I Dream of FIRE

In pursuit of financial independence and personal fulfillment

Don’t pretend your house is an investment

Homeownership has been a key component of The American Dream for generations. Long considered something you’re “supposed to do” when you become an adult, buying a home has an almost mythical allure for millions of people in the U.S.

But is it as brilliant a pure investment — a surefire way to wealth — as many people believe?

Simply subtracting purchase price from sale price may sound like a straightforward way to determine investment value, but doing so with a home leaves too many factors out of the equation.

I won’t argue whether it’s better to rent or buy a home. There are too many variables in each situation and market to make a blanket statement like that. I can, however, definitively say your personal home is not an investment.

What is an investment anyway?

In simplest terms, an investment is an asset purchased with the intent to make a profit. Investopedia lists three categories of investment: ownership, lending and cash equivalents. Real estate is part of that first category, although Investopedia suggests your primary residence should not be considered an investment, as its intent is to fulfill a basic need.

When comparing your primary home with other investments, consider it alongside stocks, bonds, mutual funds, collectibles, rental properties, interest-bearing loans, business opportunities, and the like. It will make more sense to compare the investment value of homeownership when looking at it through this lens.

Why do we buy homes?

We put money into stocks and bonds with a pure motivation: profit.

We may or may not believe in the company whose stock we buy or care about the project our bonds support. If you buy them through an index fund you’re buying hundreds or thousands of companies anyway.

Unless you’re running a complex tax scheme hoping to buy a loser stock to offset your winners, you are buying that stock or bond to make money.

When we purchase a house, profit is among the least of our considerations.

Can you imagine a couple deciding on a house by saying: “We don’t like the house or the neighborhood, but we’ll be able to make a great profit when we sell!”

No, they’re looking at how the floorplan will work with their lifestyle, whether the cabinets are the finish they like, how the landscaping blocks the view or offers privacy where it’s wanted, and whether the schools are desirable or local shops and restaurants are good. These are emotional decisions. How will this piece of property enhance or detract from their current life and the life they want to lead?

How do you put a market value on each person’s unique idea of quality of life?

We don’t buy stocks based on whether our kids will have good friends because of them, or whether they have room for our in-laws or a back yard big enough for our dog. The more your lifestyle affects your investment decision, the less likely it’s actually an investment. (Socially responsible investing not withstanding.)

Ongoing costs

For most of us, shelter is and always will be an ever-present primary need. This is where the rent vs. buy argument often gets the most heated. You’re going to be paying money to live somewhere anyway, why not build equity with a portion of those payments so you have something to show for it at the end?

As Matt Becker points out in this recent Business Insider article about the true cost of homeownership, when you factor in all of the money you’ll spend on your home over the life of a typical 30-year mortgage, you’re spending an enormous amount of capital for comparatively minuscule returns.

“It takes 29 years before the equity in your home outpaces the amount of money you’ve paid into it. And even then you’ll only have $23,969 to show for it, which translates to a 0.08% annual return. And again, that doesn’t factor in the costs of selling the home,” Becker writes.

“After 50 years, which includes 20 years mortgage-free, you’ll finally see a decent $131,746 return over what you’ve spent. Which sounds pretty good, until you remember that it’s been 50 YEARS and that your annualized return is only 0.43%.”

Homeownership is forced savings. You pay an enormous sum of money to a lender in order for them to force you to save the price of your home over time. All the while, you’re still spending a lot of money to keep that home up.

Here are some often overlooked expenses of owning a home, major renovations not withstanding:

  • Property taxes
  • Insurance
  • Upkeep
    • Roof
    • HVAC
    • Appliances
    • Flooring
    • Windows/doors
    • Exterior

A new roof on a modest home can easily be $5,000 to $10,000. A new furnace and air conditioner will be $8,000 to $15,000. Replacing a house full of windows is another $10,000 or more. New siding, new appliances, new flooring — all of these expenses should be added to the cost of a home over time. And you’ll notice these are expenses a landlord is typically responsible for if you rent your dwelling.

