AseanOutlook.com – There are lots of reasons you might want to buy a home, things like stability, privacy, and not having to deal with a landlord.
But is buying a home a good investment?
Let’s look at how homeownership stacks up against other investments and what that means for how you think about buying a home.
First, let’s compare returns. Obviously, many homes do appreciate in value.
In fact, on average, homes in the United States have appreciated more than 114% from 2000 to 2019 even after the 2007 housing bubble burst, when many homes declined drastically in value.
As impressive as that sounds, that return works out to about 3.9% per year before accounting for other housing costs.
For example, if you borrowed most of the money to buy a home at a 3.5% mortgage rate, your return falls to less than 1%.
Compare that to the roughly 6% average annual return on the S&P 500 Total Return Index over the same time period.
While this doesn’t account for potential mortgage tax benefits that increases your return.
It also does not account for other ongoing expenses such as homeowners insurance and maintenance, which further reduces potential return.
Additionally, the return on a home varies depending on where you live.
For example, from 2009 to 2019, San Francisco saw much higher growth than Cleveland. During these 10 years, Cleveland underperformed the national average.
So if you’re looking for a way to grow your money, your primary residence may not be the place to do it.
In addition to potentially providing only modest returns, buying a home can be financially risky. One reason is leverage.
Leverage is the ability to control a large asset with a small amount of money.
Leveraged investments are normally reserved for experienced investors because of their risky nature.
But getting a mortgage to buy a house involves significant leverage.
Depending on your home loan, you may put down just a few thousand dollars to borrow hundreds of thousands of dollars.
A quick rise in value could result in a big return.
For example, let’s say you paid $10,000 on a $200,000 home. A 5% rise results in a $10,000 gain, not accounting for commissions. That’s a 100% return.
If the house dropped 5% in value, the $10,000 loss would offset the amount you paid.
The example assumes that homes are easy to sell, but they take time. The ability to easily sell an investment is known as liquidity.
High liquidity occurs when there’s a lot of buyers and sellers for the same product.
Generally speaking, homes are not very liquid because an investor has to find a buyer and that could take months. Then add an agent’s commission on top of it.
Finally, owning a home means having a lot of money tied up in one asset.
Investors typically try to manage risk by diversifying, which means spreading money across various types of investments.
This can reduce risk because when one investment is performing poorly, another investment is often performing well. But with a house, you’ve got a lot of eggs in one basket.
In short, concentrating lots of money in a single, illiquid, highly leveraged asset is a recipe for financial risk.
So, does this mean you shouldn’t buy a home? Not necessarily.
It just means it may not be a good investment, and that’s ok lots of big purchases aren’t.
While it’s important to carefully consider the financial implications of buying a house, it’s better to think of it as a lifestyle choice than a purely financial one.
No matter what your family looks like, a home is a place where your family and friends grow together. It’s where memories are made. It’s a home base that provides security from rent increases and difficult landlords.
Studies suggest that homeownership is correlated with children having fewer behavioral problems, attaining higher education levels, and finding employment. Homes appear to offer stabilizing and nurturing environments.
And even if a home doesn’t have all the characteristics of a great investment, it can still have some financial benefits, like the opportunity to build equity. Equity is the value of the home minus the mortgage.
Over time, as the loan is paid down, the equity will grow if the home’s value remains the same or increases. This equity adds to the homeowner’s net worth.
So, while there can be value to homeownership beyond the family you raise and the memories you make, it may be better to think of it as more of a lifestyle choice than an investment.