Written by Corey Janoff
It is often said that buying a home is the biggest investment you will ever make. But is your primary residence your biggest investment, or is it your biggest expense? I would argue it is more of an expense than an investment. Today we will dive into this topic.
Why a Home Could be an Investment
When people think of an investment, they often think of something that will either appreciate in value or generate passive income (or both). Well, if you live in your home, unless you have roommates whom you charge rent, it isn’t generating passive income. So your only hope is for it to appreciate in value.
It is safe to say that in most parts of the country, homes appreciate in value over time. If we look at a graph of national historical median home prices, we can see home prices do increase over time. Median home prices in the US have doubled over the last 19 years. This equates to a 3.8% annualized growth rate.
Most people who are investing money for the long-term probably don’t get overly excited about a 3.8% annualized growth rate with risk. As of November 2nd, you could invest in essentially risk-free 10-year treasury bonds at 3.22% yield. Or a 30 year bond paying 3.46%. Granted, that is a fixed interest rate and the home price appreciation is compound, but still. If you reinvest the interest from the bonds, the total return can compound.
So one may look at their home as a conservative investment that appreciates gradually in value over time. But this assumes the purchase price is the total cost of the initial investment. Anyone who has owned a home knows you actually end up paying a lot more.
Actual Cost of Homeownership
Your house will actually cost a lot more than the initial purchase price on the sale agreement. For example, let’s pretend you purchase a home for $500,000 with a 20% down payment, or $100k down. If you finance $400,000 on a 30-year fixed-rate loan at 5% interest, your monthly mortgage payments will be $2,147.29. If you take the full 30 years to pay it off, the total payments will add up to $773,024.40. Add the $100k down payment to the total loan payments and the $500k house really costs $883,024.
Now, that is only the principal and interest payments! That doesn’t include your closing costs and pre-paids on the front end which probably cost about $10,000, give or take.
And what about property taxes? Let’s estimate the property taxes on this $500,000 property equate to $6,000/year. I’m sure they are more expensive in some towns and less expensive in others. According to this article by USA Today, the average property tax bill in the nation is 1.15% of a home’s value. So the $6,000 is pretty darn close to the national average.
Property taxes will rise over time as the home value appreciates. If we assume property taxes increase at the same 3.8% growth rate as home prices from earlier, we can expect to pay a total of $325,485 over the next 30 years. This brings our total cost of ownership to $1,218,509 for 30 years.
And the property taxes won’t end once the mortgage is paid off – those continue for as long as you own the home.
Don’t forget about homeowners insurance. I’m going to speculate the average homeowner spends $1,000/year on homeowners insurance. Based on some quick online perusing, this seems fair. If we assume that the cost of homeowners insurance increases at the same pace as the value of the home (you need to update it periodically for replacement costs), the cost over 30 years will be $54,247. This brings our total cost of ownership to $1,272,756.
I won’t factor in utility bills, which you will pay whether you own or rent, or silly things like lawn care or house cleaners. However maintenance expenses will add up over time. The roof will need to be repaired or replaced every once in a while. The furnace will go out and need to be replaced. You might need to re-insulate the attic. Carpet and floors might need to be redone. The list goes on.
A common rule of thumb is you can expect to spend an average of 1% of the value of the home per year in home expenses. Another rule of thumb is you can expect to spend $1 per square foot per year. Obviously these don’t factor in geography as I’m sure the price to hire an electrician is more expensive in San Francisco, CA than it is in Mobile, AL.
1% of the home price would be $5,000/year for a $500,000 house. Let’s pretend the house is 2,500 square feet – that would be $2,500/year using the square footage guideline. So let’s split the difference for the fun of this and say the average annual maintenance cost is $3,750. This won’t be consistent. Some years you may only spend $1,000 on maintenance. Other years it might be upwards of $10,000. Again, applying the 3.8% home price inflation to this maintenance rule of thumb, it adds up to $189,357 over 30 years. This brings our cost of ownership total to $1,462,113.
Keep in mind, the more expensive the house, the more costly it will be to maintain over time. One of the biggest financial mistakes people make is overextending themselves with their primary home purchase. If you buy more house than you can afford, this will really limit your ability to accomplish your other financial goals.
Alright, enough expenses. We might have overestimated some and overlooked others. I think we did a pretty good job though. After 30 years and almost $1.5 million of payments, what is our house actually worth? Well, if the home value appreciates by 3.8% per year on average, after 30 years the home you bought for $500,000 will be worth $1,474,665.
A Home is more of a Forced Savings Vehicle
The above example is a little depressing – over 30 years, you put in about as much as the house is worth in the end. If you sell at that point, you basically recoup all of that money you paid over the years. Well, that’s not too bad. That’s way better than renting. Imagine if you are a renter and your landlord gives you all your rent money back when you move out. I’d sign up for that.
Think of homeownership that way. There is a decent chance you will recoup all of the money you put in when you go to sell after a long period of time. You didn’t receive any interest on your deposits, but you are holding onto a large asset when it is all said and done.
That asset can be very valuable to you from a financial planning standpoint. I wouldn’t view it as your retirement fund (unless you live in Los Angeles and plan to sell and downsize and move to Iowa). It’s not a gingerbread house – you can’t eat it. But it will provide a safety net for you.
If your retirement assets appear they might run out before you expire, you could potentially do a reverse mortgage. Or you could sell and downsize, or move into a rental. If you have to move into an assisted living facility, it probably makes sense to sell the home. That will give you cash to pay for your assisted living for a little while.
When compared to renting, homeownership is a good thing if you plan to remain put for a long time. I’ve written before about renting being more beneficial for short time periods, as the transaction costs of buying and selling real estate outweigh the short-term benefits.
After a long-period of time, there is a decent chance a homeowner will recoup most of the money they put in over the years. Maybe even come out with a profit, if lucky.
However, I wouldn’t consider a primary residence an investment. You need to live somewhere, so you are going to incur housing costs no matter what. I don’t like many investments where you only get back the sum of what you put in, with no real appreciation. If you could live for free, you would be better off putting your money in an online high interest savings account giving you 2% interest.
Given a primary home is less of an investment and more of a forced savings vehicle, your best strategy is to minimize your home costs and invest your money elsewhere in assets that offer better growth potential or passive income.