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Why your house is a worse investment than you think

By Patrick following x   2018 Mar 12, 11:37am 5,835 views   63 comments   watch   sfw   quote     share    


https://www.usatoday.com/story/money/columnist/2018/02/18/why-your-home-lousy-investment-when-you-think-its-great/340516002/

On Jan. 1, 1995, San Mateo’s median home price was $305,083. Suppose you bought and put 20% down plus 1% closing costs. With 1995, 30-year fixed-rate mortgages going for 7.5%, your monthly payments were about $1,700.

Jump to 2005, when you sold for $763,100 (2005’s median price), a perfectly timed deal months before home prices peaked. After amortization payments, your remaining mortgage balance was $211, 837. After paying that off, you had a gain of $551,263. Then, subtracting your down payment, you had a whopping 803% return, or 23.4% annualized. Problem is you forgot a mega boatload of expenses, all of which must be subtracted.

Over those 10 years, you paid more than $32,000 in principal and more than $172,000 in interest. Subtract them, and your return falls to 468%, or 16.7% annualized. San Mateo’s annual home upkeep averaged $1,820 (general maintenance, HOA fees, yard care, etc.). Don’t forget your 1995 closing costs and 2005 real estate agent's commission (about 5%). And property tax! In San Mateo, you paid 1.125% of your purchase price, increasing 2% every year. Over 10 years, that’s more than $37,000. Maybe you remodeled for $40,000 and added a patio for $15,000. Median homes grew 500 square feet between 1995 and 2015. To generate average prices, you must maintain average size.

After all this, your amazingly lucky timing in one of America’s then hottest markets rendered a 177% cumulative return, or 10.8% annualized, pre-tax. That’s comparable to stock or bond returns over the same period in a tax-deferred 401(k). Most American regions did far worse. The one important difference since then? Uncle Sam foots less of your bill since Congress capped property tax and mortgage interest deductibility.

No matter how wonderful your home is, it’s a worse investment than virtually everyone thinks.

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24   DASKAA   ignore (3)   2018 Mar 15, 11:35am   ↑ like (0)   ↓ dislike (0)   quote   flag        

SFace says
If you own a home in San Mateo since 1995, you are a multimillionaire and owns a shitload of stocks too.


Were the "multi" part is coming from? I can see a house in San Mateo costing about $1M more than in '95 (not adjusted for anything, just nominal), but "multi"?
25   HappyGilmore   ignore (0)   2018 Mar 15, 11:38am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Patrick says
Jeez, it's just math and easily proven. Try the NY Times rent-vs-buy calculator:


It is just math, but not easily proven. The house in the OP was a good investment. Much better than renting.

As others have posted, you have to add in the cost of renting to the net gain since you got to live rent free in your "investment". Not to mention the tax savings.

Do the calculation correctly and see what you end up with.
26   Patrick   ignore (1)   2018 Mar 15, 12:44pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

NuttBoxer says
You assume no emotional investment in being right about a HUUUGGGE debt. Once they sign those papers they pretty much have to believe they made the right decision, screw the math.


Yes @NuttBoxer in my experience you are correct. Everyone with a massive mortgage believes that they did the right thing with a religious devotion that would shock hardened ISIS fighters. Facts like basic mathematics make no dent in their belief.
27   DASKAA   ignore (3)   2018 Mar 15, 12:56pm   ↑ like (2)   ↓ dislike (0)   quote   flag        

Patrick says
Everyone with a massive mortgage believes that they did the right thing with a religious devotion that would shock hardened ISIS fighters.


Not everyone. I, for one, have no fucking devotion (religious or otherwise) to my massive mortgage.
28   HappyGilmore   ignore (0)   2018 Mar 15, 1:06pm   ↑ like (2)   ↓ dislike (0)   quote   flag        

Satoshi_Nakamoto says


Not everyone. I, for one, have no fucking devotion (religious or otherwise) to my massive mortgage.


