August 24, 2021
Despite continued low mortgage rates and tales of bidding wars, multiple offers and all-cash closings above asking-price, would-be-home-purchasers should consider being cautious about putting too much money into real estate. While some might disagree, for a myriad of reasons, it’s not always a great investment.
Owning your own home – or owning several homes – has long been the American dream. Your home may be your castle, and even your biggest asset, but is it a good investment?
Although there may be psychological benefits to home ownership, the hidden truth is that housing might not be the best use of your money from a strict investment viewpoint. Although there’s certainly an investment component to purchasing a home, the primary purpose of owning is personal use and enjoyment. Part of that includes soft costs – care, maintenance and even decorating – that are part of living in the house. When you buy a house, you may wind up spending enormous amounts of money not only on upkeep but also on improving and decorating it. Soft costs represent enjoyable expenditures, but people need to keep in mind they are expenses, not investments in the property.
A good rule of thumb is that it costs as much 30% of the market value of a home to furnish and appoint it. So in some ways, that means you’re possibly starting with a 30% loss the day you get the keys.
If you’ve got a $500,000 dollar home and it costs you $150,000 to get it ready to live in, then you’ve paid $650,000 for it regardless of what your initial purchase price says. As such, because of the amount of money that homeowners sink into their properties, even if you sell for more than you paid, it may not be a sound investment in the true sense of the term.
Additionally, you have to consider the erosion that inflation inflicts on home values. According to Realtor.com, over the past 100 years, real estate prices increased an average of 3.3% annually, while the inflation rate in the U.S. was 3.1%. At times when the inflation rate exceeds the rise in housing prices, you can actually lose money.
Of course, we’ve also seen periods when home prices fall, which means that any inflation could potentially be even more harmful. If you hold a home for 30 years and it doubles in value, the nominal value may be twice as much as you paid for it, but the true value in dollars, adjusted for inflation, is often less than you paid.
Houses don’t always keep pace with inflation very easily, and if they do, by the time you consider the costs of moving in, living there and decorating it, a house may be considered a loss. Certainly, there have been periods in history, including very recently, where real estate prices have gone up precipitously, and ownership has been considered a moneymaker.
What you need to remember, however, is that such times are possibly an aberration. For those folks who experienced it, it was lucky they happened to buy and sell at the right time. But many didn’t, and now they may own an asset whose value has declined considerably.
If primary residences aren’t a good financial investment, vacation homes have the potential to be even worse. Vacation homes can be considered a luxury. As such, renting a vacation home for several weeks or even months a year might be the better financial decision.
The reasons are fairly simple: A rental home might not become a personal financial responsibility. Despite the cost per day, it may be less expensive than full-year home ownership, and renting offers you the option to go to different vacation spots each year.
The median household net worth in the United States in 2019 was about $68,000, according to the U.S. Census Bureau. This means that potentially half of U.S. households may have less than $68,000 to their name, including any equity in their homes.
It’s quite possible that better than 25% of those households are also in the red, meaning their net worth is negative, and they may be living paycheck to paycheck just to pay the interest on all the things they own, including their homes.
So what that means is that the average American household should consider thinking twice before looking at vacation homes, regardless of current low housing prices. In some cases, many households should consider their options carefully before looking at owning a primary home, given the real costs. However, for some there is the incredible psychological enjoyment in having that vacation home in the family, maybe for generations. But it can be considered by some to be a luxury and not something the average American household may be in the position to attempt.
To afford and maintain the family beach house, the owners may need to sacrifice – perhaps by downsizing to a less expensive personal residence. Or by skipping trips to other vacation spots. Then, the psychological benefits of owning a vacation home could potentially outweigh the possible financial burden of doing so. Although homes for personal and family use may not always be good investments, that doesn’t mean that people should avoid buying homes.
There are intangible benefits to home ownership. You may like owning and improving a home and the feeling that your family has its “nest.” Psychologically, it could be worth the expense to you.
That said, there is no guarantee that buying a home will make you money.
There’s always the possibility that it could cost you money – lots of it.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investments in real estate may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Other risks can include, but are not limited to, declines in the value of real estate, potential illiquidity, risks related to general and economic conditions, stage of development, and defaults by borrower.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by FMeX.
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