It seems like there are two sides on whether or not to buy a house. There are those who say it is a waste of money, once I heard someone call it a self-inflicted trap. There are those who say that it is one of the best investments you could make, even more than a business. So is a house an investment? In this post I will try to give as unbiased of an analysis of whether a house is an investment or not.
House As An Asset
Let’s get the painful part out of the way. A house, strictly speaking, is not an asset. I have addressed that before, but buying a house alone will not help you raise money. At best, a house could be a potential asset. You could always rent out at least some space in your house or use it for business purposes. Most people do not rent anything for their house and many do not form a business centered at their house. Computers are far more likely to be assets than personal houses. Most of the time, your house will never pay you. But there could be potential to save money by buying a house.
In this post I will completely ignore any tax incentive for houses. We cannot know who the next senator will be much less what they will change about our taxes. Case and point, President Trump’s tax plan capped the tax incentives in many areas of a mortgage. That may further change when the next president comes in or when congress changes. If your investments are heavily dependent on the swings of the government and taxes, chances are you are not investing right.
Since I took away some advantage for homeowners that is commonly found yet dynamic, I will do the same for renters. Utilities can be provided by the owner of a rented unit, but like taxes the advantages are never consistent. Some rented units have everything free, some have only electricity or heat free, some have absolutely no utilities free. Therefore, there will be no utility advantage for the renters.
I will not take consumer goods into consideration. Most places come with the basics including a refrigerator and oven or provide many different appliances. The accommodations of every residency will vary.
Insurance And Legal Fees
There are many additional fees to consider when buying a house, and although considerably fewer, some of these apply to rentals. Practically every home owner should have house insurance while some rentals require special rental insurance. There are also legal fees for owning a house. We will ignore these and just consider the money spent here as negligible in the equity.
Advantages Of Equity
I will address some advantages of equity briefly and separately, but I will not include it in the main analysis. I know this sounds unfair, but the equity of owning a house is all but worthless and I will address this later. If you plan to sell the house then the house is not for ownership, but instead as an asset. But remember the key rule of buying a house: if you get emotional with your property, you will lose money. I may write a post in the future about how emotional changes to your house may lower the value.
All other advantages and disadvantages will be addressed.
Is Equity In A House Really Worth It?
Owning a house creates equity, rent does not, pretty simple right? Unfortunately, no. Equity is not a measure of value as much as a percentage of whatever the value will be when liquidated. When you pay off a house fully your equity is 100% of the current value of the house. In other words, equity is pointless unless sold. If a house is sold it is not your home but an asset. Therefore, what is your home cannot be you asset.
Before anyone asks, I know that there are equity loans out there is which seems like you are just dipping into the equity. That is not what it is like at all. Instead, you are pulling out a loan in which the lender can use your house as collateral. There is a good reason many of these are called “second mortgages” because they are mortgages, not equity withdrawals. If your home is going to be purely for ownership, you can only use your house for collateral, that does not make it an asset. If you do want to sell the house as an asset, you must work towards trying to increase the value of the house and you would be surprised at the common ways people lower the value of their homes.
I will still include equity in a separate analysis, for those interested in buying a house purely for investment, also there is an interesting conclusion.
Problem With Equity Loans
It does not matter if you use a home equity loan or HELOC, you could lose your house if you default. The debt must be paid in full if you sell the home. Also there are fees. In other words, you will have to either lose your home or some money to pull out a loan. This is not an asset.
Advantages Of Renting And Buying
I have previously established some advantages with renting and owning. But there are two great advantages of owning and two with renting that play key roles in my calculation.
Owning: Only have to pay mortgage for around 30 years, fixed rate mortgage.
Renting: Do not need to pay for maintenance of infrastructure, no direct property tax.
The median mortgage payment in American is $1,030/month while the median rent is $1,012/month. There appears to hardly be a difference despite the fact that the average cost for owning a house is higher everywhere in the US. I prefer analyzing it this way because there is not likely to be any bias.
For a fixed mortgage rate of $1,030/month that should be the same for 30 years or 360 months. Luckily the mortgage payments never change, or at least should not. Mortgage is not the only thing homeowners need to pay though. You will need to pay 1% of the house value in maintenance every year, some suggest you should expect to pay 30% extra on your mortgage for that. That will be about $310/month. Altogether, the average property tax is $3,296 a year, that will be $270/month. The total cost of owning a house with a mortgage will be $1,610/month or $19,320/year.
$1,030 + $310 + $270 = $1,610/month.
Since the mortgage is fixed rate we will assume that the only thing that will change is the cost of maintenance and property tax, but those can decrease or increase. After the mortgage is paid, you will still need to pay for maintenance and property tax, which will still increase with inflation.
Rent is more straight-forward, but more complex. Unlike owning a house, rent will change. They can change for reasons from inflation to property tax. I will assume rent increases exclusively with inflation. Property taxes can change and are frequently forwarded onto the rent. There is a difference, the landlord has may try to balance rent with property tax but the rent does not always reflect the property tax. If homeowners do not pay property tax the government takes the house. Renters may or may not have to pay property tax, homeowners have no choice.
