In 2008, the housing market imploded, along with the entire American economy.
Yet this didn’t change the general population’s mindset that buying a house is an essential part of adulthood. Fannie Mae, the finance giant, found in a 2014 survey that the majority of millennials “think owning is a more sensible housing choice for financial reasons” versus renting.
The American Dream, if you will:
Buying a home is one of the “defaults” of our financial lives that should be questioned.
“Buying a home is a good investment.”
“Don’t waste your money on rent, invest in a home.”
Yet I’m a homeowner who discourages my friends from buying homes.
To understand why I’m such a hypocrite, keep reading…
- Part 1: the main reasons I find homes to be generally bad investments
- Part 2: explains why I ended up purchasing a home anyway
Note: this essay is mainly for those living in large, expensive American cities like Los Angeles, San Francisco and New York.
PART 1: REASONS TO NOT BUY A HOME
HOMES DO NOT ALWAYS APPRECIATE
The single biggest assumption about buying a house is that housing prices will appreciate, especially in the California market.
In 2007, housing prices were at an all time high. At that point it seemed like it could keep going up. Homes always appreciate, right? Until they don’t.
We all saw what happened in 2008.
“Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing. So, new ones are better.” (Source: BizInsider).
Even if you bought a home and you want to sell it, it’s not always a seller’s market. Plenty of homes that sit on the market for months.
BUT IT’S BETTER THAN RENTING…RIGHT?
To compare the cost of owning a home versus renting, let’s look at the California market. We’ll use a $400,000 home for illustrative purposes – which in many parts of Southern California would be considered a low price.
Even using a low mortgage rate, a $400k home costs $1,419/month. That doesn’t sound too bad if you live in an expensive rental market.
But then property taxes and homeowner’s insurance can catch you off guard, like it did me. In Los Angeles, the property tax is at least 1% of the purchase price of your home. Using our example, that’s $4000 a year, which easily amounts to a few months of rent.
Homeowner’s insurance can add up to another grand in annual costs.
But the single biggest risk of buying a home is the down payment, which is typically 20% of the home price.
Our example would require $80,000 upfront. That’s a lot of money that could be invested elsewhere, for potentially more return (which we’ll get to in a minute).
Yes, these costs can be predicted before you buy a home. But what about unpredictable costs?
HIDDEN COSTS OF HOME OWNERSHIP
This is the most unpredictable cost that nearly made me regret my home purchase: repairs and maintenance.
To get a decent deal on a house, you probably won’t be buying the newest house. And older homes come with problems you’ll inevitably have to deal with.
I’ve spent days draining and fixing the water heater before.
Another plumbing issue cost me thousands.
When you’re renting and something goes wrong with the home, it’s the landlord’s job to fix issues from plumbing leaks to appliance repairs.
When you’re the homeowner, all the costs of repair and maintenance fall on you. Had I know about this huge stress factor, I might not have bought a house at all.
When I mentioned that your down payment could be invested elsewhere, I was referring to opportunity cost. The concept that whenever you choose one thing, you’re also giving up another.
Aside: My other favorite example: instead of spending $100,000+ on an MBA, you can spend a fraction of that to start a business.
The biggest opportunity cost to buying a home, is investing that money in other things.
Taking a look at data from California Association of Realtor’s, we can see the year to year price change.
To cherrypick: Los Angeles had a 10.1% price change while San Diego’s was 6.3%. We can use these figures as a proxy for return on a property if you buy and sell within a year – though that figure should probably be lower due to closing costs (the cost of selling a home).
What if you invested money in other vehicles instead?
The average annual return for the S&P 500 since its inception in 1928 through 2014 is about 10%. (Source: Investopedia)
If you lend money on a peer to peer marketplace like LendingClub, you can earn a less volatile return than the stock market that still beats many housing markets. For example, I’ve been investing with LendingClub for 2 years and have earned a 6.25% annual return.
All of this is to illustrate the existence of alternative investment that can…
- Match or outperform returns of the housing market
- Require much less upfront capital (versus $80k down payment)
- Are more liquid. Selling a share of Facebook stock is much easier than selling a house
Of course, you could always dump that $80,000 into Bitcoin and cross your fingers for a lambo.
PART 2: SO WHEN DOES IT MAKE SENSE TO BUY A HOUSE?
Here’s when I seemingly contradict myself. (In the words of Zan Perrion: I am multitudes).
I’m not 100% against buying homes. There are many benefits, like the sense of independence some people feel in owning a home. DIY types may get an intangible benefit of making their space unique with home improvement projects.
Personally, my decision was based on cost. I was only able to justify a home purchase because the cost was such that I have a fighting chance of coming out ahead.
Here are additional factors that affect the economics of home ownership:
Let’s say you own a 3 bedroom house with a $1500/month mortgage. You can break even on your mortgage cost by renting out the two other rooms at $750/month.
The higher the cost of your home, the harder it would be to cover your mortgage through rental income.
This scenario also makes the assumption that your house is in an area where renters are willing to live.
A versatile, multi-use home
A home’s value can be magnified if you use it for purposes other than living. The US tax code allows you to deduct a certain square footage as home office expense.
Enterprising types who use their homes to host clients, meetings, or even paid events at your residence can get extra mileage out of their homes. Got a garage? You can use it for portrait shoots or personal training.
How does it impact your commute?
Another bonus for me was picking a home near public transportation – getting around in LA without having to rely on a car was a huge factor for me.
I don’t think it makes sense for professionals early in on their careers to buy a home and add to their commute. Affordable homes tend to be outside of the city center, while most professional jobs are located in the city.
Why not just pay a bit of a premium to live close to work? Studies show that one of the biggest stressors of life is commuting. To top that off, people switch jobs every couple years now.
All the above comes through the lens of someone living in an expensive city. But the entire game changes if you’re living in a low-cost market.
Take Kansas City, in which you can get a 4 bedroom house for $75,000, for a mortgage less than $300/month:
Am I behind in life if I don’t own a home?
This is the biggest reason I wrote this article – most of my peers think buying a home is a rite of passage into adulthood. A sign of success.
I want to debunk that thoroughly.
We should look at this the same way an independent woman looks at a man who flaunts his sports car to win her affection.
Success is not defined by the things you own. It’s a never-ending game; buy one house, and you’ll want a bigger one.
Even if we were to use personal finance to measure success, buying a home isn’t always the best financial decision.
And what is adulthood but making as informed a decision as we can, in our financial lives and beyond?