Why buying a home might not be the great investment you think it is…
People often think of buying a home as a great investment. After all, most of us have seen house prices in major metro areas like San Francisco, Denver, and New York City fetch huge sums – according to Zillow, the median asking price on a single-family home in San Francisco is a cool $1.36M. Compare that to the median asking price in 1990’s, which was $227,000, and you probably think that investing in a home is a phenomenal investment.
However, this is not always the case, and I generally counsel caution when my clients think about buying a home as an investment. For example, while homes in San Francisco still generate a higher rate of return that homes in other areas of the country, prices have actually been slumping over the last couple of years. Let’s dig a little deeper into why your home might not always be the great investment you think it is.
The Financial Upsides of Buying a Home
Before we get into why home buying isn’t always the best investment, let’s talk about
some of the financial upsides of buying a home. There definitely are some advantages!
First, there’s a concept in finance called “store of value.” Store of value is the function of an asset that can be traded or stored for future use. When it comes to your home, if you buy rather than rent, your home has store of value, meaning that you can sell it, rent it, or pass it onto other members of your family. You are paying into something that you actually own, in other words. Renting does not offer the same advantages. While you can (sometimes) sublet an apartment, you can’t sell or pass on what’s not yours.
When you own your home, you are building equity with each payment. You’re paying into an asset that you own and that has store of value, instead of paying someone else’s mortgage with your rent payment!
Additionally, if you are a homeowner paying down a mortgage, your mortgage can actually act as a “forced” savings account. You need to pay your mortgage every month unless you want to ruin your credit or lose your property, and part of each payment goes towards principal, which can be considered savings. Of course, mortgages do come with interest payments, but statistically, homeowners actually have a higher net worth than renters, largely because it’s incredibly difficult to save the amount of a mortgage without being “forced” to do so.
Lastly, homeowners do receive certain tax breaks that are not available to renters. More on that here.
The Downsides of Thinking of Your Home as an Investment
1. Low-to-Negative Rate of Return
When we talk about any investment, whether it be your home or not, we have to talk about return. This is potentially one of the biggest reasons that buying a home might not be the great investment you think it is. Over the past 30 years, the rate of return on home purchases was approximately 4%. That ends up being slightly above the approximately 3% inflation rate over the same period.
After factoring in carrying costs associated with owning a home such as mortgage, interest, taxes, insurance, maintenance, and investment opportunity cost (the cost of missing out on investing the money you’re putting in your home, in the capital markets), your rate of return is even lower, maybe even negative.
2. Lack of Liquidity and Buy/Sell Costs
A home is generally considered an illiquid asset, meaning it’s not easy or quick to sell. If you don’t have a robust emergency fund and other, more liquid assets at your disposal, forsaking liquidity for equity can spell disaster. Additionally, the more equity you have in your home, the more likely a bank will foreclose if you fall behind on mortgage payments.
Also, buying and selling a home both take time and money, so if you need to liquidate the money you have tied up in your house, you’ll probably be taking a loss if you want to move quickly and sell at market rate.
3. Should Selling Your Home Be Part of Your Retirement Plan?
While obtaining funds from selling your house can be part of your long-term retirement plan, it’s usually not a very good idea to make it the main source (or even a major source) of money for retirement. Why? For all the reasons I’ve mentioned above: homes in many areas of the country actually generate very little to no (or sometimes even negative) return, buy/sell costs are high, and it might not be as easy to liquidate as you think. Given all of this, your home isn’t a very reliable source of income for retirement. And on top of that, if you sell your primary residence to fund your retirement, you still need somewhere to live! So, what portion of the proceeds from selling your home will go to finding a new situation, and how much will you actually be able to rely on for living well in retirement?
While buying a home can be a major milestone for many people, it’s generally not a good idea to think of it as an “investment.” There are, of course, exceptions to this rule, and buying a home can be a wonderful personal investment in yourself and for your family. I’m not trying to discourage anyone if this is a goal for you, I am a homeowner myself and have never regretted my decision to buy. I plan to live there for many years and have never thought of my house as an income-generating investment, so for me, it made sense to buy instead of continuing to rent. It really just depends on what you’re hoping to get out of buying a home.
If you’re wondering whether buying a home is the right decision for you, I’d encourage you to reach out to a financial advisor who can take a holistic look at your finances and help you determine what might work best for your long-term goals. Personal Capital’s dedicated advisors would be happy to discuss how a home purchase might fit into your financial picture – you can schedule a free consultation after signing up for our dashboard here.
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