My new home. My new investment?

Mar 2020

Over the last few years, most of my friends have become homeowners. My husband and I jumped on the “American Dream” train and bought a home in a historic neighborhood in Detroit. When talking to friends about home ownership, they’ll often say things like:

  • “Your home is a great investment! We expect ours to double in value in the next 5 years!”
  • “Our rent was more than our mortgage! We’re actually saving money each month!”
  • “If we decide to move, we can make a killing renting out the property. It will be easy.”

While the above might make my friends feel better about spending most of their life savings on a home, the thoughts are misguided and require much clarification.

Let me guide you through each of the three statements above:

  1. “Our home is a great investment! We expect it to double in value in the next 5 years!”

Answer: Your home is not an investment, even if it appreciates. It is a money-sucking asset that you will love and care for. Expecting your housing value to “double in 5 years” is an expensive gamble.

Explanation: Yes, historically, real estate value does rise. Although on average, only slightly more than inflation. Assuming a home’s value increased only at the rate of inflation, a property purchased in 1970 for $100,000 would be worth $664,874 today, a 554% increase. What’s the real reason your grandfather’s house appreciated so much over 50 years? Inflation.

Alternatively, if you invested $100,000 in the S&P 500 in 1970, it would be worth $3,506,001 today.

To be an investment, you must have the ability to control the timing of ownership, like you can with a traditional stock, bond or mutual fund. Unfortunately, you cannot easily sell your house at any time under any circumstance and maximize your investment return. You will, in fact, sell your house when it no longer meets your needs and you’re prepared to move on to something else.

While you’re (patiently) waiting for your house to double in value, you’ll be putting money into it – interest on the mortgage, home insurance, emergency boiler repair, etc. etc. (More on this below.) You know what I like about mutual funds as investments? They don’t have boilers that break.

Betting on real estate to “double in the next 5 years” is essentially gambling. Buy your home because it is in the right location and offers the features you desire, not because you’re expecting to make a killing when you sell it. If you are looking to gamble, take your money to Vegas.

  1. “Our rent was more than our mortgage! We’re actually saving money each month!”

Answer: In most cases, home ownership will cost significantly more than renting. (See above: your home is a money-sucking asset that you will love and care for). Ownership comes with freedom and flexibility and many other expenses beyond the mortgage. Comparing rent to your mortgage is like comparing an Uber to a car lease.

Explanation:  I hear you; I thought the same. Our mortgage was actually $500 less than our 2-bedroom rental apartment. Now, 3-months into home ownership, I can assure you, there is no money saving opportunity here. All those hidden costs that no one talks about really add up. A few to consider:

  • Home insurance – It obviously costs a lot more to insure a home than a 2-bedroom apartment. There are many factors considered when pricing insurance. Does your house have a generator? Is your driveway gated? How old is the electrical system? Do you live in a flood zone? Home insurance isn’t cheap but it’s critical to have a good policy when the “worst comes to worst” actually happens.
  • Home security system – Not only do you need to pay for the hardware (panel, sensors, cameras, etc.) but also for the ongoing monthly service and support. We chose to use Vivint since the previous owner had already installed the hardware and the monthly service charges were affordable.
  • Property taxes – It is critical to understand the property tax obligation in advance of purchasing your home. And remember, taxes are likely to increase over time. It is important to have room in your budget for any potential increase that might come your way.
  • Heating / cooling – Heating and cooling costs can definitely add up. Things to think about: how old is the furnace and A/C system? How energy efficient is the system? Does it make sense to repair an old less-efficient system or upgrade to a newer, energy-efficient system?
  • Snowplow / lawncare – Thinking “I can do it myself to save money” is true but it also costs a lot to do it yourself. Lawnmowers, snowblowers and hedge trimmers aren’t cheap. The cost to do it yourself adds up.

Remember, extra costs related to maintenance and repair are not tax deductible and you can only deduct a maximum of $10,000 of taxes on your tax returns (this includes federal, state, property and income taxes).

  1. “If we decide to move, we can make a killing renting out the property. It will be easy.

Answer: Unless you are in the business of real estate rentals, renting property (especially long-distance) is challenging and expensive. Outside of the financial implications, it can take up mental capacity you’re better off allocating elsewhere.

Explanation: Sure, you can have a renter come into your home and cover the mortgage. Just be sure to think about all the additional expenses and risks.

  • Insurance – Just because you’re not living there doesn’t mean you don’t have to have insurance. In fact, in some ways, you now have increased liability. You will likely need additional coverage beyond the typical homeowner’s policy.
  • Property Management – Who will take care of the leaking dishwasher at 2AM on a Sunday? Hiring a property management company helps take the responsibility off your hands, but it will cost you. In addition to paying the property management company, you’ll also need to pay for the cost of repairs.
  • Heating and Cooling – Tenants tend to run up the A/C or heating bill when they’re not the one paying for it. (I am guilty of this at every hotel I’ve ever stayed at.)
  • Tax implications – Many states and municipalities, like Michigan, favor owners who live in their homes (e.g., homestead exemption). These tax breaks do not apply to rental properties. Expect a higher tax burden if you plan to give up the homestead exemption and rent out your home. Additional tax consequences may also apply.
  • A tenant isn’t an owner – No one will treat your things as nicely as you do. Expect there to be more wear-and-tear than if you were living in the place yourself.
  • The “good neighbor” factor – You screened / Facebook stalked your new tenant, but you will never really know what will happen when you’re out of sight. Let’s hope your neighbors like the new tenant and he/she follows the HOA rules.

Now that we’ve cleared that up, why should anyone buy a home? Well, for me the decision to comes down to a quality of life decision. In our new home, we have a beautiful yard, plenty of space to host family and friends, a cozy fireplace and room to grow as a family. So purely looking at the balance sheet isn’t enough. If you do decide to buy a home, be sure you factor in all the additional costs and remain comfortable with the decision. No one wants to be house-poor.

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