Selling a home and realizing gains

As Becker pointed out, it is possible to make a small profit on a home over the long haul.

Of course, this assumes you actually stay in the same home for that entire time. Let’s be honest, the chances of that happening in America today are pretty slim.

The average American has 12 different jobs over his or her lifetime. At least one, if not several, of those jobs are likely to require some kind of location change. Likewise, around half of U.S. marriages will end in divorce. There’s another trigger for finding a new place to live.

Considering that most mortgages are heavily front-loaded with interest, moving from house to house means you’re spending more time in the interest zone than the equity zone.

With other investments, it’s easier to make strategic, calculated decisions about what to sell and when. Shares of stock can be sold to minimize the tax implications or maximize profit. Bonds have a built-in expiration and a guaranteed return. Interest-bearing loans typically have a reliable profit margin.

Home sales are very much based on external factors outside the seller’s control.

For instance, let’s say you need to move for a new job. What you will get out of your home has to do with the current housing availability in your area, how well you’ve kept up your home, whether your neighbors have kept up their homes, the local job market, the time of year, neighborhood amenities that add to its value or features that detract from it. Plus, you’re now likely in a desperate situation of trying to offload a property to minimize your monthly costs as you move to a new place.

You may need to spend more up front to get more out of the sale. This isn’t something you see with many other investments. The initial capital is all you put in, and then you get the current value when you sell. You can’t buy more stock today to raise the value of the stock you bought a decade ago. And you can’t deduct a loss on your federal taxes from the sale of a home like you can stocks whose value dropped. That makes the timing of a home sale even more critical from an investment standpoint.

In addition, there are huge fees associated with selling a home. You’ll pay closing costs in the tens of thousands of dollars. You may have to pay for repairs to satisfy the buyer. There are a multitude of professional services fees along the way.

Getting the inherent value from your home is typically an all-or-nothing proposition, but there are ways to get temporary access to that equity, such as a home equity loan or line of credit. However, you’re not truly getting access to that money. Instead, you’re trading an interest in your property to a lender who gives you access to cash for the equivalent stake in the home. When you sell a stock investment, you realize the full benefit of that sale without taking on additional risk or paying interest on the funds.

Lastly, if you’re selling at a high point in the housing market, you’re most likely going to have to buy your next place at a high point in the market. Selling high, buying high is not exactly a recipe for long-term success.

I’ve seen all of this in my own life

In 2007, my now-wife and I bought a home for $212,000. Four months later, the market tanked. We sold that house last year for $250,000. On the surface, that’s a $38,000 gain over nine years, or about 18 percent. But that’s less than a 2% annualized gain.

Plus, it doesn’t account for everything we spent on the property. There was $8,000 for a new furnace and air conditioner, $10,000 for new windows, $1,300 for added attic insulation, $1,200 on exterior doors, $3,500 on flooring, $1,200 on appliances, $4,000 on a gas fireplace and thousands of dollars on other random improvements.

Some of these were necessary; others were lifestyle decisions.

When you add all those expenses and factor in inflation, we lost money. That doesn’t even factor in the sales commissions.

The new home we moved into was just 25 minutes away, so we weren’t selling in a high market and buying in a low one. We were selling high and buying high.

The decision to sell and the decision to buy were not pure investment decisions. Yes, we looked for a home that we thought was a good value for the price. But we bought a house we thought would suit our lifestyle, provided the amenities we wanted, and was in a location we wanted to live. In truth, that led to us buying more house than we wanted because it was where we wanted it.

But that’s OK. Our home is in one place; our investments are in another. I have no illusion that the sale of this house will be equal to or greater than the profit I could have made if we had stayed put and invested the difference in the market. I don’t think of my house as an investment.

When it comes to your home, neither should you.

9 Comments

  1. Ooooo, I think you may get some push-back on this. First, you’ve got the “house-hackers,” who are generating income by renting rooms on Airbnb or renting half of their duplex while living in the other half. Then, you have the “live-in flippers,” who will buy a home at a discount and rehab it while living in it. Sell at a hefty profit after two years with no capital gains tax hit. And finally you have people like me, who never met a house they wanted to sell. Instead, many of my homes started as my primary residence and became a rental properties when I left. So, I think it comes down to your mentality about your home, because in the right circumstances it can be a springboard to more investment, instead of less.

