Is your house really a good investment? | Investing 101
With the financial crisis that lasted almost 10 years, most investors have finished healing their wounds. The stock market has long since rallied and set record after record. The economy is generally healthy, unemployment is down and inflation modest.
But what about houses? Americans have long been told that a home is a key investment, essential to building wealth and entering the middle class, or staying there. But many have been hit hard by the housing crash that has left tens of millions of people owing more than their homes are worth. Is a house a good investment, or should we have learned a hard lesson?
“Homeownership is not an investment,” says Mark Avallone, president of Potomac Wealth Advisors in Rockville, Maryland. “It’s a lifestyle choice for those who want the freedom to own their own home and land. People who assume a high rate of return on their home purchase are living with a 1990s mentality. Of course, there will always be pockets of opportunity, but net increases in value are far from certain, especially when all costs are included.”
Over time, homeownership worked well, but only for those who made sense, says Aaron Hendon, real estate agent at Christine & Co. in Vashon, Washington.
“Don’t speculate with the house you live in,” he says. “Buy within your means, buy where you want to live, buy slow, buy smart, and know that over time the housing market has been as stable a driver of growth as any.”
On paper, the real estate market has indeed recovered. The S&P Corelogic Shiller 20-city Composite Home Price Index, one of the most-watched indicators, is back to where it was in 2007 before the housing crash.
But that masks a lot of misery between the two. This means that the average house, although worth much more than at the bottom of the market, has not gained in value in 10 years. People who lost their homes to foreclosure are likely still suffering. Many who would have bought their first home during this period were locked out by tougher mortgage standards. Obviously, houses have not been good investments for everyone.
Everything that is your biggest investment can also be your biggest money loser, and a house is not a guaranteed winner.
“It’s a delusion to believe that prices only have one direction and that it’s up,” says Bruce Ailion, realtor at Re/Max in the Atlanta area.
“Fundamentally, property prices are directly related to wages,” he says. “If wages go up to 2% and housing to 6%, it’s not sustainable and there will be an adjustment.”
The family’s biggest investment isn’t necessarily the best investment — the most profitable over time. Over long periods, house prices have risen about 4% per year while stocks have risen nearly 10%. Stocks have crashes too, of course, but it’s easier to get out of a stock or fund if things go wrong.
Robert R. Johnson, president of the American College of Financial Services in Bryn Mawr, Pennsylvania, says homes seem like stable investments only because you can’t get minute-by-minute price updates like with stocks, and that many owners focus on long-term price gains and ignore all ownership costs.
“Inventory doesn’t need a new oven, a mowed lawn, or annual property tax payments,” he says.
So here are five key lessons that experts say people should learn from the past decade.
Leverage can hurt. Among the cases of home ownership is the possibility of buying a rising asset with borrowed money. Make a 10% down payment and you double your equity with a 10% gain on the price of the house. But a 10% drop in value will wipe out your capital. In addition, the 10% gain is reduced by mortgage interest, maintenance, taxes, insurance and other costs that you would not have, for example, with a mutual fund.
Do not stretch to the limit. The internet is full of calculators to figure out the maximum mortgage and the most expensive house you can get, but the real estate crash was hardest on homeowners who had racked up maximum debt. So if you need two incomes to qualify for a mortgage, how will you make your payments if one of you loses your job?
Before the crash, homeowners thought they could sell if money was tight, which was often possible because house prices had risen steadily and there were plenty of buyers. But the crash showed that the escape hatch didn’t always work.
“Asking ‘What’s the most I can afford?’ is a good way to keep running in the middle-class overspending rat race,” says G. Brian Davis, director of education at Spark Rental, an advisor to real estate investors. “Instead, they should wondering ‘What can I at least spend on housing and still be happy?
To diversify. If a house is considered an investment as well as a shelter, it’s a good idea to follow standard advice on the value of allocating your money between different types of assets. Experts suggest keeping home ownership modest enough that you can always contribute to your 401(k) at work and have a few other holdings.
“Housing is the biggest personal expense for most of us, so spending less on housing frees up money to invest elsewhere. [such as] retirement,” Davis says.
“I believe that people who wish to accumulate wealth would be better served to consider committing funds to their retirement plans and allocating those plans to [stocks] and not being so eager to buy homes,” Johnson says.
Plan to hold on. Investors who stayed in the stock market during the crash recovered fairly quickly, and owners who bought before 2007 and were able to hold on were cured. On paper, it’s easy to argue for a three- or four-year time horizon — long enough for the appreciation to offset the realtor’s commission and other buying and selling costs. But it’s common for home prices to stagnate for a few years, even in a normal market. Because selling a home is expensive and time-consuming, and price gains are uneven, buying a home is best viewed as a commitment for 10 years or more, say many experts.
“The key for anyone buying a home to understand is that it’s a long-term investment,” Ailion said. “You get rich slowly, not overnight.”
Have clear ideas. It’s easy to rationalize buying a house that’s too big because you think it’ll produce bigger gains, or buying a house in a weak market because it’ll be a house even if it’s not a excellent investment. Instead, try not to muddle your thinking and look at each issue separately.
Many experts recommend buying the cheapest house that meets your housing needs and finding a healthy neighborhood that isn’t dependent on one employer. Good schools are the key to family values.
“When buying a home, people should buy the house they need, not the house mortgage lenders say they can buy,” Johnson said.