Homeownership is the American Dream. At least it used to be.
Some of the shine wore off after the 2008 housing crash. For the first time, many Americans began to see how buying a home wasn’t the good investment they thought it would be.
When you look at buying a house in the cold light of real estate investment strategy, it is easy to see how buying can be a bad decision. It blocks your cash flow, limits your diversification, and costs you money just to hold with no guarantee that you will ever see a profit.
So, from an investment perspective, maybe renting is the better choice?
Why is a House a Bad Investment?
Purchasing a home isn’t a bad thing. There is nothing wrong with owning a home as a means to keep a roof over your head. But from a real estate investment strategy perspective, purchasing a home is not a good investment to pursue.
Investing is all about growing your wealth and financial security. In fact, investing is defined as “expend[ing] money with the expectation of achieving a profit or material result by putting it into financial plans, shares, property, or by using it to develop a commercial venture.”
So a good investment is anything that can help you grow your wealth (achieve a profit). Stocks, mutual funds, cryptocurrency, precious metals, bonds. These are all types of investments. Even real estate is an investment type. So why is buying a house a bad investment?
Well, there are two reasons.
The first relates to your investment strategy. Houses are expensive, they eat up a lot of cash, both upfront and throughout the duration we own them. This limits your cash flow and has a negative impact on your diversification.
The second reason regards investment performance. Would you buy a stock knowing that it won’t make you any money? Probably not. Taking out a mortgage without any intention of ever selling your home is the same thing.
And even if you do sell it, there is no guarantee that depreciation and inflation won’t deprive you of profit.
Traditional real estate investing takes place in the form of purchasing REITs or by becoming a landlord and renting out a home or other investment property. This offers the real estate investor a cash flow, potential diversification, and potential for long-term growth.
When comparing that to purchasing a home to live in, it begins to become clearer as to why buying a home is a bad investment.
It Blocks Up Your Cash Flow
If you purchase a home with the intent to make it your primary residence, then as an investment, your mortgage, or monthly payment, will kill your cash flow.
Real estate investors who purchase a home to rent out, take rent money in and pay loan money off. If they’re smart, they are charging more for rent than the monthly mortgage payment. Which means they have a positive cash flow.
Once you tie up a significant portion of your cash in a home purchase, this can slow your overall cash flow to a trickle.
If you instead took the down payment money and mortgage payment and invested it in a diversified index fund, you would likely achieve a 6-8% return and begin earning passive income.
Lack of Diversification Because of Blocked Up Cash Flow
Ever heard of the old adage, “never put all your eggs in one basket”? If you are like me, you are probably tired of hearing it, but it is still a great way to communicate the basic tenet of investing that is diversification.
In this case, the basket is your house. With the median house price in the US hovering around $340,000, that is a pretty sizable basket.
Depending on your overall investment goals, and whose advice you listen to, it is recommended that real estate make up only 5% – 40% of your portfolio. So, unless you have another $510,000 to $6.5 million sitting around in other investments, then you are not properly diversified.
And why is diversification so important? Well if you drop your basket, you have no more eggs. Likewise, if you lose your home, you have no other investments with which to cover your loss.
You Might Never Sell Your Home
If you view your house as your forever home, then sorry to break it to you, it’s not really a real estate investment property.
The same applies to anything else you buy with no intention of reselling. Would you call your car an investment? Your iPhone? Your custom-made death star fire pit? No.
So, if you never intend to sell your home, then at best, you can call it an asset, and your mortgage an expense.
Even if you do choose to sell your home, there is no guarantee you will make a profit. Sure, you can consider it an investment in this case, if not a bad one.
And even if you do manage to sell your home for a sizable profit, you could be hit with a tax bill if you don’t meet the qualifications for a tax break on the sale.
Additional Costs Associated with Owning a Home
The single best feature of renting is the fact that you are not responsible for maintenance, the landlord is. But when you own the house, you’re the landlord.
On average, routine home maintenance costs the average homeowner 1% to 4% of their home’s value each year. And that doesn’t include expensive one-time fixes like replacing the roof.
And maintenance isn’t the only homeownership cost. There are also the dreaded taxes that seem to go up every year. Depending on whether you live in a rural or populous area, taxes range from 0.3% of a home’s value up to 2.21% of a home’s value. Yikes!
Some other costs you may need to watch out for when owning a home include:
- Homeowner’s Association (HOA) fees
- Mortgage insurance
- Utility deposits
- Utility payments (when you can’t shop providers)
And don’t forget about all of the hidden fees associated with purchasing that home. Closing costs, inspection fees, loan origination fees, etc. You’ll likely never see any of that money back again.
Appreciation Isn’t Guaranteed
When the market is hot, it can make buying a home seem like a great investment. Housing prices always go up, right? Wrong.
I must remind you of the 2008 housing bubble and subsequent market crash where home prices fell to rock bottom prices leaving many people underwater on their mortgage loans. Especially those who had bought into the “anyone can start investing in real estate” fad.
But, a major market downturn isn’t the only reason a home can lose its value.
If the major employers in an area leave, this could kill the housing market, i.e. Detroit after the car manufacturers left. Natural disasters can permanently wipe out an area’s housing values. For example, when Katrina hit New Orleans.
Or maybe the government steps in and builds a new highway or pipeline in your backyard.
And the house itself could have unforeseen problems that kill the value. A foundation issue that you find a few years from now could tank your home’s value and/or force you into a very costly repair.
Renting vs Buying
How many times have you heard that renting is just a waste of money? That homeownership and building equity is the way to go?
But is it really?
While your rent money doesn’t earn you home equity, that doesn’t mean you are getting value for your money. Aside from a roof over your head, you won’t need to pay a dime for maintenance, that is the landlord’s responsibility.
If a tree falls on the roof, you might need to replace a few of your things, but the repairs to the house will come out of your landlord’s budget.
And if the county or school district decides to raise property taxes, yep, it is the landlord’s responsibility to fork over that cash.
Once your lease is up, you are free to move, with your only cost being the transport of all of your stuff and maybe some lost deposits.
In contrast, owning your own home means the cost of all maintenance, repairs, and taxes comes out of your pocket. And when you get ready to move, you have to go through the lengthy home selling process before you can move on.
That doesn’t mean that there aren’t upsides to owning a home.
If you want to repaint a wall forest-green, go for it, you own it. If you want to chop down a tree, have at it, just watch for power lines.
While you are renting, the landlord could decide to sell the place and kick you, the tenant, out. Which is one nice thing you don’t have to worry about when you own your own home.
And of course, you could build equity in your home. Just be aware that interest is loaded on the front of the loan, so you may not be building equity as fast as you thought you were.
Buy a House with the Correct Mindset
Buying a home is a big decision and one that shouldn’t be taken lightly. Put aside the “you need to buy a home” advice for a minute and evaluate your life goals and financial situation to determine if buying a home is the right move for you.
Aside from the considerations on whether or not taking out a mortgage is the best financial decision for your family, you need to figure out if the home will be an investment property or an expense.
Once you have this figured out, then you can approach the home buying process with the appropriate mindset and expectations.
Amanda Garland is a personal finance blogger living in Dallas, TX. 10 years ago she was living paycheck to paycheck and knew nothing about how credit works. She learned some hard lessons in her fight for financial stability. Now she has a friendly competition going with her husband to see who can reach a credit score of 850 first. She is also a poet, having obtained a Bachelor of Fine Arts degree in Creative Writing.