, but $10,000 plus all the mortgage payments (which would amount to about $10,000 a year, plus the taxes, plus the insurance.
Obviously for that you are getting some place to live, so the benefit is that you’re not paying rent, so it depends on the rental costs (as I said in my original comment).”
You make a couple of mistakes here based on my argument. First, if you are considering a home, like you would consider a real estate investment, you would already factor in the cost of owning that asset. When I make a real estate investment, my model includes utility costs, repair and maintenance, asset management fees, property taxes, and expected capital improvements. I will not buy the property if the rent I am receiving plus my expected appreciation does not cover those costs and provide a low to mid teens internal rate of return or a comparable ROI.
Second, you have a general math issue. Bear with me, while I try to work through a moderately complicated analysis. If real estate appreciates 4% per year, the math would work even better than Don suggested. You would get the full 4% appreciation on the $200k, or approximately $8,000 per year. Assuming, you put 5% down on your purchase, you invested $10,000 and get a $190k mortgage.
Fast forward 5 years. At inflation of 3% (very aggressive expectation for the next 5 years), your $10k would we worth about $11,600 at an annual rate of return of 3%.
If you invested in the S&P 500 through a ETF (exchange traded fund), you would probably get about a 7% return per year and your $10k would net you about $14,000.
Importantly, if you were to just experience 4% appreciation on your real estate investment each year you would see $40,000 (simple interest, no compounding). Big number, but only half the picture.
To compare apples to apples, you would have to subtract your mortgage payments. At 4% on $190k mortgage, you would pay a yearly payment $11k. After 5 years, you would have paid about $55k in mortgage payments. $37k would go to interest with the remaining paying down principal ($18k).
Putting all of that together, in 5 years you would have a $240k home, sell it and net $226k after closing 6% closing costs. You will pay off your mortgage, which after down payment would be $190k, less the amortization of $18k, or approximately $172k, leaving you with $54k.
Given the $10k down payment plus the $55k in mortgage payments, you are out $65k, less the $54k you just got back. Basically, over a 5 year period, you paid $11k in total for rent. Assuming a modest rent payment of $1k per month for 5 years, you would be looking at $60k over that period. Subtract that from the $11k you paid and you have a return of $49k over that same time period.
And we didn’t even account for the tax break yet…
If I am missing any math in there, please let me know. Maybe you want to add repair and maintenance for 5 years at $10k. Still you are up $39k. Most renters pay their own utilities, so that is a wash. Property taxes could run you another $2k per year. That would bring you down to $29k. Is there anything else I am missing? Keep in mind its only a $200k house, so you can only have so many costs.
Even under this very realistic scenario your return is 4x the stock market return.
August 6, 2012 — 7:43 am
Don Reedy says:
Michael, this is why I wisely continue to do the algebra, while turning over the calculus to you. Good analysis, and a good comment by Damon to bring out both sides of this issue. Thanks to you both.
August 6, 2012 — 2:52 pm
jimi says:
Real estate for personal use is Consumption by definition, not investment. The fact that you can generate a positive or negative return, like an investment, does not change that. The fact that the purchase incentives are heavily subsidized does not change that. You are consuming the housing product if you live in it.
August 18, 2012 — 4:46 am
Andy says:
mmm.. pay out a lot of money to borrow lots of money to buy an asset that you then have to pay to maintain and have massive potential losses…
If you put that monthly repayment into a portfolio of various investments (5% high risk, 25% medium risk and 70% low risk) and continued to reinvest the profits I imagine you would do far better & spreading risk.
Even with rentals – go with a leveraged ETF (no bad tenants!)
Yes you can make loads if you buy and sell at the right time, but I personally think if you buy for private residential use look at it like this:
If the property price goes up when your about to sell it and retire – great
If not – hey ho, don’t sell it!
August 21, 2012 — 4:00 pm
Michal Czan says:
It all comes down to leverage. The less money you invest, and the more money your borrow, the higher your leverage rate. If your investment’s interest rate is lower than your rate of return, you are making profit off of someone cash (the bank’s). If you are rate of return is lower than your interest rate. your losing… sometimes exponentially.
September 11, 2012 — 11:11 pm