Manage Your Monies

The Consequences of Treating Your House as an Investment

Manage Your Monies

It’s easy to think of your house as an investment. As the value of your home goes up, you’ll naturally feel wealthier. Homeownership gets drilled into our heads throughout our lives, and rightfully so. It is one of the main drivers to your net worth.

While homeownership is a great aspiration, you can fall into the trap of treating your home as an investment. Doing so could cause you to put too much of your net worth into your home, and limit the returns you could have realized in more lucrative investments.

On top of this, homes have maintenance expenses and bring in little revenue. Before you go big on buying your large home, consider what your future returns and ongoing costs will be.

Home Prices Don’t Go Up as Much as You Think

Imagine buying a home in 1968 for $100,000. After 50 years, you sell the house in 2018 for $700,000. Not bad, right? You made a 7x return on that investment!

Unfortunately, $100k in 1968 is worth over $725k in 2018. Therefore, you actually lost money on that investment once you consider inflation.

This is the classic fallacy homebuyers apply. Buying a home is one of the biggest purchases you will ever make, so why not treat your house as an investment? Thanks to that, you’ll always remember that purchase price, even 50 years later.

How much do homes go up on average? Yale professor Robert Shiller wrote about home price appreciation in his book “Irrational Exuberance”. It turns out that on average, homes appreciate less than 1% more than inflation.

Comparing Your Home to Other Investments

The good news is that you shouldn’t lose money from owning a home. Going back to our example, a house as an investment was bought in 1968 for $100,000 should be worth closer to $1.17 million in 2018.

Before we jump for joy on being millionaires, let’s consider the opportunity cost of this investment. What would $100k from 1968 be worth in other investments?

There’s no question that the S&P 500 index would have been a better place to invest your money, which is why Warren Buffett says it’s the best investment to make.

This is exactly why we recommend to not put all of your net worth in your home. Your returns are likely to be a lot lower in your home than they would be in stocks or rental properties.

What Else To Consider?

Home appreciation is not the only reason you shouldn’t treat your home as an investment. You should also consider the lack of revenue, ongoing costs, and the risk of taking on too much debt.

Your Home is Not Making Money

Since you live in your home, you aren’t generating income off of it. Feel free to disregard this if you are renting out a room or portion of your home.

While it is true that you are technically saving money by deducting your mortgage interest expense, there is rarely additional cash flow coming in from the house.

Homes Cost Money to Maintain

Not only is your home not bringing in money, it also costs money to maintain. The rule of thumb is to set aside 1% of your home for maintenance expenses. For example, if you own a $300k home, budget $3k per year in maintenance costs.

Make sure to factor in these maintenance costs when buying a home.

Don’t Take on Too Much Leverage

The more money you borrow, the less of your own capital you’re putting into the home. This could be a wise move as long as this money is going to appreciating assets such as stocks. With that said, you could put yourself in a huge bind if you take on too much debt.

It’s easy to take on more housing debt when you treat your home as an investment. As your house goes up in value, you can take out more cash by refinancing your mortgage, or through a HELOC (home equity line of credit).

Just remember that more leverage puts you in greater risk if the market goes south. You’ll owe more interest as you take on more debt. If prices go down, you won’t be able to sell your home and pay off your debt. This could make you house poor, where all of your money is going to housing payments.

Your House as an Investment – The Bottom Line

Homeownership is an incredible aspiration, and one of the biggest transactions we’ll make in our lives. While this is a crucial step to building your net worth, make sure you don’t put all of your net worth in this basket.

We remember the price we paid for our home, but we don’t remember inflation. Once you factor that in, your house returned 1% per year. Better than nothing, but light years worse than the S&P 500’s average of 10%.

Owning a home only brings in money if you’re renting part of it out. Aside from the limited cash flow, you have ongoing maintenance expenses, as well as interest expenses. If you take on too much debt and pay too much interest, you could be a victim of the next market downturn.

Don’t treat your house as an investment, treat your house like a home. Make it a place for you to live, and keep putting money into income generating investments like stocks or rental properties. Not only will you have a much larger net worth over time, you’ll appreciate your home even more.