For most people, their home is the single largest purchase they make in their lifetime. Many also consider it their single biggest investment. But should a house be considered an investment? And, if it is considered an investment, is a house a good investment?
Is a House an Investment?
What Does Investment Mean?
An asset or item that is purchased with the hope that it will generate income or appreciate in the future.
Primarily, people purchase a home to live in, raise a family and to have greater control over their environments. The alternative to owning a home is, of course, renting (see our previous discussion of the buy house or rent decision). Clearly, a purchased home can be viewed as an investment that generates “income” equal to the rent that would otherwise have to be paid.
Additionally, most home purchases are made with the expectation that the home will appreciate in value over time. Until the recent Great Recession, this was generally the case in most US housing markets.
Most home purchases are also highly leveraged with just 10% or 20% downpayments. The combination of rising values and high leverage have fostered the conventional wisdom that buying a home is a prudent investment – even a critical step towards building wealth and an adequate retirement nestegg. The Center for Retirement Research reports that for typical households aged 55-64, the primary home accounts for 21% of “wealth holdings”(see graph).
On both counts (income generation and value appreciation), a home purchase in the eyes of most home buyers would certainly be considered an investment.
Is a House a Good Investment?
A dollar used to purchase a median-price, single-family California home in 1980 would have grown to $5.63 in 2007, and to $2.98 in 2010. The same dollar invested in the Dow Jones Industrial Index would have been worth $14.41 in 2007, and $11.49 in 2010.
While a home purchase should be considered an investment, a recent opinion article in the Wall Street Journal makes an interesting case that A Home Is a Lousy Investment. Using data from California, the author notes that since 1980 median housing values have risen an average of 3.6% per year – well below the performance of alternative investments such as the stock market. Of course, an investment in the stock market cannot provide the shelter or physical comfort that a home can. A 3.6% annual return may be an acceptable side benefit given the other returns realized from investing in your own home.
Ultimately, the answer to the question Is a House a Good Investment? depends on individual preferences, perspective and other subjective factors – just as the buy versus rent decision does.
It is useful to compare homeownership to investing in a stock fund using factors other than rate of return. In the following table I’ve listed some of these factors that give perspective and can help you determine whether a house is a good investment for you. For this purpose we view the home as a dual investment in two components: land and dwelling.
Investment Factor | Land | Dwelling | Stock Fund | Comment |
|---|---|---|---|---|
| Depreciating Asset | NO | YES | NO | Older homes expected to be worth less than newer homes. |
| Forced Savings (mortgage) | YES | YES | NO | Portion of each mortgage payment goes to pay down principal and increase equity stake. |
| High Leverage | YES | YES | NO | Most home purchases have low downpayment resulting in 5:1 or 10:1 leverage. |
| Ongoing Tax Deduction | YES | YES | NO | Property taxes are deductible on primary home. |
| Ongoing Tax Payments | YES | YES | NO | Annual property taxes on homes; most taxes on stock investment deferred until sale. |
| Taxes Upon Sale | NO | NO | YES | Most gains on sale of home excluded from taxation. |
| Ongoing Maintenance Costs | YES | YES | NO | Maintenance on home can be costly in terms of cash outlays and time spent. |
| Liquid Investment | NO | NO | YES | Stocks are far easier to sell than home. |
| High Transaction Costs | YES | YES | NO | Agent fees, other costs can amount to 10% of home sale. |
Finally, a further point made in the Wall Street Journal article is worth repeating here:
Is it wise for coming generations to continue to view (home) ownership as the cornerstone of personal finance? Young people planning for retirement increasingly face a choice between house payments and contributions to retirement accounts. They simply can’t afford both. With the specter of looming cuts in Social Security and other entitlement programs, or even possible systemic insolvency, the challenge for tomorrow’s retirees is income self-sufficiency.
The conventional wisdom about the virtues of homeownership that baby-boomers grew up with may not be sound advice for future generations. Even if the current housing bust is just as a blip in the long term advance of housing values, societal changes that have occurred or are likely to occur – i.e. Social Security reform, the decline of traditional pensions, the rise of 401k plans and ever-increasing longevity – need to be carefully considered when deciding: Is a house a good investment?
Thank you to Kitten a Go-Go Blog for including our post on Is a House a Good Investment? in the July 18, 2011 Carnival of Personal Finance #318: The Breaking Bad Edition.
Be sure to check out the Carnival for a rundown on other recent high-quality personal finance blog articles.