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Why Owning a Home is a Bad Investment — But Often a Smart Decision

flickr.contractorsExperiential learning is always better than any lesson from a book. But when it comes to personal finance, too often the experience comes at the price of losing or spending way too much money.

This past summer, my wife and I decided to finish our basement. We met with our contractor, who was honest and hard working. But he’s the first to admit he’s no numbers whiz, either — we know that now, anyway. When he originally estimated $15,000, we thought that might be optimistic. So Amy and I planned for $20,000.

But it wound up costing us $40,000. Ouch.

Many factors contributed to this: a shot water heater, issues with plumbing leaks that popped up during the buildout, the contractor failing to use cheap labor for no-brainer tasks such as demolition and hauling debris.

Okay, so we increased our living and working space by a good 25 percent. But the deep dive into the money pit also brought to light this truth: Big investments often have bigger “carrying costs.” (I’ll explain that term in a bit.) And if you look at a home in that light, it’s not the best investment in the world.

Not by a long shot. In fact, you’re better off renting than owning.

That’s right. I’d argue that for most of us, a single-family home or condo is a questionable investment at best, and in all likelihood owning a home is a bad investment, financially speaking.

Before you call me a communist or a home hater, notice that I didn’t say “owning a home is a bad living decision.” I said “owning a home is a bad investment.” Most of us grew up hearing that home ownership is the American Dream. But the days of homes as sound investments — strictly from a profit basis — are now rare, if not over.

I’ve come to this conclusion thanks to the work of Rich Arzaga, the founder and CEO of Cornerstone Wealth Management and an adjunct professor at the University of California at Berkeley. Examining 250 properties around the U.S., and going through close to 40 of his client files to project the financial impact of owning real estate versus liquidating it, he found that “100 percent of the time it was better to rent rather than own.” As in 100 percent.

This is where carrying costs come in. As the name implies, a carrying cost is what you pay to keep a possession or a piece of property, be it real estate or a box of baseball cards. I’ll give you an easy example: Let’s say you own 10 boxes of rare baseball cards. Those cards are worth $2,000, and they go up in value by 10 percent a year. But you can’t keep them in your basement, so you have to rent a storage unit, which costs you $50 a month.

That $50 becomes a carrying cost — the price you pay to keep the investment instead of liquidating it. And after 40 months of rent, your carrying costs have eaten up all the value of those cards, except for the yearly percentage increases. Wait another year or so, and the rent will eat up every bit of  value, and it will actually cost you money to hold onto those “valuable” cards. But if the cards have sentimental value as the first collection you ever owned, the money lost or made on them may not be the one and only consideration.

It’s like that with homes as well. People have strong feelings about where they live, as they should. But letting those feelings cloud your financial judgment could be dangerous if you’re betting the home will turn into a gold mine. Any homeowner knows the carrying costs can be enormous, even under the best of circumstances: property taxes, mortgage payments, utilities, homeowner’s insurance, property maintenance and routine repairs are just a few categories, offset only by the mortgage interest deduction in most cases. I did a rough calculation of my baseline carrying costs, and it comes to roughly $15,000 a year — before I factor in mortgage payments of $2,200 a month.

And if you have a major repair issue with plumbing, a new roof or a kitchen remodel, prepare to pay for it big. Yes, it’s true that some projects increase the home’s value, often by much more than what you pay. But what if you’re not selling right away? Will that $50,000 kitchen remodel still make a buyer drool 10 or 15 years down the line? Or will it seem dated? And what if you financed it? Does a $50,000 remodel wind up costing you, say, $80,000?

Now, let’s look at the renting scenario. Even if your utilities aren’t covered and you pay renter’s insurance, all major repairs, upgrades and routine maintenance will be covered by the landlord. There are no property taxes. And that leaves you a lot of money to invest in other areas to create wealth.

Greg McBride, a senior analyst at Bankrate.com, agrees with one distinction Arzaga makes. “Home ownership is not so much a creator of wealth as a store of wealth,” he says. “The promise of home ownership is that over the long haul, it can rebate many or perhaps all of your costs, unlike rent, which doesn’t rebate a dime.”

So if you hold onto a home for 20 or 30 years and keep it up, chances are it will rise in value and you’ll see a good amount of money when you sell. But you also paid out a lot of money (in taxes, for example) that you’ll never get back. Now factor in all the major expenses. What’s the bottom line?

McBride himself crunched the numbers in a pre-bubble era (2004) for a home purchased at $200,000 by a buyer in the 27 percent marginal tax bracket. Factoring in a 30-year mortgage, $1,200 in annual home insurance, closing costs of $5,500 and maintenance costs of $100 a month, along with property taxes, he calculated that it would take a selling price, 10 years later, of $395, 404 just to break even. His conclusion? “Homeownership may not be the moneymaker you think it is.”

So why own a home? After my basement project finally concluded — three months late and $20,000 over budget — Amy and I held a huge party. Dozens of close friends showed up. They were amazed at the rebuild. We felt proud. Months later, the glow of the rejuvenated space hasn’t faded. Once the coldest, bleakest portion of our house, the basement is now the warmest, brightest and coziest.

Maybe it was a bad financial investment, or a clumsy one. But the project fits into the calculus behind why we bought our property in the first place — quality of life. Here’s what I’ve learned: When it’s time to buy, do it because of the school district it will put your kids in, the amenities in the neighborhood, the community where you can plant your life and family. The vibe of the structure.

If you wind up selling someday and making money, that’s fabulous. I never said it couldn’t be done. But if that’s the main goal, then ask yourself which is more important to you: The house? Or the home?

Whether you own or rent, the value of a home cannot, nor should not, be measured in dollars and cents.