I agree. I've rented when it's cheaper to rent (or if I need a bit more flexibility) and bought when it's cheaper to buy.

Usually, in my experience, it's cheaper to buy. Patrick is right that one should run the numbers and see what the math says. When I've done it, renting only made sense when I lived in CA. (although I guess if you don't include the cost of rent that you aren't paying when you own, renting will look much better)
29   JZ   ignore (0)   2018 Mar 15, 1:08pm   ↑ like (2)   ↓ dislike (0)   quote   flag        

Patrick, I have to remind you that one should NOT underestimate how much influence emotions have on human behavior. Cold blooded math may be secondary to people who wants to leave a good memory for their children. With a place that records things that happened through out their lives. The scratch on the wall, the clock, the table they spend years having dinner together. These are worth spending money on in the same way people pay hookers for sex, another form of emotion. If you want to put a price on this? Difficult, very subjective. On numbers, I definitely agree with you that a house may NOT be the best investment.
30   ThreeBays   ignore (0)   2018 Mar 15, 1:08pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

lostand confused says
Don't forget until the recent Trump tax reform, you could deduct mortgage interest on your taxes for very high amounts and state tax.


Not really, because of AMT. With the Trump tax reform I pay ~$10k less tax than before. If I didn't already own a home I'd still be able to afford more home than before the tax reform. Hard to tell but this could be why Bay Area homes prices are soaring again.
31   Patrick   ignore (1)   2018 Mar 15, 1:24pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

Satoshi_Nakamoto says
Patrick says
Everyone with a massive mortgage believes that they did the right thing with a religious devotion that would shock hardened ISIS fighters.


Not everyone. I, for one, have no fucking devotion (religious or otherwise) to my massive mortgage.


Lol, OK, not everyone. But the temptation to justify your own actions is a strong one, even when the math is against you.

JZ says
The scratch on the wall, the clock, the table they spend years having dinner together.


Sure, but it doesn't work out like that for most people. The median period of house ownership is only 6 years.
32   Malcolm   ignore (1)   2018 Mar 15, 4:30pm   ↑ like (2)   ↓ dislike (0)   quote   flag        

Hi Patrick,

I tend to agree with your premise, in general, but at some times it was unquestionably a great investment to buy a house in California. I saw some people questioning methodology like adjusting for down payment, etc. It is easier to make your point with a typical example. I know of a couple of examples of people who bought houses for $600,000 and then like 5 years later sold for $800,000. Was it a good deal? They made $200,000, but no, as an investment you are right. Forget down payments, that is part of the cost basis. Do remember also, that you have to consider opportunity costs/benefits of the investment. One of the benefits is that you avoid rent payments, that is part of the income stream of the cash-flow.

So assume $600K cost, normal selling and buying costs and they got a 6% interest only loan for ease of calculations. Annual interest is $36K.
We will assume 0 down because most people end up refinancing anyway or getting a HELOC.

So, $600K + purchase and loan costs (2,000) + improvements (Your figure $40,000) $642,000 cost basis.
Average ($7,000) of your property taxes for five years $35,000. after tax benefit $25,000.
Mortage interest $216,000 after tax benefit $142,560
Maint (your figure approx $2,000) total is $10,000
Utilities wash with renting
Sale price $800K less selling costs 10% average $720,000 gross proceeds less (total cost of ownership $819,500) equals a net loss of $99,500.

The benefit, no rent so that is a savings of $3,500 per month times 60 months. $210,000, which nets out to be $110,500 after subtracting the net loss of $99,500 from owning.This is a savings stream of $22,000 a year, based on the cost basis, this investment has an ROI of 3.44% if you owner occupy, but is a complete dud if it was a second home purchased as a speculative investment. In that case you would not factor rent savings. Like you have said in the past, part of a home's value is the actual housing it provides.

The real money is in lower priced homes that go from $150,000 to $350,000. That actually did happen.

