Investing in a Home vs. Investing in the Stock Market
There are many that have downplayed the investment benefits of homeownership. Considering the running average for real estate appreciation is about 3.5%, and the stock market has returned 8% over the same period of time, it’s understandable we some would advocate for investments other than homeownership. But this argument ignores some key facts about homeownership and real estate investment in general. Even if your main concern isn’t investment (you just want to know if it’s better to rent or buy), understanding the financial benefits of homeownership is crucial.
You can’t live in the basement forever
As with any investment, buying a home is not without risks (you could over-pay, get stuck with a high interest rate, live in Detroit, etc.), but the key difference between investing in the stock market and real estate is that the stock market is an avoidable cost (you don’t have to invest). However, with housing, unless you plan on living rent-free in your parents’ basement indefinitely, you have to pay for housing. It’s a survival expense (like food), so if you must pay it, you may as well get a return. It’s one of the few survival expenses that can actually pay you back if you do it right (and it’s hard to do wrong!). As you make that monthly housing payment that you would have to make anyway, owning the home gives you about 3.5% appreciation every year (on a $200,000 home, that’s $7000 just in the first year, for about the same amount you would pay in rent for the same house). You would have to invest over $7000 a month in stocks to see the same return over the same year.
Better Financing
The other significant investment advantage of real estate is the favorable terms and availability of financing. Most of us can’t afford to pay cash for a house and are required to use a mortgage, with the majority of our monthly housing costs going towards that loan in the form of a mortgage payment. You can also borrow money to invest in the stock market (this is called “margin trading”), but the terms are significantly worse. For example, the average mortgage interest rate is now about 4.25% for a purchase compared to 6.50% to borrower money for stock investments. Down payments for mortgages are also significantly lower, with most borrowers only putting down 0% - 5%. For margin trading, you normally have to put down at least 50%.
The Cut-Off
There is a cut-off (a minimum amount of time that you need to keep a house in order for it to make financial sense). Real estate has its own share of costs (taxes, insurance, maintenance, etc.), but there are also significant costs associated with selling a property. If you’re going to purchase a home, you’ll need to be sure that you own it for enough time so that the appreciation at least equals the costs of owning/selling the property. Consider the following scenario:
You could rent a $250,000 home in Provo, Utah, for about $1500/month (perhaps a bit more). If you purchased it instead, the total monthly payment (including taxes, insurance, etc.) would be about $1537 (0% down with a 5.10% interest rate), but let’s also consider $100/month for maintenance reserves to be realistic/safe (over time, you’ll need to fix/replace things). That gives a total “ownership” payment of $1637 ($137/month more than renting). Let’s also assume that the home will appreciate at about 3.5% per year (a proven average) and that you’ll get about $2100/yr (to start) in reduced income taxes (because mortgage interest in tax deductible). We also have to assume that it will cost about 6% of the home’s value to sell the property. Considering everything, if you bought the home and sold it after just 12 months, you would lose about $2700 compared to renting the same property. However, if you stayed in the home for 2 years, you would make over $10,000, compared to renting the same property. The actual cut-off, with these assumptions, is 18 months. In short, if you purchase a home and keep it for at least 18 months, you’ll end up better off than if you rented to same property. Finally, after 30 years of payments, you will have an asset worth over $700,000 (with no mortgage). If you sold at that point, the cash would give you $3000/month in income for 20 years (that’s straight cash, no additional investing).
Bottom Line
For most of us, our homes will be the most valuable asset when we retire. The longer you rent, the less time you have to realize the appreciation of such an investment. Even if you will only be in an area for a relatively short period of time (at least 18 months), buying a home can significantly increase your net worth. In addition, the exceptionally low interest rates and still affordable home prices, along with the real growth in Utah, make this an ideal time and location to begin or expand home ownership. If you pay rent and don’t plan on moving in the next few years, buying a home could be the smartest financial move you ever make.
