Your House is Not an Investment
Here’s the truth about real estate: Unless you’re a landlord and someone else is paying your mortgage, your house will probably be the worst investment you ever make.
The illusion of home ownership is that it’s a great investment, a way to build equity rather than wasting it on rent.
Bollocks.
My parents bought their 5 bed/3 bath home in San Diego, CA for $231,000 back in 1991. Redfin estimates it is now worth $1,407,829 in 2022. “$1,176,829 profit? Homeownership is a great investment! I hear you saying. Okay, fair enough. Let’s do the math.
A gain of $1,176,829 on $231,000 between 1991-2022 equals a rate of return of 6.10% annually. It’s important to note that $1 million dollar profit occurred over the course of 30+ years. On the surface not half bad, but it still underperformed the market over that time period or, 8.62%. However, that’s not the full picture. So, let’s crunch some more numbers, shan’t we?
What’s The Real Rate of Return on My Home?
6.10% assumes my parents’ only cost them $231,000 the entire 31 years. That’s only the principal, what about property taxes? Yearly taxes on their home average $3,823. Over the past 31 years you’re looking at total cost of their home:
$231,000 Purchase Price
$116,625 Property Taxes
Total Cost: $347,625; Today’s Value: $1,407,829; Annual Return: 4.69%
As you can see the true cost of a home is not what you see on the purchase price. Property taxes are real costs my parents paid over that time period, and we’re not done yet. My immigrant parents weren’t in position to purchase their home in cash so they had to get a mortgage on the property. Since no one will just lend you money for free there will be interest to pay, over the life of the loan and you’ll need insurance. 10% down, 30-year fixed at 4.5%. Now the total cost of their home breaks down to:
$231,000 Purchase Price
$116,625 Property Taxes
$171,324 Interest
$15,377 Insurance
Total Cost: $534,325; Today’s Value: $1,407,829; Annual Return: 3.23%
Congratulations, you just made 3.23% a year on you investment in a primary residence, which would barely keep up with inflation, historically. Wait, that’s not all. That total cost is JUST purchase price, taxes, and insurance. We still haven’t accounted for repairs, maintenance, and upgrades. Such as replacing a roof, wood flooring, remodeling kitchen and bathrooms, new appliances, etc. Even the cost of replacing a light bulb would lower your annual return. That’s just how the math works. And the numbers never lie.
Why it matters: Going back to my previous statement of real estate only being an investment if you’re a landlord, had my parents rented to cover their mortage over the years and instead put that money to work in the S&P 500, their return value today would be $2,527,489 PLUS the value of the home $1,407,829 since your tenants are paying the cost for a grand total of $3,935,318. You would have compounded your original 10% down payment by 14.42% over 30 years handedly beating inflation and crushing the market.
Key takeaways:
Your parents, aunties, uncles, relatives, home they bought for dirt cheap was a lousy investment if they’ve been living in it this whole time.
There is more to the real return on investment of a primary residence. That’s why you can’t just take a quick glance at purchase price vs. today’s value or price sold over time and say it’s a great investment. There are added costs of taxes, interest, insurance, repair, and maintenance costs.