Posted on January 1, 2019
People often talk about and think about houses as a good investment. At first glance it appears to be reasonable considering houses generally appreciate in value over time. If one purchases a house and sells it for more than the purchase price surely it is a good investment, right?
Not quite. A house is an asset as well as a liability. Assets in and of themselves do not necessarily equate to "good" investments, and indeed a house is terrible investment. Let's review the reasons why.
Good and Bad Investments Defined
An investment is committing capital (i.e. money) with a reasonable expectation of obtaining a return (i.e, profit). Therefore a good investment is an acceptable return of capital relative to the risk assumed whereas a bad investment is an unacceptable return, or loss, of capital relative to the risk assumed.
Now that we defined what good and bad investments are we can now apply this to a home purchase scenario.
A House as an Investment
Let's look at a home purchase from a true investment perspective. Using the assumption listed below, which are rough averages for the US, we can start calculating expected returns.
Given these assumptions we can now see that the home value in 30 year's time is expected to be around $969K. However, the costs of maintaining the house, paying property taxes and insurance, and factoring in inflation add up to $923K. We not done yet since we did not add in the cost of the mortgage over the 30 years - that is about $387K for an original loan of $160K.The investment is expected to be a net loss of around $341K. I summed up these calculations below:
Clearly this is a bad investment.
Where the Value Is
But that isn't the end of the story. Instead of looking at the $341K as a loss, look at it as the total cost of living in a house as compared to renting. Averaging this out by month equates to $947 a month, which is already much more favorable to the average rent of $1,405 a month. Further, rent at year 30 would be around $3,400 if adjusted for inflation.
The hypothetical home purchase appears to be a good financial decision considering the alternative of renting. Therefore the real value in home ownership is the lower overall cost as compared to renting over the long term in addition to added value that home ownership brings. Just don't call it a good investment.
The Bottom Line
Does this mean you should not buy a house since investment returns are unfavorable? Of course not. Homeownership over the long term has proven historically to be a good financial decision, since the opportunity cost relative to renting is more likely to be favorable.
I challenge you to view home ownership not as an investment at all but rather as an opportunity cost to renting. That is, given two choices of owning and renting, which choice would provide more value given your situation?