Is Buying A House A Good Investment Or Not?

Includes: REZ, SPY
by: Skyler Greene

Two months ago, Shaun Connell wrote an article analyzing why now is a great time to get into the housing market. I think the attractiveness of real estate right now has been well established. However, while I'm certainly a huge supporter of homeownership, it's important to consider arguments on both sides of the proverbial white picket fence. For most of us, choosing to buy our first home is a major decision that shouldn't be taken lightly.

I'll start off with some of the strongest arguments in favor of buying a home. These are especially relevant now in context of the rock bottom interest rates and relatively low real estate prices.

Argument in Favor of Homeownership #1: Lower Recurring Costs

A commonly perpetuated myth holds that homeownership is more expensive than renting because of two factors: property taxes and maintenance/upkeep of the property. But after a little analysis, this myth falls flat on its face. If you think you're getting a free pass on property taxes and maintenance, think again. If you were the owner of a house that you were renting out to generate income, would you be willing to lose a significant chunk of your income as property tax and maintenance expenses? Of course not. As with any business endeavor, costs are passed along to the consumer in the form of higher prices. Especially now, with record low interest rates, mortgage payments on a house in an inexpensive part of the country can often be lower than rental payments.

Argument in Favor of Homeownership #2: You Have To Buy A House Sometime
Another factor that makes mortgage payments more attractive than rent payments is the fact that you're building equity. Consider the following scenarios:

  • You pay $1,000/month rent on a property for 20 years
  • You pay $1,400/month mortgage on the same property for 20 years

Now let's also assume that housing prices stay flat (even though they'll probably go up) and that half of your mortgage payment goes directly to interest (even though that's a ridiculous assumption.)

Under these conditions, you've spent $240,000 after 20 years in scenario 1, and you have nothing to show for it. You've spent $336,000 in scenario 2, BUT half of that ($168,000) is equity in the house. So really, you only "spent" $168,000 by taking out a mortgage and buying the house -- 70% of the cost to rent.

The point is, over the longer term, buying a house is the smarter move. (This discussion doesn't even factor in inflation protection -- rent will go up, whereas a fixed mortgage payment won't.) Unless you're 100% positive you're going to have millions of dollars in net worth when you retire (not a certainty), you probably don't want to have to continue paying for rent in retirement. But if you rent all your life, and you don't "own" anything when you retire, you'll be forced to rent what you can afford, which most likely will result in a far lower standard of living than you'd hoped for.

You have to buy a house sometime, and for the reasons established in the introduction, it might as well be now.

Argument against Homeownership #1: Opportunity Cost of Capital

This, in my mind, is the biggest argument against homeownership, especially for young Americans. The amount of capital required to make a down payment on a house is high, and especially with equities generally considered undervalued, better returns on that capital can be found in the stock market. Furthermore, a diversified investment portfolio offers more liquidity in case of a personal or family emergency requiring quick access to cash. From a purely return-on-capital-focused point of view, better investing strategies include:

  • A broad index-based investing strategy. Historically, the S&P 500 has returned an average of 13.4% -- 4.8% higher than the 8.6% average return on housing. ETFs like the SPDR S&P 500 (NYSEARCA:SPY) track the performance of the index, allowing investors with smaller portfolios to diversify. With average trading volume well over 60M/day, such investments are clearly more liquid than a down payment on a house.
  • A portfolio of mutual funds. Highly rated mutual funds offer passive investors ease of mind: the best and brightest money managers pick stocks that beat the index. While the S&P 500 returned an average of 4.55% over the past decade, a quick screen reveals well over 2,000 mutual funds that gave investors an annual return of over 5%. (Some even provided a return of 10%+.)
  • Current income strategies, like REITs, high yield bonds, and dividend investing. Although such investments may not provide as much long term capital appreciation as stocks, they can provide a 4 to 10% yearly return through dividends. $20,000 invested this way would provide $800 to $2,000 extra income per year.
  • Paying off debt, whether credit card debt, student loans, or otherwise, can yield an impressive "return" of up to 20 to 30%, depending on your interest rate. It should stand to reason that if you're already in debt, it's probably best to pay that off before taking out a mortgage.

Argument against Homeownership #2: Limited Mobility

Especially in the current market, selling a house can be difficult and time consuming. Moving into a house just to turn around and sell it the next year is a headache. Furthermore, real estate closing costs can eat up a good chunk (in some cases, up to 5-6%) of value. This is a minimal consideration when buying a house for the long term, but for a young American in a job like the military that requires frequent moves, it can be a significant consideration.

Conclusion: Buying a House is a Good Investment, Especially Right Now -- But the Pros and Cons Must Be Weighed

As you can probably tell by the length of the arguments for homeownership compared with the arguments against homeownership, I'm a strong advocate of homeownership. As a general rule, the wealth always flows from the hands of the renter to the hands of the owner, so for your own financial security, you probably want to be the owner. As Shaun established, today's housing market presents awesome buying opportunities. However, as with all investments, you must consider your own financial situation and determine if a home is the right investment for you at this time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.