Have you purchased a home instead of renting? Why did you decide to, and was it a good investment?

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About Lou Carlozo

Based in Chicago, Lou Carlozo is a personal finance contributor for Reuters Money, a columnist with DealNews.com, and a former managing editor at AOL's WalletPop.com. Contact him with story ideas for Money Under 30 at feedbacker@aol.com, or follow him via LinkedIn and Twitter (@LouCarlozo63).

Comments

  1. Demo is no simple task, less you want to risk your whole house falling down

  2. I’m curious; given how the tax code as currently constructed seems to give preferential treatment to home owners, and also to real estate investors [in terms of deductions for property taxes, mortgage interest, and/or depreciation deductions], does tax time [and the sometimes considerable chunks of cash that come in the form of refunds] balance out the carrying costs and other expenses over the lifetime of home-ownership? just randomly wondering this out loud…

  3. There are a few key points that this article ignores. I’m not saying the author is right or wrong, but ignoring these issues is a pretty material oversight.

    First, owning property is an inflation hedge. If you have a mortgage, your payments under your 15 or 30 year loan will ALWAYS be the same in nominal dollar terms. Your rent payments for your apartment will not. I don’t have any data on what percentage rent payments increase per year, but I’d be shocked if they weren’t in the 3%-5% range.

    Second, if you don’t think renters pay property taxes, you are sorely mistaken. Sure, you aren’t making a monthly deposit into an escrow account or making a semi-annual payment for real estate taxes. That said, you’re still paying property taxes. The company that owns your apartment complex or the owner of your duplex IS passing that cost on to you in your monthly rent payment.

    I’d be very interested in seeing how these items would change the assumptions in McBride’s study.

    • I couldn’t have said it better myself

    • I absolutely agree. When we bought our house, it was because the house we were renting was $750 per month, while other comparable houses on our street started renting for 1000-1250. We knew we would soon be priced out and have to move into a smaller house or less safe area. By buying our home, we now know that our payment won’t go up at the end of a 12 month lease when the landlord decides he could make way more money on his property.

      I don’t consider our house an investment, but I do consider it a way to pay less over the long run for our housing costs.

    • Totally agree. Also, what about the security you have when you pay your house off? No chance of being evicted then, and one less (large) expense to worry about during retirement (or earlier if you play your cards right). Granted, you still have to pay taxes, insurance, and maintenance expenses, but on average those would probably be pretty minimal compared to rent which never goes away.

  4. I agree that owning a house isn’t a ‘good investment’, but I really don’t believe it is more expensive than renting.

    Here is my situation when I moved out of renting, and then moved into home ownership.
    Apartment rent: $824 for 1000 sq. ft. and cheap contractor grade appliances. No garage, noisy neighbors.
    Rental insurance: $13
    Utilities: $110
    Total monthly: $947

    25 year old house 2 car garage, with fairly extensive upgrades to include, backyard deck, complete kitchen remodel, 2 bathroom remodels, new water heater, furnace, A/C. The only thing I might have to do in 5-10 years is a roof replacement, so I’ll cook that in too.
    Mortgage: $450 for 1400+ sq. ft.
    Property Tax: $200
    Insurance: $45
    Utilities: $125
    Total monthly: $820
    Savings after 5 years $7620, probably enough to get close to a roof replacement.
    Result: Renting and buying is about the same after 5 years, in my situation, plus my mortgage payment is constant, while rent increases with inflation. In 5 years, the rent will be north of $1000 a month.

    One final gripe from the article: You do pay property tax with your rent payment. It is just hidden in monthly rent.

  5. I believe the author understands that property tax is passed onto the tenants as well as property insurance and honestly all other routine costs but the author is correct in stating that as a renter you do not have property taxes….there is after all no bill that shows up in the renters name for property tax.

    • I am sure the author understands that property tax expense is passed on but that isn’t explained or implied anywhere in the article. A mathematical comparison of renting versus owning has to take this into account whether the cost is implicit or not.

  6. Sorry, but I just disagree with this article. You have instances where, living in a house is cheaper over a longer period of time, rather than renting.

    Living in Houston, Texas I can tell you that I am optimizing the best case scenario for living expenses right now at the age of 24. I own a townhome and I pay $1600 a month to live in it on a 15 year note. In the Houston area, there are more pricey places to live and I happen to be located in one of those areas -Uptown, Galleria. Now, I also have a room-mate that I charge that cuts that payment in half. I could never live in the Galleria area, or find a place, that is decent for $850 a month. So, why is this a bad idea? I am building equity. I am already seeing the benefit of having tenants. I have more disposable income and the house is appreciating as Houston, TX is a hot market. I just don’t see why I would ever go to renting ever again or at all. That townhome will be making me money over the note and when it matures. Also- my carrying costs? Less than a $1K so far. No major repairs have been needed, but small projects have been done here and there which makes the place more valuable.

    • You have a roommate/tenant, though, so you’re paying less than you would if you lived there alone. Also, I think the point is that when you liquidate down the road – sell the house in 10 years, let’s say – you may sell it for less than your mortgage + carrying costs. I’ve read other articles that make it clear that housing improvements actually depreciate in value. For example, if you remodel your kitchen for $50,000, that doesn’t necessarily mean you can tack $50,000+ onto the value of the home.

  7. I think it depends where you are and your job. Like me military so I might only be some where for 3 years and have to move. So What than I did not stay long enough to get my money worth. And I would than have to be able to rent it out for my payment to break even. Now I would say I have thought about doing this still. I would also say I believe if you buy a home have at least 6-8 months of a emergency fund in case something comes up. I also would only look at loans for 20 years or less preferably a 15 year loan.

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