Is Buying a Home a Good Investment?
By Jason Hoffman, CFP
Is buying a home really a good investment or even necessary to have a successful financial life? One of the biggest financial misconceptions is the idea that you HAVE to buy a home to build wealth. In reality, data shows this is actually not the case for most people.
Let’s first start with some general historical data on the housing market and stock market: according to the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index the U.S. housing market has seen an average 10-year return of 6.12%, and if we use the MSCI All Country World Index as our benchmark for the stock market as a whole, it had an average 10-year return of 9.52% during the same time period from April of 2011 to May of 2021. By just looking at these 2 average returns, it seems like the clear winner is the stock market. I’d like to dive in a bit deeper though, because I know the national average 10-year return of the housing market isn’t necessarily representative of what it is like to buy a home in a “hot market” as many would say, so let’s look at some real numbers.
I often hear stories about people who buy a home and suddenly have $300,000 in appreciation after 6 years. This is what commonly leads most people to think purchasing a home is absolutely a great investment that is imperative to building wealth, but it is important to remember that price appreciation does not equal return on investment. We’re going to break down exactly how this scenario can be misleading with some real-life numbers!
I personally purchased a home in Austin, Texas back in August of 2017. Austin is commonly referred to as one of the hottest real estate markets in the U.S. At the time of my home purchase, the Austin real estate market had experienced strong and steady growth for many years, and since then we’ve had what many experts call exponential growth. According to data from the Austin Board of Realtors median home sales prices in Austin are up 37% from just a year ago.
I purchased my home for $272,900, and now my home’s Zestimate is $451,000, just shy of a $200,000 increase. Sounds like a nice return for 4 years, right? Well, let's dive in and see exactly what the return on my initial upfront costs would be if I sold today, and compare it to how the MSCI All Country World Index performed during the same period of time. When calculating the return on investment in real estate it is important to take ALL expenses into account. Here’s the breakdown of the cash flow if I sold my home today:
$451,000 Home Sale Price
-$36,080 Sales Cost (8% of the sale price)
-$13,080 Renovations/ Maintenance During Ownership
-$76,967 Principal, Interest, Insurance, & Property Taxes for 48 Months
-$201,663 Mortgage Payoff Amount
-$54,915 Original Down Payment & Closing Costs
$68,295 Total Cash Out After Expenses
This means that my initial $54,915 investment made me an additional $68,295. If I do a simple return on investment calculation, that means the total return on my initial investment of $54,915 was 124.36%, which is an excellent return. The average return of the MSCI All Country World Index from August of 2017 to August of 2021 was 63.09%, which means investing in real estate did win in my specific scenario. However, there are a few additional things I’d like to point out:
The timing of my home purchase happened to be pretty great - I bought right before a major real estate boom, and not during a major real estate boom. This was not intentional and is something that is nearly impossible to plan out. The growth of Austin’s real estate market is also MUCH higher than the national average return I mentioned above and likely outpaces most other large cities in the U.S.
This investment is MUCH riskier than investing in the stock market. It is a lot safer to own thousands of companies than it is to own one single piece of property.
The value of my home 8 months ago in January of 2021 was only $330,000, meaning for about 3 years the appreciation of my home value was pretty slow. Had I opted in to sell 8 months ago, my original down payment would have performed much better in the stock market.
I’ve been incredibly lucky and haven’t had any major repairs come up during my time of ownership. Others in my neighborhood have had foundation repairs, roof replacements, and plumbing issues. It is very normal to have SOME sort of major repair needed while owning a home, and I anticipate something will come up in the future.
I haven’t had a home inspection done since I purchased the home, so it is VERY likely that additional repairs could be needed if I actually sold, thus eating away at some of my ROI. Yes, I’ve maintained my home well, but that doesn’t prevent certain things from needing to be repaired or replaced that I might be unaware of.
While my rate of return has been better than the stock market, my money is still tied up in an extremely illiquid investment and would take a month or two longer to access if I needed it.
If I continue holding onto my home, it is likely that the real estate market will cool off a bit as the stock market continues to increase in value, meaning my rate of return will slowly decrease.
The moral of the story is: purchasing a home can be a good investment if you purchase within your means and at the right time, but it isn’t by any means something you HAVE to do to build wealth. If you do find yourself buying a home, make sure your main motivation is to have a home of your own, and NOT to use it as a tool to get rich.