I hear this question pop up quite a bit.
Someone has a nice little chunk of capital sitting around and they are trying to decide whether they should buy a house for themselves or buy an investment property (or 2, depending on where you are living and/or buying).
I am usually of the mindset that buying a house for yourself is absolutely not a good investment. If I buy a house for myself, I consider it a liability rather than an asset. However, I am willing to explore this a little more in case you are still undecided.
I’m not going to say that buying a house for yourself will never be a good investment. If you buy at exactly the right time, in the right market, and the right property, you might be able to make a profit off of it. I will say, however, that this does not end up being the case for most people buying. Why not?
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Why Buying a House isn’t as Profitable as You Think
Most people see that they buy a house in year 1 and it appreciates x amount by year y, and boom they’ve made a profit. Well let’s really look at this:
- Expenses. Have you ever really tallied up how much you spend on your home while you own it and live in it? Expenses include: mortgage interest, closing costs, repairs, improvements, property taxes, and insurance. According to the Office of Federal Housing Enterprise Oversight, the total expenses over 30 years, on a $290,000 house purchased in 2007, totals $783,000. I admit that some of the numbers they used to calculate that seemed quite high to me, specifically their improvements and repairs costs, plus interest rates were a little higher back then too, so to feel better about the expenses on this property, I’m going to knock it down to $600,000 in expenses just to be nice. Regardless, the expenses on this property are more than double the original purchase price, just in expenses! So in theory to profit on a sale from this house, you would have to sell it for more than $600,000. Well, maybe appreciation jumped it up that high. Or maybe it didn’t…
- Appreciation. It doesn’t happen quite as nicely as you think. Don’t get me wrong, it does happen for sure thanks to inflation (which I’ll touch on in a minute), but the reality of appreciation isn’t always what it seems. Appreciation oftentimes only keeps up with inflation, so really that doesn’t help you out much. And too, despite what people think, this most recent real estate crash we experienced is far from the only crash we’ve seen. Not only have there been industry-wide crashes (maybe not as devastating as this most recent one, but crashes nonetheless), there have been several market-specific crashes as well. Remember when the oil boom went bust in Dallas in 1986? We don’t even need to talk about Detroit. What about other industry crashes you remember that sent the associated markets into the toilet? Now, with that said, I fully believe if you ride anything out (real estate, stocks, whatever) that you will see an upside and you can do something then. But what if the timing is off? What if your elderly parents get sick and you have to move closer to them but you own your house so will now need to sell, but it happens to be a horrible time for the market? You can’t tell your parents to hang on. You might be able to rent the house out, but if you’re like me and paid too much for your first house only to then take move unexpectedly, you will rent the house out but lose money on it every month while you wait for the market to come back. You can’t time everything to work in your favor. Timing aside though, what about appreciation versus the expenses? The Office of Federal Housing Enterprise Oversight continued their studies of the numbers associated with owning a house and decided to look at the total cost of owning a house versus appreciation. They give an example of a house purchased in 1977 for $50,000. In 2007, that same house was now worth $290,500. Whoohoo!! Oh wait… Over a 30 year lifetime, the expenses on this house (again including everything mentioned above, but not adjusted for inflation), came out to $394,000. That is including financing costs if you were financing, so let’s also look at the expenses had you paid all cash and the property been paid off the whole time. Now you’re looking at $344,000 in expenses (basically just less principal and interest). So even with all of that perceived appreciation, you are still negative either $103,500 or $53,500 on that property, depending if you were financing or not. You’re in the hole! I bet you didn’t see that one coming. And what about inflation?
- Inflation. Inflation is both your friend and your enemy in this. One nice thing about buying real estate, of any sort, is that it is one of few hedges against inflation. If inflation happens, housing prices go up. Yay! But at the same time, if your house value goes up so does the value of every other house you would ever want to buy. So even if you sell at a nice profit, you inevitably need somewhere to live and to buy a new place, and you will have to pay the inflated price which will likely take any profit you made.
Risks in Buying a House
I admit the things I’m about to mention are extremely dependent on the buyer. Some are risks and some are temptations. The temptations depend on the person and not everyone will fall for them. Some people will be very smart when they own their own house and not make any rash (or expensive) decisions with it. However, owning a house opens up a lot of dangerous roads.
