Why a house can be a terrible or great investment

A “House For Sale” sign is seen outside a single family house in Uniondale, New York. (Reuters)

Is your home an investment?

Some say yes.

Some say no.

I say:

  • It is an investment
  • Not a great investment
  • But for a lot of people, the best investment

Let’s unpack.

A House Is a Terrible Investment

A house has a very high cost of carry. Unless you buy a new house, you will probably have to spend up to 1% of the value of the house on maintenance every year. Stuff breaks. Pipes burst, roofs leak, and occasionally the whole thing burns down.

It’s important because your investments must yield something. A bond could yield 4%. The average stock yields 2%—about what T-bills yield. Your house essentially yields -1%, unless you rent it out

You have to pay to insure it, you have to pay the property taxes, and you have to pay for all the other crap. This doesn’t include the mortgage, and you probably can’t deduct any of this stuff on your taxes after tax reform.

Usually, you wouldn’t consider something that costs you money a good investment.

But house prices go up over time, right? Well, as we learned 10 years ago, they can also go down. Sure, over a 40-year time horizon, I feel pretty comfortable that the price of my house will go up, even if only because of inflation.

But the U.S. housing market has changed dramatically in the last 20 years. We’ve had one big national bubble. And now, we have some very pronounced regional bubbles.

People should stop thinking about their house as a trade and start thinking about it as a place to live. Throughout most of U.S. history, that is what it was and nothing more.

Renting gets a bad rap—the “I’m just flushing all that money down the toilet” argument. Yes, but if you buy a house, it is possible you will flush even more money down the toilet.

The Math of Leverage

If people realized how risky buying a house was, they would puke down their shirt.

Let’s take an example—my first house purchase.

The condo we bought was about $179,000.

Our down payment was about $40,000.

We sold it for $300,000.

So we made $121,000… off a $40,000 investment.

That’s a return of a bit over 300%.

If you can make 300% in two years, you can lose it, too. Let’s say we bought our condo for $175,000 and sold it for $135,000.

Our equity would have been wiped out. We would have walked away with nothing. A 100% loss.

If you can make 300% on something or lose 100% on it, I would not consider that a safe or boring investment.

And of course, if prices decline even more, then you have to pay to get out of the house. And if you don’t have the cash, then you are dunzo.

A House Is a Great Investment

The single most important financial innovation of the last 100 years is the 30-year fixed rate mortgage.

Most people suck at saving. No matter how many times they read The Millionaire Next Door, they simply cannot do it.

The 30-year fixed rate mortgage is a forced savings program. With each monthly payment, you amortize (pay down) a little bit of the principal. And over time, you build equity.

It happens slowly at first, and then picks up speed. Before long, you own 30%, 40%, or 50% of your house.

Of course, the interest that you pay is wholly unproductive, and you want to minimize it as much as possible. If you don’t prepay your mortgage at all, you will end up making hundreds of thousands of dollars of interest payments.

Building equity in your home is super important. Real-life example: Myrtle Beach is full of people from places like Queens, NY, who sold their homes for $800,000–$900,000 after paying the house off over the course of 30 years and having no other savings.

They sell their house, receive cash, move south, pay $300,000 for a house, and live off the rest.

Let me be clear: These people often have no other savings apart from the equity in their homes. And they are living well in retirement.

Magic.

I am saddened when I hear of people doing things like cash-out refinancings or HELOCs. I know people who have made payments on their homes for 20 years and have zero equity.

They literally have nothing to show for it. They would have been better off renting. Never tap the equity—not even as a last resort.

Read more from Jared Dillian at Mauldin Economics.