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A House May Not Be Your Best Investment

A House May Not Be Your Best Investment

August 31, 2017

One of the biggest mistakes I see as a financial planner is clients who have purchased too much house. What defines too much house? Total monthly costs that keep one from meeting other goals such as saving for college and retirement or even spending during retirement. Before I continue, let me be clear. I support home ownership, and this isn’t an article about renting versus buying. I do, however, want to persuade you to be careful about how much home you purchase and to not consider your home as an investment, in the traditional sense.

I often hear the phrase “a family’s house is typically their biggest investment.” This makes me nervous because what I think people mean when they say this, is that most families have the bulk of their net worth tied up in their house. There is a stark distinction between the two concepts. You see, I have never believed that a house is an investment. In fact, for most families, home purchase is a poor investment; or in fact, no investment at all. But, I guess this depends on how we define the term “investment.”

According to Merriam Webster, an investment is defined as “the outlay of money usually for income or profit.” In other words, an investor will provide money for a cause with the hope that the cause will provide some sort of total return in excess of money provided. For example, an investor may purchase a stock with the hope that the stock will provide dividends (income) and grow in value (growth). Thus, the total profit (income plus growth) will hopefully be larger than the amount initially invested.

For most Americans, their house generates neither income nor positive growth. In the case of house ownership, an example of income would be rents received from someone leasing a portion of the house. I’m pretty sure that most people don’t have renters in their houses. So, we must all be counting on positive growth to provide a return on our investment. An example of positive growth would be the eventual sale of the house at a net sales price that is greater than the net purchase price plus maintenance and carrying costs incurred along the way. Let’s break down each of these components.

Net purchase price equals the cost of the new home, less purchaser’s closing costs, moving costs and expenses associated with upgrading the house (including furniture) to the standard of the new owner. Maintenance and carrying costs equal routine maintenance and landscaping as well as non-routine repairs (roof, heat and air conditioning, paint, carpet replacement, appliances, etc.). Net sales price equals the selling price less real estate broker’s commissions, repairs required by purchaser and seller’s closing costs.

If one were to track all of the associated costs outlined above, I believe they would find that, in most cases, house ownership ends up a losing proposition – exactly the opposite of that which is desired by an investor. But, you say, what about the appreciation in value of the house? Doesn’t that offset all of these costs? Well, maybe. Certainly there are cases where appreciation is extensive (a rapidly appreciating real estate market or the case of someone who purchases when prices are really low). For the most part, however, land appreciates at a rate very close to the general rate of inflation which is not high enough to counterbalance all of the costs of ownership.

So let’s stop calling house ownership an investment because it’s not by any definition of the term - the math proves it. Let’s do think of home purchase as a process that will serve our emotional needs. We buy houses because they are in desired school districts or neighborhoods, they are close to what we like to do, they make us feel good about what we have accomplished, they represent our status in society. But, unless we are purchasing property to lease, we are not making an investment in anything but a home - a place where our heart is, where our families bond, where friendships flourish, where we seek refuge from the crazy world in which we live.

I want to make this distinction for one important reason. If you can free your mind from the “home is an investment paradigm,” you can look at the size of your home purchases more objectively. This shift should allow you to give math an opportunity to help drive your home purchase decisions.

Consider this: When you are young, instead of purchasing as much home as you can afford, decide to spend no more than 50% of your take home pay on all of your core expenses (home related, food, medical, insurance, clothes for work, transportation). When you are close to retirement, determine how much projected income you will have once you stop working. Evaluate whether or not the costs associated with your current home are too high relative to that income.

Because they represent such a large part of your budget, your home purchase decisions will be some of the most important planning decisions that you will make during your lifetime. Please consider them in the context of your other planning goals. Be careful about having too much of your net worth tied up in your home, either when you are young or when you are near or in retirement. Too much house may well keep you from achieving some of your important financial goals. But, just the right amount of home will help you achieve your most important emotional goals.

If you have any questions about the methodology used in this article, please contact me, and I will be glad to share my thoughts with you.

By the way…what is your Second Half Strategy?   


Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Second Half Strategies, a registered investment advisor and separate entity from LPL Financial.