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5 Reasons Why a Home is (Still) a Great Investment.

Posted on | April 2, 2008 |

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Ryan over at the Debt Reduction Formula blog asks the age old question of Rent or Buy. He’s looking for opinions on a specific scenario - a choice between buying house A or renting house B.

Few people would have argued that buying a home was a bad investment during 2005-2006, but with the subprime fiasco causing the recent housing “meltdown” I see a lot of people arguing that owning a home is a poor investment. It’s certainly an easy argument to make in the current climate, but is it accurate?

eFinanceDirectory.com has an article from last February titled “Rent Vs. Buy Myths That Ruined the Housing Market” They do a good job of laying out 5 myths that caused at least some people to buy a house during the recent housing boom. At the very least it offers 5 reasons why you shouldn’t buy a home, but that’s different than saying that it’s not worth being a homeowner.

I respectfully submit that both these sites are missing a critical question essential to the decision to buy vs. rent, specifically - Why do you need housing?

In other words, is this an investment in real estate, or are you looking for shelter? Is this a long term commitment, or a quick real estate play? If you need shelter, and you are likely to stay in the same place for a decade or more, then you should absolutely consider buying a home.

Consider following scenario:

Both Bob and Fred live in the same town and work for the same employer for similar wages for the same 30 year period. Over those 30 years, Bob never bought a home, instead renting an apartment. Fred, meanwhile, bought a home at the beginning of this 30 year period with a 30 year fixed mortgage and didn’t sell his home until he retired.

Who is better off at the end of the 30 year period?

Few people would disagree that Fred would come out in a better financial position than Bob, all other things being equal. Bob’s rent would have risen over the years as would Fred’s property tax, but at the end of 30 years Fred owns a home free and clear while Bob has nothing.

Is the realistic? Of course not. There are so many factors that I’ve ignored for the sake of example. But take heed - I’m not alone in doing so. Everyone who wants make an example will leave some facts, figures and variables out. It’s human nature to want to simplify, and it’s also impossible to account for all the variables. If it was then there would be a hard fast rule for owning vs. buying.

There is no concrete rule for when renting is better than buying, but there are some major factors that should be considered. Which gets to the title of this post and why I believe that owning a home is a great investment, given the following conditions:

  • You are looking to stay in the house for a significant period of time.
  • You can afford the mortgage and down payment.

If you are not looking to put down roots in a community, then owning a home doesn’t make much sense. In fact, I personally don’t think owning a home for the short term makes sense for most people. I’m not talking about speculators looking to profit from flipping homes. I’m talking about more traditional reasons to buy a home, which brings me back to the title of this post and my five reasons why a home is still a great investment.

I think that most people who are pondering the Rent vs. Buy question aren’t looking for investment in real estate, they’re wondering if they’ll be better off financially being a home owner. This is for them.

  • 1. Forced Savings

Contrary to the image portrayed in the media, few people lose their homes to foreclosure (As of June, 2007, foreclosures in the United States were 1.28%. Read about it here). This is good from a shelter aspect, but not so good financially if you still end up owing more than the house is worth. This is unlikely over the long term. If you put at least 20% down, then you have that bit of instant equity as a margin of safety. Also, if you’re in your home for at least 10-15 years, then your mortgage payments become a sort of forced savings because at least a portion of that goes toward building equity - equity that can be cashed out for retirement or tapped for college tuition for your kids, or just about anything else. Renters can certainly save and invest on their own, but many are simply not motivated to do so. With a mortgage, you don’t have the option.

  • 2. Leverage

You’re making your investment with other people’s money.
Example (from The Automatic Millionaire): You buy $250,000 house with down payment of 20%. It costs you $50,000 up front (plus closing costs) and the bank lends you $200,000 in the form of a mortgage. You’ve put in only 1/5th of the purchase price - that’s 5:1 leverage.

Now, say the value of the house increases to $300,000 over next 5 years (an average of 4% return which is not unreasonable), since you only put down $50,000 that additional $50,000 appreciation has effectively doubled your money. Yeah, I know there are a lot of “what ifs”. What if it takes 8 or 10 years to appreciate? What if you spend $20,000 on realty fees when you sell? But these are reasons why buying a house is a long term investment, and not a short term one. Renters can’t claim this one. No one is going to lend you money to rent an apartment.

  • 3. Tax Breaks

Most homeowners can deduct at least a portion of their mortgage interest from their taxes, and in some states even their property tax. This reason alone isn’t enough to buy a house, but if buying is something that fits your situation then it’s a nice perk. :)

Aside from tax deductions, owners pay no federal income tax on the first $250,000 ($500,000 for married couples) of gains, provided it meets the requirements specified in the Taxpayer Relief Act of 1997.

Rent payments simply aren’t tax deductible, and at the end of your tenure you don’t have anything to sell tax free.

  • 4. Pride of Ownership.

USNews published an article in 2006 that highlights some of these benefits of home ownership. They had some interesting aspects, like the following:

“The children of owners are more likely to graduate from high school than the children of renters. Owners’ daughters are also less likely to become teen mothers. Researchers are not sure why this is so, but Joseph Harkness, an associate research scientist at the Institute for Policy Studies at John Hopkins University, says one plausible reason is stability.”

I’ve already highlighted other aspects of the pride of home ownership here.

  • 5. Real estate has proven to be a great investment.

I see a lot of people argue that this is not true simply by virtue of the recent housing bust. They point out that house appreciation pales in comparison to that of the stock market. These points are true, and are a good reminder of why you should buy a house for shelter, and not for investing alone. But that’s only half the story. The full story, I would argue, is that owning a home is not solely an investment (it’s primarily a shelter), but it is a shelter that doubles as an investment. It’s also an investment that has a tendency to not to move in lock-step with the stock market - real estate often zigs when the stock market zags. This offers diversification when considered as part of your overall net worth. Renters do have an option here, they can invest in REITs. But again, they need to take the initiative to do so.

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Comments

One Response to “5 Reasons Why a Home is (Still) a Great Investment.”

  1. Services
    March 19th, 2009 @ 11:05 pm

    Great quality stuff.

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