- Refinancing. Don’t be tempted. It is very easy, when you have equity, to refinance your house and use that money for who knows what. Now, if you are a smart investor and you use that equity money to buy more properties, then that’s one thing and I support that. However, what do most people buy with equity? Vacations. Or some other big expense item. Then you are essentially paying interest on that “vacation” for the next 30 years. Whatever you do, don’t do that.
- Buying at the top of the market. Well that’s just silly. If you’re going to buy a house for yourself, at least get a good deal. Buying at the top of the market will cost you a fortune, both on the front-end and the back-end.
- Losing your house. If you are financing your house and in 20 years you lose your job or life gets crazy and suddenly you can’t make the payments, you can lose the house to the bank. If you do, you just lost 20 years’ worth of payments on that house and you have no house. That’s worse than had you rented for 20 years.
- Trusting your house to support your retirement. People become too trusting that their home will serve as their retirement income. Think again! Back to that timing thing, for one, and then factoring in expenses, how much have you really made? Not enough to support a full retirement, for sure.
As a concluding note about the downside of owning your own home, due to interest payments and expenses to buy, buying a house almost never turns out to be worth it before about year 7 (sometimes year 5). The average homeowner only lives in a house for 7 years. That math doesn’t seem to support profitability. And please, do you really plan to live in the same house for 30 years? Maybe 15 if you have a 15-year mortgage I could understand, but I can hardly think of anyone I’ve ever known to be in the same place for 30 years.
And Investment Properties?
I will never say buying an investment property will always protect you from financial hiccups. However, investment properties do mitigate a lot of the risks of owning a home. Looking at the same factors as for buying your own home:
- Expenses. Guess what! Your tenants pay the majority of your expenses, if not all (if you set it up right). So no factor there.
- Appreciation. If appreciation happens, great! Bonus. For one, how much it appreciates doesn’t matter as much because you don’t have the expenses to subtract out of your profits because your tenants covered those. But also, if appreciation doesn’t happen, oh well! You still made money for the time you owned it so you likely still profit.
- Inflation. The more inflation, the higher the value of your investment! Woot!
- Refinancing. Still a risk if you spend it the wrong way, but if use any equity you have to buy more properties, you’re golden!
- Buying at the top of the market. Still don’t do it. Still stupid.
- Losing your house. If you made cash flow along the way, who cares! You still profited. Same as appreciation.
- Trusting your house to support your retirement. The cash flow each month is the best support for retirement. Have enough channels of passive income coming in and you are much safer than with most other methods of income!
Granted, I say all of these things like they happen every time and with every property which is often not the case. But it is certainly all possible. If you buy right, manage right, and stay smart, you can nearly mitigate every risk of owning a house (and make some nice coin on the side!).
The American Dream?
Absolutely. I totally get that owning your own home has been a lot of people’s dreams since they were little. I’m the last person to try to rip anyone’s dream away from them. If all your life you have wanted to own your own house and in doing so you will be that much happier, I say buy the house for yourself! I get it. Life isn’t always about numbers and logistics. If you lead your whole life doing everything “right”, you won’t necessarily be happy. Ultimately you should do what makes you happy, even if it means buying the most expensive absurd house you can find for yourself. But if you are in the debate about which to buy because you have extra cash to spend and want to be smart about it, or you are just out of school and ready to pick a path, or whatever… think it all through carefully.
I agree with Robert Kiyosaki on this one. He says to buy enough assets to fund buying liabilities. Translated to this conversation, buy enough investment properties that will support you buying your own house. If you don’t consider your own house an investment but rather as a toy, you aren’t putting everything you have into it and hoping it works. If you buy with expendable funds, if you lose them you are fine. But then if you profit, well then kudos!
If you still want to buy your own house, I’m far from one to stop you. I’m not convinced it is a good investment (usually, with some exceptions for the really right buys) and I know I personally am far from a stationary-enough person to buy a house because there is no telling where I’ll be tomorrow versus today. But maybe you are stationary and know how to buy right and you can profit from it. Who knows!
If you are set on buying a house for yourself before an investment property, why?