Is Buying a House Really an Investment?
Your house is often described as the biggest investment you’ll ever make. You’ll hear these words from your realtor or your loan officer when you’re pondering the leap into homeownership. But is your home actually an “investment”?
Homeownership is much more complex than investing in a stock or mutual fund — and you have to factor in both the financial and personal returns. Yes, you can make money from a home, but you’re also making memories and securing shelter for you and your family for as long as you own the property.
You can quickly sell a stock if its value starts to drop, but selling a home is much more complicated. You have to figure out where you’ll live next and how it will affect your family — all before the weeks-long process of actually selling.
Your investment in a 401(k) or IRA is fairly hands-off. You’ll make regular contributions and check on its performance every once in awhile. Maintaining a home involves mowing lawns, cleaning air filters and fixing plumbing.
In this article, we’ll explore some of these considerations in more detail, and try to answer the question of whether or not housing is actually an investment.
- Why is housing called an investment?
- Has homeownership always been considered an investment?
- Evaluating your home as an investment
- What do the financial experts say about housing as an investment?
- Factoring in your personal return on investment
- The personal dividends of a housing investment
- The final analysis of housing as an investment
Why is housing called an investment?
In its simplest definition, an investment is something that uses money to earn more money.
That’s exactly what you’re doing with a home. Your down payment is your initial investment, and with every monthly payment on your mortgage, you start building something called equity. Equity is the difference between the value of your house and the balance of your loan. This equity can ultimately be accessed as cash with a home equity loan or cash-out refinance.
When you think about investing, the stock market may be the first thing that comes to mind. You invest your money in a company you think provides a good product relative to the competition and has prospects for growth and stability. You hope that as the company grows, you’ll reap the rewards through increases in the price of the stock over time.
Investing in a home has some basic similarities. If the homes in your neighborhood are well kept, and the area has appealing features like good schools, grocery stores, hospitals and basic entertainment, and proximity to your job — the value is likely to increase over time.
However, that’s where similarities really end.
You can reduce risk in stock market investing by putting money in more than one company. There’s really no way to “diversify” your home investment. Also, selling a home is not as easy as selling a stock. That’s because the home has a feature that is different from all other investments you own — it is also your shelter.
The loss of value in a home doesn’t just threaten the initial monetary investment you make with your down payment, monthly mortgage payments and ongoing maintenance cost. It affects the stability and security of having a roof over your head.
This aspect of homeownership is what creates the most debate over whether homeownership is truly an investment or a lifestyle preference.
Has homeownership always been considered an investment?
The idea that a home could be an investment was not even within the realm of possibility for most Americans 200 years ago. In the early 1800s, very few people had the ability to own a home at all unless they had the cash to buy the home outright, instead renting primarily.
This slowly started to change. The Federal Thrift Charter was created in 1831, allowing the townspeople of Frankford, Pa., to pool their money and buy their own homes. This inspired the creation of other thrift banks to provide residential mortgages into the early 1900s.
The expression “own your own home” was first coined by the National Association of Real Estate Boards in 1917. The U.S. Department of Labor quickly adopted the phrase and launched the first federal program to encourage Americans to own homes.
As the Great Depression raged on by January 1, 1934, fully one-half of U.S. home mortgages were delinquent, and an average of 1000 home loans were foreclosed every business day. A minimum down payment of 50% was common and loans had to be paid off in five to 10 years, and the result was that six out of every 10 households rented their homes.
That all changed when the Federal Housing Administration was created in 1934, offering FHA loan programs with lower down payments and longer repayment periods. Over the years, Fannie Mae and Freddie Mac joined FHA with their own loan product offerings, providing additional sources to purchase mortgages. Slowly, the homeownership rate rose from its lowest level of 44% in 1940 to 64.8% in 2018.
Evaluating your home as an investment
In order to determine the value of the investment in your home, let’s really look at how your housing dollars are spent and ultimately returned over the life of homeownership.
First, let’s set up a framework.
The value investing model
Investors often reference Benjamin Graham as the “father of value investing.” He is best known as Warren Buffet’s mentor and the author of “The Intelligent Investor” — which is still a foundational text for business students today.
According to Graham, a good investment is one which, upon thorough analysis, promises “safety of principal” and a “satisfactory return.” Investments not meeting these requirements are “speculative.”
While his methods are mostly associated with stocks, the same principles can be applied to housing to determine whether homeownership passes the investment-worthiness test.
Let’s explore each of these in some detail to determine if your housing dollar meets the investment definition laid out by Graham.
Does housing offer safety of principal?
Safety of principal means that whatever money you put in, you get back. One example of how this could relate to a home would be your down payment — if you put $20,000 down, how likely are you to get the $20,000 back when you sell the property in the future?
With a stock or cash related asset it’s a little bit easier to determine because the stock either increases in value over time, or it doesn’t. With a house, it’s a moving target.
Your monthly payments represent extra principal contributed over the life of the loan, so you have to add that to the mix when calculating the safety of your principal. On top of that would be any expenses for maintaining a home.
So when all is said and done, you have to look at all of the money you’ve put in to the house at the time you sell it to truly determine if your principal was “safe.”
Does housing offer a satisfactory return?
Satisfactory return refers to how much you make above and beyond your initial principal investment, also called your return on investment.
There’s no way to calculate this until you sell a home, so if you keep the home for your lifetime, the return really can’t be calculated. Also, keep in mind that mortgage interest and property taxes can be written off for as long as you own the loan, which can reduce your tax obligation. This would have to calculated into the return figures, making the analysis even more complex.
Other definitions of investment
The dictionary definition of “investment” may be more relevant to homeownership in particular. Oxford puts it this way: “an act of devoting time, effort or energy to a particular undertaking with the expectation of a worthwhile result.” These can be the non-tangible, heart-string hooks that homeownership has on families.
