the final answer on housing as an investment
Is your house an investment?
There are differing opinions about whether a house is an actually an investment. Some argue that a house makes you money by increasing in value and building your equity as you payoff principal with each mortgage payment. Others say that houses take money out of your pocket each month, and that money can be better used in an investment that increases in value faster than housing and with less maintenance. I'm happy to let you know the final answer on this question. Ready?
Answer: It doesn't matter
That's right. It doesn't matter. And more importantly you're asking the wrong question. Presumably, you're asking whether your house is an investment because you're interested in having more money and don't want to waste a ton of it on something that's not an investment. Instead of asking whether your house is an investment, focus on the best way to build wealth with your money. So what's the best approach to building wealth when it comes to housing?
First, you need a place to live. Assuming no one is letting you live in their house, you need to pay money to live somewhere, whether by renting or purchasing a home. This is your first decision point, and like all decisions it's not black and white and depends on your personal situation. Most people planning to live in a place for less than three years should consider renting because the closing costs required to purchase a home may not be paid back to you in the form of home equity in such a short time. However, for the vast majority of people, purchasing a home will help them build substantially more wealth than renting.
Why would owning build more wealth? First it's important to understand the difference in financial net worth between renters and homeowners in this country. Based on the most recent Survey of Consumer Finances conducted by the Federal Reserve, the average financial net worth for a renter was $5,200, which actually represented a decrease from three years earlier. The same survey reported the average financial net worth for a homeowner was.....wait for it.....$231,000! And that represented an increase of 15% over three years earlier. For those without a pocket calculator, homeowners have a financial net worth 44 times larger than that of renters!
But how can that possibly be?! We've heard plenty of experts tell us convincingly that someone can take that money they're paying for new roofs and furnaces, invest it in the stock market and build more wealth as a renter. They can even back it up with numbers, with the exception of the one number that matters - their financial net worth. They're wrong because they're missing something very important that continues to be underestimated and even ignored in the personal finance community. It's this: there's a very significant aspect of personal finance that is both mental and psychological. The math of investment A vs. investment B doesn't account for the human element.
Homeownership is a form of forced saving. Renters can and should invest money they're not spending on a house, but their financial net worth proves that they DON'T. When we're not forced to do something (like a when a mortgage bill shows up in the mail), we tend to not do it. Most of those renters know it would be smart to invest the money they're not spending on a house, but things come up like car repairs, lattes and avocado toast. At the end of the day they don't invest that money, and that's all that really matters. So the major lesson here is not just to own a home if you can, it's to force yourself to make smart financial decisions. Protect yourself from yourself by paying yourself first and automating it. Take a read through Automatic Millionaire by David Bach, and don't let life or a lack of discipline get in the way of building wealth.
A word of caution. We've shown here that home ownership leads to more wealth than renting. There's a strong chorus of people touting the renting approach, but you'll notice many of them are landlords and that should tell you something. Does it concern you that landlords are telling you renting is a better financial approach when we've clearly shown that it's not? You renting is a better financial outcome FOR THEM, not for YOU.
What to do
Own your home
You should buy your home if you can, but you also need to do it the right way. Only buy what you can afford, and don't buy so much house that it limits your ability to invest through other means such as retirement accounts. The wealth you build in your house shouldn't be the only wealth you build by a long shot.
Don't do it for tax breaks
Never EVER buy more house to get a larger tax break. I've never understood why people pay an extra dollar in order to get 25 cents back from the government. Buy a house you can afford, invest that extra dollar and turn it into a $1.25. That's much more valuable than the government's 25 cents.
Don't use your house as an ATM
As you build wealth in your house, don't use it as an ATM. People love to borrow the equity in their house for wants and they justify it by using it to pay for housing upgrades. After all they're "putting it back into the house". Wrong. You're borrowing an amount of equity (say $25,000) to pay for an upgrade. You will pay interest on this amount (I don't care that it's tax deductible) and then the value of your house will increase by far less than the amount you spent on the upgrade. If you want to make an upgrade that's a want and not a need, save for it.
Turbo charging house wealth
If it works with your life situation, consider purchasing a multi-family unit and renting out the other units. I regret not doing this when I was younger. It's a way to own your home and turbo charge your equity by having others pay down your mortgage. You're also purchasing a more expensive property than you would have otherwise, increasing your capital gain potential. Other ideas include owning your home but buying something very inexpensive to free up capital for other investments. The classic examples are buying a tiny house or even living out of an RV. Not for everyone, but it's a way to significantly limit housing costs.
Any other ideas, thoughts or comments? Let us know!