Monday, March 05, 2007

Your House Can be a Bad Investment

Like it or not, your house is a bad investment. "Heresy!", you say. Maybe, but here are my reasons for making what many would consider an outrageous claim.

1. A House is a Large Undiversified Investment - most sane investors would shudder at the idea of investing 80% of the portfolio in a single stock, even if that stock is the bluest of blue chips. Yet many Americans have absolutely no qualms about not only investing all of their assets in a house, but also taking on large, often excessive amounts of debt. Many do so because they believe that their house is the best and safest investment available. Wrongo. If it's not yet clear, housing prices can and do go down. You may have seen this graphic from the NY Times, but I think it makes the point that investing in a house has not been a great strategy over the past century. You want to invest in real-estate? Diversify and buy a REIT index (NASDAQ: VGSIX).

2. A House is not a Liquid Investment - If a stock disappoints you, you sell it. The whole process takes you 30 seconds and costs a few dollars in fees. However, as many people around the country are currently finding out, selling a house can be a long, arduous and expensive process.

3. You Never Really Cash-Out of a House - if a stock has a nice run-up, you can easily realize your gains and walk away. If you live in your "investment" you never really cash-out, and so the higher value of your asset will not increase your standard of living. In fact, if you want to increase your standard of living by moving to a bigger, nicer place you will probably find that its price has also increased and more so than your own house (since the new house was more expensive to begin with). Conclusion: for most people house appreciation does not translate into real wealth.

Of course there are exceptions to this argument. For example, if you are willing to move to a smaller house, or you are willing to sell your house and rent, your house's price appreciation will translate into a real increase in your standard of living. Similarly, if you move from a high cost market, such as California or New-York, to a lower cost market, such as Texas, you can also gain from price appreciation. However, that is not the case for most people.

4. Opportunity Costs - many say that renting a house is like throwing away money. After all, at the end of the month you have nothing to show for your payment. This argument is false. By paying rent and not investing in brick and mortar you are able to take your investable assets (such as those you would have used for a down payment) and invest them in alternative investments, e.g. the stock market. Given that mortgage payments tend to be higher than rent, the opportunity cost of investing in a house is considerable and grows over time. Tax considerations may change this equation, especially for people in higher tax brackets whose mortgage deductions can translate to larger tax savings.

So, do my arguments mean that you should not buy a house? Far from it. A house is an investment, of sorts, but it is much more than an investment. It is a place to live and a place to call home. Humans are emotional animals and we need to be emotionally invested and attached to a physical location. My real point is that the cult of real-estate investment and home-ownership is over-zealously promoting itself. Sure, for many it makes financial and emotional sense to buy a home. For many others it would make more sense to invest their money elsewhere. Your house is your home, not an investment, and that's the right way to think about it.


Escape Brooklyn said...

Great graphic from the Times and I like your points. Although my co-op has gone up significantly in value, it's just paper money until I sell, as you point out. And even if I sell where could I afford to move?

However, I do like the idea of real estate as an investment if instead of selling your home to buy another one, you borrow money (or save) for the downpayment, and rent out the first. (Let someone else pay your mortgage.) Then repeat a few times until you have several properties under your belt.

Landlording is a lot of work, but I think it's a good long-term strategy for folks who don't have a lot of cash on hand to buy stocks but want to increase their net worth. You just have to wait for deals in areas you're willing to live.

Shadox said...

Yes. I completely agree with your points. Real estate can be an excellent investment. My article was mostly aimed at those that treat their home as an investment. There are a couple of reasons real-estate investing can be a good idea, the main ones are:

(i) real estate investing is one of one a few opportunties where an ordinary individual can make a leveraged investment, i.e. invest other people's money. One other possible example is investing in stocks on margin (however that one a much different risk profile);

(ii) if you live in your investment for a period of time, you actually get a tax break on capital appreciation if you sell it. So, theoretically, you can buy an investment property, live in it for a couple of years and THEN sell. Repeat the process several times and you got an interesting thing going. Crazy life style, but it could work.

This is a very good topic for a post and I will write it up as a follow up in the coming days.

Thanks for the great comment.

silverbax said...

Real estate is only an investment if it isn't your primary home or you intend to flip your home in a set amount of time for a profit. Buying a home, living in it for ten years and then thinking you've got great net worth because the value of your home went up is a mistake. Real estate investing is buying a property that you collect rents on or can sell quickly to cash out.