The idea that owning a home can be an investment comes from the fact that, historically speaking, real estate values tend to increase over time — and that’s still true today.
According to Zillow, the average value of a home in the U.S. has gone up by 20.6% over the last year.
That means that if you bought a home for $276,000 a year go, that same home would be worth $331,650 today.
But the prospect of an increase in value alone isn’t enough to make a house a true investment. Here’s why.
A house has a more important primary purpose
Probably the single biggest reason why a house is not an investment is that its primary purpose is providing you with a place to live. So, it’s not something you can really do without — like a company stock or a share of a mutual fund, for example.
Because of that, you will have little control over its sale from an investment perspective, as you’ll likely sell it when it no longer fits your lifestyle, and not when it’s more convenient in terms of a return on investment.
This latter part was proven during the financial crisis of 2008, when the lack of control over the timing of buying and selling properties had a major negative effect on houses as investments.
At the time, many people bought houses at ridiculously high prices because that was the time when they needed a home for their families. Then, some were forced to sell their homes when the market collapsed, so they actually experienced a negative return on investment as they bought high and sold low.
Although this happened over a decade ago, this scenario is not unusual when it comes to the housing market, and it’s one of the reasons that largely disqualifies a house as an investment.
A house can only be an investment if you plan to sell it
True, houses generally increase in value, but the only way to profit from that increase is to sell them. However, selling your house means you’ll have to find another place to live.
So, you’ll have to use some — if not all — of the equity you obtain from your sale to fund that purchase.
If that’s the case, your equity is “trapped,” which means you won’t make a profit, unless you downgrade to a less expensive house, or move to a rental situation.
Related: Should you buy or rent a home?
Thinking of your house as an investment can lead to equity stripping
There is another way you can get money out of your house, but it is hardly a method that’s risk-free.
You can borrow the money out of your house, based on the amount of equity you have. This can be done either through a home equity line of credit (HELOC) or through a straight-up cash-out refinance of your first mortgage.
But when you do either, you are borrowing money against the house. That may put more cash in your pocket for purposes unrelated to the house, but it also creates a corresponding liability. That liability not only creates a reduction of future cash flow via the monthly payments but also puts your house at risk.
A lot of people found that out the hard way during the financial crisis. As house values either went flat or declined, homeowners realized they had no equity in their homes. That left them unable to refinance to lower the monthly payments, and unable to sell to move to a less expensive housing arrangement.
The widespread use of HELOCs and cash-out refinances made a lot of people feel richer in the short term, but it jeopardized their long-term financial security in the process. Thinking of their homes as perpetual investments, many engaged in serial refinances, and ended up with an underwater mortgage (owing more on the house than what the house was worth).
That’s where thinking of your house as an investment becomes a dangerous assumption.
The carrying costs of owning a home are too high for it to be an investment
When you purchase an investment, you typically don’t need to put more cash into it for it to make money for you. But the same can’t be said for houses.
Besides that, houses need some TLC over time. This can include replacing the roof, siding, windows and doors, carpets and flooring, and driveway. You may also engage in major remodeling like the replacement of kitchens and bathrooms.
Each of those expenses individually can cost thousands of dollars, and are known as the “carrying costs” of homeownership.
True investments don’t require that kind of ongoing outlay of cash. You can rationalize those expenses based on the fact that the house is providing you shelter. But that gets back to the original premise — if your house is your shelter, it’s not really an investment.
Carrying costs can really work against you
Say, for example, you purchase a house for $200,000, and 10 years later you sell it for $300,000. Sounds like a good investment, doesn’t it? That is, until you take a closer look at all the money you put into it over the years.
If the house cost you $1,000 per month for principal, interest, taxes, and insurance (PITI), plus $300 per month for utilities, you will have spent $15,600 per year, or $156,000 for the decade that you lived in the house.
If you spent another $3,000 per year on routine repairs and maintenance, you will spend another $30,000. And if you did some of the more major repairs, like replacing the roof and flooring, and remodeling the kitchen and bathrooms, you probably easily sunk another $50,000 during that decade.
That’s a total of $236,000 over a 10-year period, to get a $100,000 gain on the sale.
While it is certainly nice to walk away from the house with $100,000 more than you paid for it, the math doesn’t support the idea of the house as a winning investment. And we haven’t even accounted for transaction expenses (like the 6% realtor commission), inflation, or the fact that the value of the house may not rise that dramatically over the next 10 years.
Your house won’t generate cash flow
The hard truth is that your home simply won’t offer any form of cash flow when you’re a homeowner. That is, unless you own an investment property and rent it out.
Whether you own a multi-family home and rent a unit or two out, you rent out the whole house, or you simply rent out a room, this is the only way you’ll make any sort of profit. Renting out part or all of your home will help you pay the mortgage, insurance, and other costs associated with homeownership, so it’s worth it for many. In a best-case scenario, this will actually provide cash flow to the owner.
Although buying and managing real estate investments can be lucrative, it takes a lot of work and money, and it involves a significant amount of risk. If you like the idea of earning investment income from real estate (as opposed to stocks and bonds), consider real estate crowdfunding.
Crowdfunding platforms give you the chance to invest a small amount in large real estate deals and share in their profits. (Take note that, like all investments, real estate crowdfunding involves the risk of losing some or all of your investment).
If you are interested in a crowdfunding platform, Fundrise is a very popular option. With just $10 and a simple sign-up process, you can invest in a variety of real estate opportunities all from a convenient mobile app.
If you’re more interested in a streamlined buying process when it comes to rental properties, Roofstock should be your go-to. They offer a huge range of properties, most with tenants already living in the homes, so you’ll have an immediate influx of passive income.
Appreciation is the magic ingredient, but it’s not guaranteed
Finally, let’s revisit the primary reason why so many people consider their house to be an investment. The whole notion rises and falls on the future value of the property. During times when the value of the house increases, people commonly think of their houses as investments.
But during the financial crisis of 2008, and particularly in certain markets, not only did property values not increase, but most fell. Some fell spectacularly. For people in that situation, not only was their house not an investment, but it became a major liability.
Read more: What to do after a stock market crash
The possibility of a flat or declining housing market can no longer be discounted. Should that happen, you’ll be forced to live in your house much longer than you expect, and you’ll probably find that you can neither sell the property nor borrow out the equity.
That doesn’t sound much like an investment at all.
Read more: Should you buy a “starter home” or wait?
The main takeaway is the following: don’t buy a house thinking of it as an investment that will someday lead to a substantial profit. Buy it for what it is: a place to live. Anything extra is just a bonus.
Featured image: Eddie J. Rodriquez/Shutterstock.com