While investing in real estate is a common path to wealth, is buying a house an investment? Here’s what you have to consider. It’s not a simple yes or no answer.
By default, buying a house is not an investment, at least not without explicitly planning to make it one. That doesn’t necessarily mean buying a house is a bad idea, however.
Investments produce income
The people who make money in real estate make money by renting it out. Unless you’re renting out part of your house, it’s not producing income for you. The traditional single family house in the suburbs with a big yard and a white picket fence isn’t an investment at all. Instead, it costs you money, and it costs you money in several ways. First, there’s the pressure to keep up with the Joneses. When one of your neighbors buys something, then you want one too. That leads to unnecessary spending. But secondly, on average, you’ll spend $1,000 a year on maintenance. Some years it will be small, incidental repairs that cost around $100. But every 15 years or so, you’ll have a major expense that runs several thousand dollars. So on average, it works out to around $1,000 a year. And if you cheap out and don’t do those things, the value of the house decreases. So you’ll pay that thousand a year one way or another.
If your housing needs are relatively modest, you can make your home an investment by purchasing a multi-family unit and then renting out the unit(s) you don’t live in. For example, at the moment I wrote this, you could buy a two-family unit in St. Louis for $115,000. The mortgage payment on such a unit, assuming an interest rate of around four percent and a 30 year term, would be around $544. Real estate taxes and insurance might add another $100 per month. But that second unit would rent out for around $800 per month. So, technically, you could live in one unit, rent out the other unit, and make about $600 per year in profit.
Why not everyone lives in a duplex and makes their home an investment
But there are reasons not everyone does this. First, the selection of multi-family units is much more limited. In some areas, you can’t get one at all. Even in areas where you can, there might be 10 times as many single-family homes available. You’re going to have to settle. You’ll probably find a place you can live with, but realistically, you can’t expect it to be a no-compromises dream house.
Second, you’re going to live next door to your tenant. In my experience, this can be a problem. As someone who’s owned his own home for nearly 20 years and as a landlord, I can tell you that if a house needs more than three repairs in a year, it’s having a bad year. Repairs do seem to come in waves, so it can happen. But it’s not typical. But for some reason, when I see a tenant at a school function, or at the grocery store, or otherwise out and about, my phone rings within a couple of days.
Obviously, if you’re living next door to each other and seeing each other several times a day, each sighting won’t turn into a project. That’s impractical. But you’re going to have to set and keep some serious boundaries, otherwise your doorbell might be ringing at 10pm with one questionable emergency or another.
I once worked with a guy who lived in a duplex and owned several more duplexes in the same neighborhood. He didn’t have a lavish lifestyle but he was very secure financially. But it’s certainly not a life for everyone.
Investments can be liquidated
The other reason I say your house is not an investment is because I can’t liquidate it like one. To sell a mutual fund, I can visit a web site, make a couple of selections, and within a day or two have money in my bank account.
Selling a house is a major life change. It’s also not always easy. In some cases, a house can sit on the market for years, and the longer it sits on the market, the longer it’s likely to stay, because people automatically think there’s something wrong with it. During a hot real estate market almost anything will sell, but 2018 isn’t the norm. It was an extreme. Early in the same decade, I saw the other extreme, with houses sitting on the market for 18 months or more.
The other problem is the housing market is fickle. The cable TV network HGTV exists solely because trends from 10 or 20 years ago look hopelessly dated today. So it fills the airtime with hour after hour of shows ripping out stuff that was trendy in 1999 and replacing it with what’s trendy today. But those renovations cost money. Either you spend the money to bring a house up to date enough to sell, or you sell at a discount to someone who’s willing to either live with a dated house, or update it themselves.
And in some cases there isn’t much you can do. If the house is too big or too small for current lifestyles, it’s going to be difficult to sell. Small houses can become rentals. But I think one of the reasons we see angst between generations right now is because millennials don’t like the same kinds of houses baby boomers did, and that’s making it harder for boomers to downsize.
Don’t forget the hidden cost in buying and selling a house
There’s also a hidden cost in buying and selling houses that cuts into any profit you might make. That’s moving. Moving costs thousands of dollars, and we frequently don’t think of that. We just see that we can sell a house for $10,000 more than we paid, then we think we made a good investment. Never mind all that money ends up going into moving expenses.
Investments can be replaced relatively easily–or not
The other reason I say houses aren’t an investment is because replacing them is difficult, and non-optional. When you sell a house at a profit, you have to replace it with a house, which that owner is probably also selling at a profit. It’s much more difficult to buy high and sell low. All you can do is what one of my coworkers did. He moved from Denver to Des Moines. The equity he had from his house in Denver allowed him to pay cash in Des Moines, because the market in Des Moines isn’t as hot as the market in Denver and the cost of living is also much lower in Des Moines.
To make that work, you have to be willing to move from Denver to Des Moines. Now, I’d much rather live in Des Moines than Denver. But I’m in the minority on that. Part of the reason houses are more expensive in Denver is because more people want to live in Denver. That’s how supply and demand works.
Buying low and selling high is easy with investments. In any given year, one category of investments is doing better than another. For example, I invest in an index fund that tracks the S&P 500, and another fund that tracks the Wilshire 4500 (which is approximately 4,500 small companies). Some years, the S&P 500 fund costs more per share and some years the Wilshire 4500 fund does. So I sell off some of my shares in the one that costs more and use that money to buy more of the cheaper one, flip-flopping between the two throughout the years. It’s no harder than ordering pizza.
And if I have to sell all my mutual funds to deal with an emergency, I can do that. It’s much easier to live without mutual funds than to live without housing.
Why owning a house is still a good idea even if it’s not an investment
While I say buying a house is not an investment, I still say it’s a good idea to buy one if you can. Just make sure you can afford it first. Renting a house gives you flexibility, but landlords wouldn’t rent houses out if it wasn’t profitable for them. The benefit for the tenant is being able to walk away from a property at the end of a term, and paying a very predictable amount of money over the course of that term. But the landlord makes money by agreeing to this. It’s just questionable how much the landlord will make from one year to the next.
But, generally speaking, you can live in a house for about 75% of what you’d pay to rent a comparable house. And once you pay off the mortgage, the cost falls through the floor.
The key is buying a house, spending the $1,000 a year to maintain it, and go for practicality over flashiness, especially early when you don’t have it paid off yet. Remember, spending $20,000 to renovate a kitchen doesn’t make you any money. But spending $2,000 to replace dated countertops and backsplashes with something that looks nice and won’t go out of style improves your quality of life and when the time comes to sell, you’ll probably get most of that money back out of it.
Food and clothing aren’t investments either. The scam society has played on itself is convincing large elements of the population that one of the three basic needs for life is an investment, and therefore worth overpaying for. The trick is to get your basic needs in a cost-effective fashion. Do that, and then you’ll have more money to spend, or can retire earlier.