It could be planting a rose garden, painting a new baby’s room, family pool parties or first kisses commenced on a front doorstep. These emotional returns on investment that can’t measured in monetary terms, and are unique to an investment in housing.
What do the financial experts say about housing as an investment?
There are varying opinions on the financial investment value of owning a home. Often, real estate and mortgage professionals will cite statistics that are accurate on the surface, but don’t look at real life economic realities like inflation.
Robert J. Shiller, a Nobel Peace Prize winning economist, academic and author has analyzed data going back to 1890 to evaluate the return on housing. He wrote in The New York Times, that often people look just at the price of the house at purchase and then resale, without taking inflation into consideration.
Under current inflation projections, a home selling for $200,000 today would be expected to sell for around $250,000 four years from now, even without any underlying price change, Shiller wrote. “Because people often forget to correct for inflation, they may have the illusion that the market is improving,” he wrote.
Renting versus owning
Other experts emphasize the importance of comparing rents with home prices. Looking at it this way, homeownership generally looks like a better investment. A 2018 study by the Urban Institute found that when calculating how much homeowners would have spent on rent instead of owning, from 2002 to 2016, homeownership resulted in a rate of return that outperformed stocks and bonds.
The argument over whether to rent or buy a home may seem like a sales pitch at first, but it’s worth exploring. Every payment you make toward rent is going into that property owner’s pocket to build his wealth. You’re simply paying for shelter.
As a homeowner, each mortgage payment brings you one step closer to owning your own residence. You end up with your own shelter free and clear of loans once you finish the payments. Plus, over the years, you can access the equity you build over time to purchase other assets like cars, investment properties or to help subsidize major life events like weddings and college educations.
You also have the opportunity to reduce your taxable income with the mortgage interest and property tax deductions available for homeowners. As a result, you can either decrease your tax withholding, giving yourself more discretionary income, or expect a large potential tax refund to contribute towards other financial goals.
Factoring in your personal return on investment
Owning a home and living in it is an emotional experience for many people. Financial planners may refer to homeownership as a lifestyle choice instead of an investment, and there is some truth to that.
Owning a home is not a need, it is a want. Your need is for a shelter to protect you from the elements, provide you with security and a steady place to live is a need — and that can be met by renting.
While financial benefits can often motivate someone to decide to purchase a home of their own, the personal returns may be far more valuable to some people.
Pride of ownership
Owning something, whether it’s a car, a cell phone or a couch, provides a sense of accomplishment and pride. If you had to save up for it using money you earned working, it also provides you with a sense of financial and emotional satisfaction knowing you can own something you paid for.
Owning a home can magnify that feeling. Knowing that your down payment, monthly payments and time spent maintaining your property could eventually lead to you owning something you can pass on to future members of your family can be a powerful motivator. You no longer have to worry about a landlord increasing rents, restricting the type and number of pets you have or how bright or how many colors you use to paint your living room.
Every month you pay property taxes, you contribute to the financial wellbeing and safety of your community. That money is spent on schools, road maintenance, fire and police department services and much more. You may also develop friendships with neighbors that last for years, or watch your kids grow from toddlers to teenagers on the same street.
Homeowners often join neighborhood associations to make sure the homes are maintained, or to help neighbors who fall on hard times. Having neighbors you know provides an extra layer of security if a strange car drives through the area, or if you are injured and need help that can’t wait for the local law enforcement to arrive.
These are the moments that you can’t put a price on but stay with you a lifetime. That hallway where your baby boy took his first steps, the kitchen where you cook with generations of family members every Thanksgiving, the backyard patch of lawn where you cooled yourself under the ever increasing shade of a tree you planted when you first moved in are all rewards reaped by an investment in homeownership.
As a homeowner, you no longer wait anxiously to find out how much a landlord will increase the rent this year, or worry about having to repaint the neon highlighter-pink wall in your daughter’s room before you move out. You can sell your home when you want, access equity you’ve built when you want and gift it to a family member as an inheritance for future generations to come.
The personal dividends of a housing investment
Researchers have studied the social and economic benefits of homeownership for years, in hopes that government policymakers will make homeownership more attainable for more people. Below are some of the findings of those studies:
- The typical homeowner has a net worth of $231,400, while the average renter has a net worth of $5,100.
- Homeowners are 2.5% more likely to have good health than renters.
- Homeowners are far less likely to be crime victims than renters.
- Housing stability lowers teenage pregnancy and reduces the likelihood of needing public assistance
The final analysis of housing as an investment
Housing may not fit neatly into Benjamin Graham’s definition of an investment. There’s no easy way to determine if the money you spend to buy, make payments on and maintain a home will be recouped.
While the dollars spent on a home may not result in a return that beats the stock market, there are a host of other factors to consider. For one, you’re building equity by owning a home, while spending money on rent only contributes to your landlord’s return on investment.
At the end of the day, individuals may be the best judges of whether housing is a good investment for them, based on their own personal and financial reasons for wanting a home. A 2017 National Housing Pulse Survey by the National Association of Realtors showed that 84% of Americans believed that purchasing a home was a good decision.
That feeling has withstood many economic cycles. As one famous quote put it, “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid in full, and managed with reasonable care, it is about the safest investment in the world.”
This quote has been attributed to President Franklin D. Roosevelt, and it speaks to many truths about investing in a home as a primary residence. If you buy a home you can afford, with the plan to pay it in full, and take care of it, it can be a foundation for wealth — and an investment.
But the bigger investment value may lie in the personal satisfaction that homeownership can provide, which is something that can’t be quantified with financial calculations.