The math is rough, but I wanted to share the methodology of how someone in real estate would evaluate this type of deal. Also, the effect of a 3.5% loan verses a historic 6% loan in itself can sway a deal from unattractive to attractive.

Note: ROI is used here in a casual way to approximate a return on the cost of the house. In strict financing theory, the interest would not be considered and the project would be considered attractive if you could borrow at a rate that is less than the ROI aka IRR.
33   Patrick   ignore (1)   2018 Mar 15, 5:06pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

Malcolm says
Do remember also, that you have to consider opportunity costs/benefits of the investment.


Sure, and the biggest opportunity cost is not being able to put your money into the stock market instead. Here's the key line:

That’s comparable to stock or bond returns over the same period in a tax-deferred 401(k).


Would be interesting to run the actual numbers with the real return from the stock market, using https://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

Here's some numbers if you're into it: the annual growth rate in the house price for those 10 years is 9.6% (305083 * 1.096^10 = 762998)

Here's the stock market returns for those 10 years:

1995 37.6%
1996 23.1%
1997 33.4%
1998 28.6%
1999 21.0%
2000 -9.1%
2001 -11.9%
2002 -22.1%
2003 28.7%
2004 10.9%
2005 4.9%
34   Malcolm   ignore (1)   2018 Mar 15, 6:34pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

In my example I calculated the return at 3.44%, with zero down, you would still have your money to put in stocks, unless you pay cash for the house or a portion.

Now, if it was the case that you were placing money in the house or the stock market, you would be correct in evaluating both deals and choosing the higher return. That situation would mean interest rates are prohibitive to the deal making sense, in other words the loan interest is higher than the IRR.

With rates so low, it makes sense to use leverage to control a house asset. I don’t see why someone wouldn’t.
35   JZ   ignore (0)   2018 Mar 15, 6:47pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

Human emotions are fickle, and people change minds. The point is, houses being a bad investment does NOT prevent people from buying it due to the emotional factor.


href="/post/1314386&offset=0#comment-1490942">JZ says
The scratch on the wall, the clock, the table they spend years having dinner together.


Sure, but it doesn't work out like that for most people. The median period of house ownership is only 6 years.
36   ThreeBays   ignore (0)   2018 Mar 15, 6:54pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

Owners today would be holding ~3% mortgages if they bought or refinanced in the last few years, and selling costs 5~6%. A real example today would be buying for $700k in 2012 and sitting on $1.5M value today, paying a lot less PITI than the equivalent rent.
37   Strategist   ignore (2)   2018 Mar 15, 8:16pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

PrivilegedtobeWhite says
SFace says
If you own a home in San Mateo since 1995, you are a multimillionaire and owns a shitload of stocks too.
I love when house-humpers say stuff like, "Well, if you bought your house in 1995, before the biggest bubble of all time, you'd be a multi-millionaire with tons of stocks."

Get me a time machine, and I'll happily go buy a whole block. But until one gets invented, why should any normal person buy a house right now when renting that same house is a fraction of the monthly cost? That's when speculation is in full swing.


When speculation is in full swing, renting is cheaper than buying. However, factor in double digit appreciation rates that are common during boom times, and you will see buying rather than renting is a no brainer.
Even 4% appreciation rates would make buying a better option, simply because interest rates are 4%.
38   Patrick   ignore (1)   2018 Mar 16, 7:36am   ↑ like (1)   ↓ dislike (0)   quote   flag        

Strategist says
Even 4% appreciation rates would make buying a better option, simply because interest rates are 4%.


What about property taxes, maintenance, insurance, and the fact that the stock market went up 32% in 2017?
39   Malcolm   ignore (1)   2018 Mar 16, 8:00am   ↑ like (1)   ↓ dislike (0)   quote   flag        

Patrick says
What about property taxes, maintenance, insurance, and the fact that the stock market went up 32% in 2017?


