As Far as a Bad Investment Goes, Your House is Right Up There!!
Before we get into this, just know that real estate is not necessarily a bad investment. And I’m not against buying real estate.
But I’ve heard over and over again, “Buy a house! It’s not a bad investment!”? Or, “Stop renting, You’re just throwing money away!”
Listen closely, your house or primary residence is not an investment. Before we dig into why a primary residence is a bad investment, let’s discuss what an investment is.
By definition an investment is the action or process of investing money for profit or material result.
An investment is expected to earn you money. You put some of your money in, and you naturally expect to receive more in the future. In other words, you expect to earn a rate of return.
This basic principle of investing is not complicated. But deciphering the costs can be!!
There are various costs associated with all investments. Some investments, for instance index funds and ETFs (Electronically Traded Funds), have very low fees associated with them (0.1% or even lower!). Other investments have varying cost structures. Mutual funds can have higher fees depending on the specific fund.
In general, understanding the various costs is one of the most important factors in choosing a good investment.
With this in mind, let’s consider your primary residence as an investment.
Though I’ve already said it, in my opinion, this is a bad investment.
Why is Your Primary Residence a Bad Investment?
Remember that all investments have fees, and a house is no exception. The actual amount of the fees can be difficult to approximate just because they vary so widely and depend on many factors such as the neighborhood, condition of the house, your DIY acumen, and your mortgage interest rate. Here are 5 more reasons . . .
1. Low Appreciation
Real estate on average appreciates at a rate of around 3.5%. Or right around inflation. This doesn’t sound like a great return to me when the stock market averages ~10% before inflation. So we’re already off to a bad start.
2. It’s illiquid.
This means that it’s tough to get your money (equity) out of it. It takes time to sell. And then there’s the logistics of moving all your stuff. I, for one, hate moving!! It’s stressful and a huge hassle.
We always seem to lose or break something. And then there’s the unpacking and re-organizing. No thanks.
3. Transaction Fees are High.
With a house transaction, that transaction fee is called ‘closing costs’. And most of that money goes to the bank or the lawyers for helping you complete the deal. Everytime money changes hands, the transaction costs somebody (usually you) something. The transaction fees to sell your house are high.
You also have to pay real estate commissions. These are usually 6% or even higher. We once listed a house with a broker who charged 7%. It’s not that they aren’t deserved, it’s just that you wouldn’t normally have to pay 6% on every transaction you made with your other investments.
So, closing costs could be 3-4% of the purchase price, and commissions could be another 6%! If you turn around and sell/buy another house a few years later, you’ll have to pay some percentage or even all of these costs again. Don’t forget about these costs when it comes time to figure out how much house you can afford.
This is probably common sense, but if you own a house, you’re responsible for fixing things that break. If you need a new roof or furnace, it’s up to you to cough up the funds to replace them. I’m speaking from experience here. We had to replace both the roof and the heating/cooling system in the first year!
I hope you have a substantial emergency fund. Because if you don’t, you’re asking for trouble to move in with you. Something will break, and you’ll have to take care of it. Most experts recommend an emergency fund of 3-6 months of expenses.
In order to maintain the value of your house, you’ll have to upgrade things periodically. These are things that don’t necessarily add value to your house, they just help to maintain the current value trajectory. Just replacing the roof doesn’t increase the value of your house. But not having a roof will certainly lower your house’s value.
All these are costs that you need to be aware of. Do you have some outdated rooms or features that will have to be addressed?
For instance, if your kitchen looks like it came out of a 1970’s design magazine, it’s probably time to upgrade. Your home may not be appreciating at the expected rate because your kitchen is dragging it down.
Depending on the size of your retro kitchen, this remodel could cost upwards of $20k or more. But don’t think that you’ll increase your home value by the same price. You’ll just keep the value from falling off a cliff by putting a modern kitchen in. In other words, the value will be back to where it should be.
In order to actually increase the value of your house, you’ll have to add something you didn’t have before. Like an extra bedroom or bathroom. Or maybe another garage bay or shed or even a whole new addition.
All that, and we haven’t even considered the opportunity costs of a 20 year, 30 year, or even longer mortgage loan. For instance, while you’re “investing” in this house, you can’t invest in anything else with that money.
Not that this is necessarily a bad thing, just don’t consider it a great investment. See it for what it is!!
It’s a nice place to live that you happen to own, and you have almost uni-lateral control over . . . and also a bad investment.
So Then Why Should I Own a House?
With all these added or hidden costs and fees, some may be nervous or even scared to take the plunge into home ownership.
But don’t worry, there are benefits to home ownership.
One benefit is that you can lock in your housing costs for the rest of your life. First with a mortgage (the payment is always the same with a fixed rate loan), then with just taxes and insurance (once you pay the mortgage off). This is a huge benefit.
Think about the time-value of money. A $1000 mortgage payment 10 years ago is the same as $1200 today when you factor in inflation. But you’d still be paying $1000 for your mortgage. Inflation eats away at your purchasing power. And in this case, that’s a good thing!
It means your housing costs effectively decrease year over year. You can’t say that about renting. This is a big piece of the wealth building puzzle. As your housing costs are likely the largest line item in your budget, decreasing them year after year is fantastic!!
When you rent, your housing costs can increase year after year. You’re at the mercy of your landlord and the market when it comes to rent. And like taxes, rent rarely decreases.
A second benefit is that your house is yours. You own it. If you want to paint or remodel – you can!
Don’t like noisy neighbors? You can buy a house far away from everyone. Try renting an apartment without neighbors. You could possibly rent a house out in the boonies, but those houses are not plentiful.
And third, you can sell your house and downsize to recapture some of your equity if you chose. You could also take out a home equity loan or get a reverse mortgage – but I would never recommend either of those options.
If you are realistic about what your primary residence is, there’s no good reason to not own a house. Just keep the price a reasonable part of your budget and later your net worth.
With the facts about the costs and fees in mind, your house is not a great investment. It’s actually a pretty bad investment. The costs will eat away at the appreciation over the years.
The only way to make real estate a good investment is to not live in it. Rent it out!!
Do you own your house? And how is your “investment” doing?
Let me know in the comments and thanks as always for reading and sharing.