Your Home as an Investment? Let’s Re-think this.

December 14, 2008 by  
Filed under Investing, Retirement Planning

Mr. ToughMoneyLove engages in many debates over “good” and “bad” debt and the logic of having substantial equity in your home or even paying off your mortgage.  Regarding the latter, some folks insist that their home is an investment and resist building equity through their own efforts (such as making a substantial down-payment.)  Instead, they want to rely on market appreciation to build that equity.  In other words, these homeowners assign their homes to the “capital appreciation” class of investments in their portfolio.  I think it is time to re-think that entire concept.

We know what happened to real estate values in the last 24 months.  “Appreciation” became “depreciation” followed closely by homeowner “depression.”  Nevertheless, the optimists among use remained hopeful for the future.  Homeowners still want to think that their house is an investment that will appreciate as in years past.  Other experts are not so sure.  This article from the USA Today states the case that residential real estate values have seen their day.  The boom valuation party is over, permanently.   Part of the reason, of course, is that home values are closely tied to the availability of easy credit.  A lot of us think and hope that those easy consumer credit days are gone forever. 

So maybe it is time to re-think this “my home is an investment” idea.

What does this mean for us?  To Mr. ToughMoneyLove it means that more than ever, your home should be viewed not as an appreciating investment but as an asset to supply you shelter, one of life’s basic necessities.  Therefore, it is in our best interest to preserve and protect that asset by: (a) not treating our home equity as a cash machine; and (b) paying off that mortgage so that we can receive those shelter services for as long as we need them, without having to pay for them.  In other words, you should strive for a mortgage-free life as many baby boomers are now trying to accomplish. 

A home that is 100% owned by the occupant can still be considered an investment, even if it never appreciates in value.  Your home can be an income-producing investment. 

To explain my reasoning, let’s assume that you own a home, 3-BR, 2 bath, 2000 sq. ft., in which you have invested $200k in equity.  Let’s further assume that you could rent an equivalent home in your community for $1500/month.  (You need some place to live, whether you own it or not.)  You don’t have to pay that $1500 in rent because you own your home free and clear.  Thus, your paid-for home is providing you $1500/month in imputed income, or $18,000 per year.  That’s a 9% return on your $200k investment, regardless of what happens to the actual value of your home.  Moreover, that imputed income is tax-free, which if you are in the 25% tax bracket, is equivalent to a 12% yield on a taxable investment.  I’ll take that return any day, any year.

I realize that I am omitting some factors here, such as property tax, insurance, and maintenance costs which may reduce the imputed income benefit.  I’m also aware of the argument that a homeowner can receive the same shelter services with a mortgage payment and invest the equity somewhere else.  Right now, I am not sure I know what that “somewhere else” would be.  On the other hand, I am not including a potential future benefit that the paid-for home can provide later in retirement:  return of equity from a reverse mortgage.  Also, you may end up reducing your tax obligations in retirement as well by living in a paid-for home.

To summarize, Mr. ToughMoneyLove suggests that homeowners look at their homes as an income-producing investment (like a bond or CD) rather than as an appreciating investment (like a stock or real estate during the now deflated bubble).  If some experts are correct that home values will never return to their glory days, re-thinking in this way will help us make better financial decisions about choosing and paying for where we live.

What are your thoughts on owner-occupied real estate as an investment?

By the way, my writing was featured at five different personal finance carnivals this week:

Carnival of Money Stories #88 at the Dough Roller.

Money Hacks Carnival at the Financial Wellness Project.

Carnival of Personal Finance #182 at Free From Broke.

Carnival of Debt Reduction #169 at Four Pillars.

Carnival of Financial Planning at The Skilled Investor.

Thanks to all of the carnival hosts.  Please take a look-see at the carnivals for some excellent reading.

Feed Mr. ToughMoneyLove

FREE UPDATES: If you enjoyed this, please subscribe to receive the newest hard truth from Mr. ToughMoneyLove automatically by RSS feed (what is RSS?) or by spam-free Email.

  • Banner


8 Responses to “Your Home as an Investment? Let’s Re-think this.”
  1. Matt SF says:

    I think anyone who couldn’t see a real estate bubble building was blind as a bat. Maybe I’ve got too much “trader” in my blood, but I unloaded my investment property in 2005 because no property – not even if you someone builds a yellow brick road adjacent to your property – should appreciate as quickly as we did in the mid 2000 bubble.

    I think if you want to own a home, it’s your home and let it be only that. If you want to be Donald Trump, use investment properties as cash flow generators in high demand areas. CountryWide said several weeks ago that 60% of their foreclosures were second homes, so now we can see the darker side of easy credit surfacing and what it cost us.

    As for the future, real estate as a wealth builder is most likely over. Unless, you can buy property at 25-50 cents on the dollar today and get a generous appraisal of course.

  2. FFB says:

    Thanks for linking back to the Carnival of Personal Finance!

  3. vilkri says:

    I agree with you. This whole investment notion of buying real estate has been a misguided development of recent years/decades. Buying your own home should be just that: buying a home in which you live and maybe raise a family. That is what all generations have done before we got all crazy about the investment part of the deal. Let’s hope that this crisis gets us back to this very sensible approach of “home” ownership. Let’s forget about buying a house and let’s buy a home again.

  4. I can only agree in part.

    It is probably unsafe to rely on your home as a means of retirement funding. It’s illiquid (compared to stocks and bonds), for most people it represents a high proprotion of their assets concentrated in a single investment and emotional factors can often distort judgement.

    That said, owning your own home can be viewed as an emergency fund. If your other investments run into difficulty, it can be sold, it can be rented out (in whole or in part) and a reverse mortgage can be taken out. Many people also get a lot of peace of mind from owning their own home.

    Given how big a slice of most people’s assets is, I would view it as a mistake not to crunch numbers from an investment perspective (including a buy v rent calculation and affordability considerations).

    To address a point made by other comentators, I fail to see why residential property which you do not live in cannot be viewed as an asset class which can be considered for investment purposes. It has value which fluctuates, it can generate cash flow and it can be used as collateral for borrowings. This does not mean it is a good investment at all times – bit if the prices fall low enough or the yields are high enough it can be a good investment.


  5. Matt and Vilkri: It seems that the two of you and I are thinking alike on this. I do think that older adults (pre-retirees particularly) need to focus on getting stability in their housing situation, including full ownership.

  6. Lurker Carl says:

    Houses have always been shelters, even in the latest real estate boom and current bust. This isn’t the first cycle and it will not be the last. Appreciation on real estate is an illusion unless you deal in cash.

    The few homeowners purchasing real estate with cash can reap profit from buying in depressed markets and selling on the appreciation of the next cycle, ONLY if they don’t have to buy another home to live in during that up cycle. But everyone who holds mortgages seldom break even because of the interest owed on their mortgages. The interest payments on the loan can come close to doubling the original cost, few bother to calculate that interest cost when selling. These losses multiply each time a homeowner sells and “trades up” to a more expensive property, they typically return to a new 30 year loan with the majority of their payments dedicated more to interest than principle.

  7. A home is a financial asset but I would hardly consider it an investment asset.

    Aside from the recent real estate bubble and a period of time following WWII, real estate prices have appreciated historically at about the rate of inflation.

  8. I agree with Roland that your home is not an investment asset. It’s been my experience that folks who are making it big in real estate are doing so in commercial real estate, not residential real estate.

Speak Your Mind

Please leave a comment and tell us your version of the hard truth...

You must be logged in to post a comment.