Believe it or not, my most impressive deal was a house purchased in 1998 and it tripled in value when I sold it in 2006. I would suggest that you consider overall historic averages for comparison. That same house ended up in foreclosure after I sold it, and the stock market is more likely than not to have negative years as well.

I am certainly not suggesting that now is an entry window, only because I am presently bearish on California housing.

A great financial suicide strategy right now would be to buy a house and use leverage to buy some expensive stocks. Max out the credit lines, hell, put a new deck in while you’re at it, a new kitchen is always nice.

I hate that Montelongo fuck face. There are people literally paying him 10s of thousands of dollars to learn how to get rich in real estate. I saw a woman interviewed who paid $38,000 saying if it didn’t pay off, she would be ruined. Ya think?
40   MrMagic   ignore (11)   2018 Mar 16, 8:14am   ↑ like (0)   ↓ dislike (1)   quote   flag        

Patrick says
What about property taxes, maintenance, insurance,


You're paying that already as a renter, but don't get and benefit of the tax deduction.
41   Patrick   ignore (1)   2018 Mar 16, 8:17am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Not always. What the landlord pays does not necessarily get passed through to the renter.

You really have to work out the numbers and it's fairly complex, dependent on predictions about appreciation and the stock market.
42   MrMagic   ignore (11)   2018 Mar 16, 8:17am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Patrick says
and the fact that the stock market went up 32% in 2017?


What about the fact that the market went sideways 2014, 2015 and 2016 with very little growth?
43   JZ   ignore (0)   2018 Mar 16, 10:08am   ↑ like (0)   ↓ dislike (0)   quote   flag        

The house have 4 characteristics that makes buying decision complicated.
1. Shelter utility.
2. Jewelry utility to anchor your emotions and memories.
3. Investment. Long term cash flows.
4. Speculation. A gamble on what others will do.

I know this thread is about “Investmet”, but people keep dragging in the other 3 and confuse things.
For 1, shelter utility, you buy houses like you buy groceries. You buy it on sale when there is less demand and more supply. Current situation is ther is more demand, which is reflected in rent, it is NOT on sale. If you can avoid it, wait till on sale sign. If you have to buy it for its utitlity, then do it.

For 2, everybody is different, but it is a strong driver for decision making.

For 3, at Price/Rent =30, and history of rent suggest that current rent is actually high, the investment aspect is poor. You can argue with low rates, this is NOT bad, but still low return is low return.

For 4, this is gambling on other people’s move. Other people included local W2 shelter buyer, flipper, wall street, foreign money laundering. I usually give up this aspect for decision making because I am NOT good at gambling to transfer other people’s wealth.
44   missing   ignore (1)   2018 Mar 16, 10:17am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Sniper says
You're paying that already as a renter, but don't get and benefit of the tax deduction.


Maybe he's paying for it, maybe not.
45   PrivilegedtobeWhite   ignore (1)   2018 Mar 16, 10:57am   ↑ like (1)   ↓ dislike (0)   quote   flag        

Strategist says
factor in double digit appreciation rates that are common during boom times, and you will see buying rather than renting is a no brainer.
I agree, but how do you know that's going to happen? If renting is cheaper than owning right now in many parts of CA, wouldn't that signify that double-digit gains are unlikely to happen and future prices may be flat or drop?
46   Patrick   ignore (1)   2018 Mar 16, 11:04am   ↑ like (1)   ↓ dislike (0)   quote   flag        

PrivilegedtobeWhite says
Strategist says
factor in double digit appreciation rates that are common during boom times, and you will see buying rather than renting is a no brainer.
I agree, but how do you know that's going to happen? If renting is cheaper than owning right now in many parts of CA, wouldn't that signify that double-digit gains are unlikely to happen and future prices may be flat or drop?


Exactly. For safety, you want to buy only if the price is low enough that you can rent it out and cover all monthly expenses.

