Is buying a home a good investment?
A primary residence as an investment
- Historically appreciates only just in pace with inflation
- Illiquid, or hard to quickly convert into cash
- Often requires substantial debt to purchase
- Carries extensive ongoing costs in terms of maintenance and taxes
- Often encompasses most of your net worth
- Carries emotional significance
“Renting is like flushing money down the toilet!”
“But homes barely keep pace with inflation!”
You’ve probably heard some version of this argument before when discussing whether to rent or buy a home. There are many valid reasons to become a homeowner, but is buying a house a good financial investment?
Good investment vs. good decision
A good financial investment is not the same as a good financial decision.
Investments generate income. Moreover, good investments are typically liquid — that is, easy to sell and convert into cash — don’t require substantial debt or ongoing cost and should not encompass the majority of your net worth or have emotional significance. For example, buying the latest smartphone you’ve been eyeing for a $300 rebate is a good deal and a smart financial decision compared to buying the phone at its original retail price. It is not, however, an investment. Oftentimes, buying a home can be a good financial decision but not the best investment.
It is difficult to compare hypothetical investment gains, particularly as your success as an investor depends on your investment style and frequency. Homeownership also provides emotional benefit that cash alone cannot. In making your decision, however, assessing a primary home as an investment vehicle can help you better understand whether buying a house is the right financial move for you.
A primary residence does not generate income from rent like an investment property. Rather, the value of the home can appreciate in value over time. As with a securities portfolio or any other type of investment, the value can potentially rise or fall.
Home values historically only just keep pace with inflation. When your grandmother sold the house she purchased at $100,000 in 1950 for $1 million today, inflation likely accounts for the bulk of that numerical difference.
Property value can increase dramatically in certain locations, but much of it is left to chance. Most people evaluate the location of their primary residence based on their employer, nearby amenities and schools, rather than potential for appreciation.
Real estate is one of the most illiquid assets you could hold. Converting your home into cash is time consuming and expensive, especially after accounting for Realtor commissions, closing costs, potential concessions and taxes.
Not only does this make timing the market difficult, even if you are able to sell quickly, you must find replacement housing as you no longer have your primary residence. This is sometimes called “trapped equity,” in that you own an asset of value but that value is not always free to be cashed out upon selling the home.
Many people require a mortgage in order to purchase a home, which means that the lender is the true owner of the property until it is paid off. It often takes decades for individuals to own their homes free and clear — even longer if you tap into home equity with a line of credit or second mortgage. In fact, homeowners frequently sell their houses before they are able to build up much equity or see the home appreciate from its purchase price. It typically takes living in a home for five to 10 years before homeowners can start to realize a true gain from equity or appreciation.
It’s no secret that there is a financial cost to home ownership even after you’ve paid off all your closing costs. These include non-negotiable expenses such as maintenance — after all, if you fail to keep the home in good condition, it loses value — and property taxes, which can be expected to increase. Changes to tax codes could also affect the deductions you can make, potentially upping your tax bill. Consider the opportunity cost of these expenses. Invested elsewhere, your money may generate stronger returns without the ongoing costs.
For many people, their primary home is the most expensive asset they will ever purchase and encompasses much of their total net worth. This is highly risky from an investment perspective, as it puts most of your eggs in one basket. If you are counting on the value of your home to fund your golden years, a drastic depreciation could wipe out your retirement fund.
You wouldn’t necessarily buy a stock because you liked the way the company made you feel. With a house, however, personal attachment and lifestyle changes make it difficult to take an impartial view of your home as an asset in order to make strategic sales decisions that maximize returns.
This emotional value is arguably the strongest benefit of homeownership, however. For many people, the sense of stability and satisfaction that home ownership provides is worth far more than any financial gains. Is buying a primary home the best form of financial wealth creation? Oftentimes not. Yet if you want to have a place to call your own and build memories with your family — and don’t expect to realize substantial financial gains from it — buying a home may ultimately be the best financial decision for you.