We will assume a 3% inflation rate. With the rent of $1,012/month for the first year the first year rent will be $12,144. With the 3% inflation the next year rent will increase by 3% each year. I will show a chart in which explains the total cost of rent and owning.
In the chart below some assumptions are made for this chart. The median mortgage cost and rent are assumed to be the values above. The rent will increase with inflation, but mortgage payments will not. Maintenance and property tax paid for ownership will increase with inflation. The down payment for the house will be $14,000, which is considered the average down payment for a house. If you take these factors alone, owning a house will cost more than renting for the first 40 years and then the total cost will be less than if you rent.
There are many assumptions there. For one, I am expecting that equity plays no role in the cost (which is not inaccurate). Also I am expecting inflation to affect every aspect equally. That is not accurate, rent can always decrease and value of homes can decrease very rapidly while both can increase as rapidly. Another assumption is no one ever changes from renting to owning or vice versa, as soon as either happens the calculation will be irrelevant.
Let’s say you take equity into the calculation, you will only have a higher equity to total cost of owning a house in the first 15 years. You can almost instantly see why the equity argument falls apart. If equity really played a role in buying a house as an investment everyone could buy a house and sell it within the first 15 years and make a profit. That is not always the case, in fact, there are many costs and risks to selling your house before the mortgage is paid off.
Furthermore, we are assuming that property investors will in no way seek profit in selling a house to you. In other words, they only sold the house at market value for you or lower. There are plenty of fees involved and it is unlikely you will pay for only the value of the house.
According to my math, the cost of rent will only exceed owning property in 40 years. But the cost will be significantly smaller after owning for a while. Therefore, owning your house will pay off later on in life, but not really before retirement. Therefore, owning a house would lower your cost of living later on in life and make retirement less costly. Taking only that into consideration, owning a house could be a good investment. COULD BE.
Taking Equity In Consideration
Owning a house can provide you with equity. Equity by itself is worthless. Unless you plan to sell you house this will never play a role in your wealth. Unfortunately, the equity is only a percentage of your ownership and does not reflect the value. You do not need to be knowledgeable in real estate to know that house values are volatile so you should not rely on average inflation nor the original value of the house to determine the value later on. Simple changes in a house can affect the value and I have heard that most consumer changes can not only have no positive effect on the house value, but a negative effect.
Inheritance Of House
The other argument on home owning I have heard is that you can pass a house on to your kin while you cannot for anything you rent. First, there are massive taxes know as an estate tax in which will negate a good part of that value. Second, according to my math, the increase of maintenance and property taxes from inflation will beat the increase in equity. In other words, a house over time will be less of a contributor to wealth and more of a drain of your wealth. It is likely your inheritors will have to pay more to maintain the house you bought than they could receive from the value itself. And that is assuming the housing market is stable and none of the changes you have made negatively affect the value.
This post may sound like I have stated that owning a house is pointless since the cost of owning a house is only lower than renting 40 years after starting. Considering the fact that the median age of owning a house is 34 and the life of expectancy in America is about 79, in theory you may only see 5 years of benefits from owning a house.
This is in theory, I have made multitudes of assumptions, but I had no choice in the matter. Every individual is different and the benefits of renting versus owning could significantly differ at different blocks, much less different states. If you live in a region where property tax is not very high, you will have more benefits from owning as the calculations I made include property taxes. Also, if you are a handy person, maintenance will not cost you as much as the next person.
I also did not take into consideration the business aspect of whether a house is an investment or not. Renting will be more restrictive on what businesses you can run in a residence, although zoning laws narrow the gap of potential businesses you can run in a property you can rent or own.
As for inheritance, I hate to step on anyone’s toes by saying that the benefits of equity will eventually be outpaced by the cost of upkeep and your next of kin may have to pay more to keep your house than they could benefit. Without regard to your feelings, it was presumptuous and kind of selfish to believe that your next of kin will put in any effort to maintain what you value. Everyone has different values and your next of kin will have different needs than you will so you should not buy a house expecting your kin to keep it.
Get A House For Yourself
If you buy a house, buy it for yourself and your immediate family. You should eventually benefit from the house as an investment. If you have a business idea in which you require home ownership for, then the house becomes an invaluable platform to building an asset. If you intend to sell the home, it is not a home as much as a real estate asset, but you must learn how to make sure you can sell your house and maintain it to convince the next buyer that the house is an investment and not a liability. Check out the Jay Morrison Academy or other real estate classes to learn how to do this. Essentially, you must be creative with your house to make it a tool to make your wealth, and most people never actually follow this path.
Be Honest With Yourself
Most debts require some collateral, and a mortgage is no different. The house can be collateral if you default on your mortgage. If you fail to pay your mortgage, the lender may not be above foreclosing. When foreclosure becomes a reality, all the extra cost you took on by trying home owning over renting is completely meaningless. You have no house, you have no equity, you wasted that money. You should make sure you are financially sound before you ever buy a house. One mess up could cost you all the effort you were putting in. Use this advice to help you forge your wealth.