For most "retail" houses on the market, you cannot actually rent it out and cover all monthly expenses. That's why they have to advertise, cajole, and manipulate buyers to overpay.

There are other, non-retail houses that are better bets, like foreclosures, that are generally not listed in the MLS because they are cheaper and drag comps down.
47   MrMagic   ignore (11)   2018 Mar 16, 12:13pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

FP says
Sniper says
You're paying that already as a renter, but don't get and benefit of the tax deduction.


Maybe he's paying for it, maybe not.


In the majority of cases, the renter is paying it.

Patrick says
For most "retail" houses on the market, you cannot actually rent it out and cover all monthly expenses.


You guys really need to get away from the bubble known as the Bay Area. Landlords don't become landlords because they like to lose money every month on their tenants. Housing in the rest of the country isn't appreciating double digits to make up for the monthly loss on rent income.
48   Patrick   ignore (1)   2018 Mar 16, 12:23pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

Sniper says
Landlords don't become landlords because they like to lose money every month on their tenants.


You're right about that, and in most of the country landlords can buy places that will be cash-flow positive.

But not in the Bay Area. Around here, landlords cannot buy rental property and be cash-flow positive. Prices are just too high to make it profitable. So landlords either have to make a bet that appreciation will make up for their monthly loss, or to have to have bought so long ago that all their property taxes are paid by new buyers due to Prop 13.
49   HappyGilmore   ignore (0)   2018 Mar 16, 1:09pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

Patrick says
Exactly. For safety, you want to buy only if the price is low enough that you can rent it out and cover all monthly expenses.


I think you are 100% correct, except that I'd argue that you shouldn't only look at today when analyzing the rent/buy decision. If you are reasonably stable and expect to stay in the same place for many years (kids in school, love the area, etc.) then you should take a reasonable timeframe into account.

The main cost advantage of buying is that your shelter expense is constant while rent increases. If you disregard that advantage, you will make a poor decision.
50   missing   ignore (1)   2018 Mar 16, 1:16pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

Sniper says
Landlords don't become landlords because they like to lose money every month on their tenants.


In bubbly places people often buy to speculate or because of fear of missing out, and other such stupid reasons. Then they end up renting their units for more than the upkeep. There are many such examples - take any major Canadian city, for example.
51   beershrine   ignore (0)   2018 Mar 16, 4:28pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

Patrick says
Jeez, it's just math and easily proven. Try the NY Times rent-vs-buy calculator:

https://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html


The problem with this calculator is it's wrong in Orange County, Ca. Rents are considerably higher then the scale. Not a good time to rent or buy.
52   Patrick   ignore (1)   2018 Mar 16, 4:37pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

beershrine says
The problem with this calculator is it's wrong in Orange County, Ca. Rents are considerably higher then the scale. Not a good time to rent or buy.



@beershrine What do you mean? Rent is an output of the calculator, not an input. I don't think they have any upper limit on the output rent number.
53   MrMagic   ignore (11)   2018 Mar 16, 9:40pm   ↑ like (2)   ↓ dislike (0)   quote   flag        

Patrick says
Sniper says
Landlords don't become landlords because they like to lose money every month on their tenants.


You're right about that, and in most of the country landlords can buy places that will be cash-flow positive.

But not in the Bay Area. Around here, landlords cannot buy rental property and be cash-flow positive


That's my point. Many here keep referencing the Bay Area as the poster child for rentals, but it's a very small piece of the pie. There are like 43 million rental units in the country. I'm sure the vast majority of those landlords are cash positive each month.

What goes on in the Bay Area regarding rents not covering the monthly nut of the landlord is a outlier in comparison to the rest of the country.
54   Malcolm   ignore (1)   2018 Mar 17, 8:19am   ↑ like (2)   ↓ dislike (0)   quote   flag        

I would never invest in a high rent district, in general. My reasoning is simple, people who can afford them already own, and the renters in those areas tend to be wannabes, they tend to be overextended, they’re not good quality renters.