    • I know, touchy subject, right? 🙂 I thought about those angles, but decided against addressing them in this post (which was already getting long) because those arrangements fundamentally change the nature of the property to become actual investments. But they’re really fairly small segments of the market.

      If you’re house-hacking, you’re essentially a landlord who happens to live in the same building as your tenant(s). That’s a rental property, even if you’re choosing to be one of the renters. It’s also not what most people consider when they talk about buying a home. Complete guess, I’d say fewer than 1% of homeowners are actually house-hacking, though some may have relatives living with them and paying some rent.

      If you’re a live-in flipper, again, you’re buying an investment property for the profitability, and you’ll happen to live in it while you do the repairs. That’s a business — buying and selling homes — and you’re opting to forgo stable, long-term personal housing to reduce your expenses and increase profit margins. Like house-hacking, that’s a very small segment of the market.

      In your case, where you’re converting an owner-occupied home (with the associated easier-to-get mortgage), you’re now shifting that primary residence to a bonafide investment. Ideally you’re charging a rent that covers all your costs and leaves you cash positive on a monthly basis, while also gaining principal. The data is a little outdated, but a 2013 survey by Bigger Pockets suggests 11% of Americans own a rental property.

      So I agree that real estate can be a good investment. I still don’t think a traditional, owner-occupied, single-family home fits in that category.

      • Wait, doesn’t everyone want to be a landlord?! Ha ha, it’s true, I spend so much time with real estate investors that I’m a bit skewed in how I view a home. But, I am big a fan of getting creative with your primary home to begin real estate investing as a path to FIRE.

        • That’s a great way to jumpstart a real estate investment. My wife and I are leaning toward picking up a rental home in the next year or two. We won’t go down any of those fine paths. Just not for us right now. So we’ve got to save up the 25% down payment to get a regular investment property mortgage.

  2. I agree with you on this one, but will throw this one out there for you thoughts. What about the ‘leverage value’ a traditional owner-occupied home possibly offers? For example:

    Credit Score – despite whatever one’s score was to procure the home, timely mortgage payments will (in time) improve your score as it shows you can manage a greater capacity of debt. Essentially, decreasing your future cost of debt (capital).

    Cheaper Source of Financing – although interest rates are creeping up slowly, they are still advantageous compared to credit card APRs and some student loans. A home equity line of credit (HELOC) might be a cheap source of financing to pay down high interest rate CC debt and swap for a low rate (albeit variable).

    Last Resort Retirement Fund – maybe a few years into your debt-free retirement, the market takes a nose dive. The next few years and/or decade looks grim, which just so happens to be a substantial portion of your retirement plans. Your paid-off home could possibly act as a bank with a reverse mortgage helping you keep your head above water.

    Again, in my opinion, a personal residence is a money pit; however, there are intangible levers to pull in the right scenarios that could be very beneficial to your financial health.

  3. Great post! I always caution people against looking at their home as an investment. Too much work and maintenance, with too little return. I am a home owner but for me our home represents stability and roots for my family. But I can’t wait to sell and downsize when my children are older.

    • Agreed. I wouldn’t have a problem renting again in the right situation, either. My wife and I will most likely downsize at some point, maybe even before our daughter is out of the house, but for right now we’re in the location we want to be!

  4. Good post, with an unusal slant on a topic that most people take as a given – “your house as an investment.” However, I also wanted to point out that you did not seem to include the costs for an alternative – renting. Some form of expense for a place to live should be factored into the math??

    • There’s definitely a cost to renting. It’s typically a more stable cost in that the cost of rent will be locked in for the duration of your lease and renters insurance is cheaper than homeowners insurance. You’re not growing equity, but if you’re smart and invest the difference between renting/buying (again, this is extremely variable depending on so many factors), you should be able to come out with better returns on that money than if you had put the same amount into a traditional mortgage.

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