The colossal housing meltdown we’ve experienced, in the wake of the unprecedented boom in home appreciation, has turned many people sour (and not without good reason) on the concept of house-as-investment. Many arguments in favor of renting, rather than buying, have come out of the woodwork, and have their fair share of merits. The better among these arguments ought to provide sobering considerations to those tempted to jump on the next bandwagon of “never-ending” price spirals, treating their home as a short-term, get-rich-quick instrument.
Of course, the same arguments don’t serve to convince those who place a higher value on home ownership’s intangible benefits: a long-term residence at which one establishes roots, builds memories, raises a family, and modifies as they wish.
The benefits of home ownership, however, are not limited only to those intangibles that play to emotion or nostalgia. There are very real long-term economic benefits as well (note the careful choice of words: I did not say, “It’s a good investment”). Of primary consideration (and what the arguments in favor of renting over buying often neglect in their calculation) is the hedge against inflation that a mortgage provides. The cost of housing, including rent, is going to go up over the long-term, just as the price of a gallon of gas or of a hamburger will go up.
A (fixed-rate) mortgage payment, on the other hand, remains the same. Property taxes do go up, but in most areas voters have passed initiatives to limit the annual increase of property taxes to a lower percentage than that of inflation. Moreover, property taxes are only a small portion of the mortgage payment, so even if they were increasing at a similar rate as inflation, the total aggregate mortgage payment, 80% or more of which is not property taxes, is still going down over time when adjusted for inflation. Property taxes are often reduced when you reach a certain age, as most states have partial (sometimes even full) property tax exemptions for senior citizens. Finally, most people also get a tax break by virtue of being able to deduct mortgage interest from their taxable income, so the tax benefits of home ownership often end up a wash with the tax burden. So it’s safe to say that the home owner’s overall housing payment, adjusted for inflation, is going down with time. The same cannot be said for the renter.
Many homeowners of the generation before mine are a living example of this principle in action, having bought their home 30-40 years ago for $40,000 or less. Yes, many of them still have a mortgage because they’ve refinanced a few times through the years, the wiser ones pulling out equity for various updates and improvements to the property rather than using the house as an ATM machine, thus keeping their mortgage at or near the same level as their original purchase price. Consequently, many have enjoyed a mortgage payment of $500 or less to this day, and have a home that even in today’s depressed housing market is worth several times more than what they owe or what they paid for it. But the property’s appreciation is only a side benefit, not the thrust of my argument. If they have no intentions of selling, that aspect is a moot point anyway. The real benefit is that they’ve fixed their housing cost (that is to say, lowered it year after year when adjusted for inflation), knowing that the cost of rent would eventually outpace their expense as owners.
Someone will counter with the argument: “Yes, but they could have instead invested that $40,000 and watched it grow at 12% ROI in mutual funds all those years on the road to millions.” No, they couldn’t have. For starters, most of them did not have $40,000. They might have had enough (with help from parents) for a 25% down payment on a $40,000 house. There’s a big difference. Even assuming they could get 12% over 40 years, and that it didn’t get wiped out in a stock bubble, it doesn’t come anywhere close to doing as well for them as buying a home did. Plus, then they would have had to rent, and would not have had the benefit of all that extra disposable income to invest in the years subsequent to when rent outpaced the mortgage payment they could have fixed, because their housing expense would have continued to increase at a comparable rate to their income.
Moreover, if they had invested the amount they originally put down on that house, the net value of that cash asset would still not have equaled what their home is worth today because their home, even if it appreciated at a lower rate of return, was gaining ground on the full value of the leveraged asset, not merely on the amount they had invested. If I put $10,000 down on a $200,000 home, I’m going to net much higher gains at a nominal rate of appreciation than investing that same $10,000 would at a phenomenal rate of appreciation. In other words, I’d forego the 12% rate of appreciation on $10,000 in cash, for the sake of getting a 4% annual rate of appreciation on the $200,000 house, and have more money to invest in stocks or mutual funds in subsequent years because I’ve fixed my housing expense as a hedge against inflation.
So, at the end of the day, is a house a good investment? In a very real sense, no. Let’s look at that $200,000 house. Assuming a long-term average rate of appreciation of 4%, that house might be worth $662,000 in 30 years. If someone takes out a $190,000 mortgage on a $200,000 house at 6% interest, they will end up putting $420,000 into that house over the same span of time. $420k invested to yield $662k over 30 years is a pathetic rate of return of 1.52%, which is illiquid, only converts from unrealized to realized gains when you sell, and that’s before you factor in taxes and maintenance. Nothing to write home to mom about.
That being said, now entertain this more accurate way of looking at it: It’s inappropriate to ask whether or not a home is a good investment. It’s a false question, akin to exploring whether or not food is a good investment. Housing is a basic necessity that one has to pay for whether they own or rent. In that sense, home ownership is a “bad” investment, if one insists on calling it an investment at all. And rent would be a far worse investment by that standard, involving not even nominal gains, but rather a negative return (i.e. the loss of 100% of your principle invested each month). But the case I make isn’t that either is a good investment. Rather, that a mortgage, under the right circumstances, can be an effective inflationary hedge against the rising cost of housing, allowing someone to “fix” their housing cost (or lower it, relative to inflation), so that they can soon pour more money into other, better forms of investing, while at the same time reducing their monthly liabilities for their retirement years.