Profitable rentals are usually in your regular middle-class neighborhoods.

The ideal time to buy them is during economic downturns and when interest rates are higher. That is the optimal time.
55   PrivilegedtobeWhite   ignore (1)   2018 Mar 17, 8:58am   ↑ like (1)   ↓ dislike (0)   quote   flag        

HappyGilmore says
I think you are 100% correct, except that I'd argue that you shouldn't only look at today when analyzing the rent/buy decision. If you are reasonably stable and expect to stay in the same place for many years (kids in school, love the area, etc.) then you should take a reasonable timeframe into account.
I don't think most people buy with an idea of leaving in 2 years. Life happens and things out of your control can force one to sell and move. If any of us had bought in 2005/2006 with the idea of long term in mind, we'd be barely breaking even right now, 12 years later.
56   Patrick   ignore (1)   2018 Mar 17, 11:25am   ↑ like (0)   ↓ dislike (0)   quote   flag        

Sniper says
What goes on in the Bay Area regarding rents not covering the monthly nut of the landlord is a outlier in comparison to the rest of the country.


Yes, I should be clearer about that.
57   HappyGilmore   ignore (0)   2018 Mar 17, 3:15pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

PrivilegedtobeWhite says
I don't think most people buy with an idea of leaving in 2 years. Life happens and things out of your control can force one to sell and move. If any of us had bought in 2005/2006 with the idea of long term in mind, we'd be barely breaking even right now, 12 years later.


Yep--unexpected things happen. But if you ran the numbers in 2005/2006 you never would have bought in the first place,
58   PrivilegedtobeWhite   ignore (1)   2018 Mar 17, 4:23pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

HappyGilmore says
PrivilegedtobeWhite says
I don't think most people buy with an idea of leaving in 2 years. Life happens and things out of your control can force one to sell and move. If any of us had bought in 2005/2006 with the idea of long term in mind, we'd be barely breaking even right now, 12 years later.


Yep--unexpected things happen. But if you ran the numbers in 2005/2006 you never would have bought in the first place,
And if you run the numbers now, no one should buy. Oh wait, it's different this time ;)
59   Patrick   ignore (1)   2018 Mar 17, 4:28pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

PrivilegedtobeWhite says
And if you run the numbers now, no one should buy.



Might be OK in a lot of places away from the tech money.
60   PrivilegedtobeWhite   ignore (1)   2018 Mar 17, 4:31pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

Patrick says
PrivilegedtobeWhite says
And if you run the numbers now, no one should buy.



Might be OK in a lot of places away from the tech money.
True. I was generalizing
61   HappyGilmore   ignore (0)   2018 Mar 17, 4:38pm   ↑ like (1)   ↓ dislike (0)   quote   flag        

PrivilegedtobeWhite says
And if you run the numbers now, no one should buy. Oh wait, it's different this time ;)


It really depends on your time horizon. If you're planning to stay for 7+ years, then with rare exceptions (in the BA maybe, I don't know), it will be better to buy.

It is much different now than 2005/6 though--the price/rent ratio is pretty normal in the US.
62   PrivilegedtobeWhite   ignore (1)   2018 Mar 17, 9:44pm   ↑ like (0)   ↓ dislike (0)   quote   flag        

I’m primarily referring to expensive coastal areas such as LA, SF or SD. It certainly warrants doing the math wherever you’re buying.
63   bob2356   ignore (3)   2018 Mar 18, 3:24am   ↑ like (0)   ↓ dislike (0)   quote   flag        

HappyGilmore says

It really depends on your time horizon. If you're planning to stay for 7+ years, then with rare exceptions (in the BA maybe, I don't know), it will be better to buy.

It is much different now than 2005/6 though--the price/rent ratio is pretty normal in the US.


There is no normal ratio across the us. All markets are local. The markets run all across the spectrum from strongly favoring renting to strongly favoring buying.

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