Are you as foolishly lavish as me? And self-deceptively naïve? I own my home, and a vacation place, too. What an idiot! A really rational investor would never do that because houses are almost always lousy investments. I’ll show you exactly why sinking money into them is stinkin’ thinkin’.
On Jan. 28, we compared home buying with saving for retirement. We found that taking on a mortgage may be the wrong choice.
Homes are investment wonders, some people would shoot back. Yes, homes are wonderful, but the reason to buy them is identical to owning boats, race cars or exotic pets: You have more money than you’ll ever need. The house as retirement piggy bank argument says: Don’t “waste” rent. Save in this appreciating asset. Put 20% down, mortgage the rest. Slowly build ever more equity. Profit later when you sell. With housing prices averaging above 2005’s peak, you hear this again like in earlier decades, and recent gains in selected urban markets get fools’ juices flowing. According to the Federal Housing Finance Agency (FHFA), national home prices have risen more than 30% since bottoming in 2011.
It’s all a fool’s argument. Yes, you might make money if you spot some trend, then buy right, at the right time and the right location, then put lipstick on a pig (which few do well), and flip it. It’s a comforting mythology, like reality TV. Folks routinely fool themselves by calculating returns dead wrong.
Here’s an example from a decidedly profitable decade and place — Northern California’s San Mateo County, where I grew up. It’s a perfect location: There’s the famously sunny weather, at the northern edge of Silicon Valley’s endless growth, where the Bay Area’s major freeways intersect — and in its midst, the San Francisco airport. Beat that!
On Jan. 1, 1995, San Mateo’s median home price was $305,083. Suppose you bought and put 20% down plus 1% closing costs. With 1995, 30-year fixed-rate mortgages going for 7.5%, your monthly payments were about $1,700.
Jump to 2005, when you sold for $763,100 (2005’s median price), a perfectly timed deal months before home prices peaked. After amortization payments, your remaining mortgage balance was $184,091. After paying that off, you had a gain of $579,000. Then, subtracting your down payment, you had a whopping 849% return, or 25.2% annualized. Problem is you forgot a megaboatload of expenses, all of which must be subtracted.
Over those 10 years, you paid more than $60,000 in principal and more than $247,000 in interest. Subtract them, and your return falls to 174%, or 10.6% annualized. San Mateo’s annual home upkeep averaged $1,820 (general maintenance, HOA fees, yard care, etc.). Don’t forget your 1995 closing costs and 2005 realtor’s commission (about 5%). And property tax! In San Mateo, you paid 1.125% of your purchase price, increasing 2% every year. Over 10 years, that’s more than $37,000. Maybe you remodeled for $40,000 and added a patio for $15,000. Median homes grew 500 square feet between 1995 and 2015. To generate average prices you must maintain average size.
After all this, your amazingly lucky timing rendered a mere 59% cumulative return, 3.1% annualized. That’s way worse than stocks or bonds over that period. The one important difference since then? Uncle Sam foots less of your bill since Congress capped property tax and mortgage interest deductibility.
No matter how wonderful your home is, it’s a worse investment than virtually everyone thinks. Yes, home ownership has many benefits. If you didn’t own, you’d pay rent (which is tiny compared with the above, as I showed in last month’s column).
If you haven’t started investing yet, these tips will help get you on the right track for retirement. USA TODAY
Having a family home and yard for the kids and dogs is great. Home-owning neighbors can be wonderful, too, creating community. But the real value isn’t the investment, it’s the roof over your head, the satisfaction it brings and the memories it creates. Home ownership doesn’t compare with real saving and real investment, where real retirement millions compound over your lifetime.