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Homes Are Shelters, Not Investments

May 5, 2014

Owning a home is the foundation to the American Dream. It represents shelter, independence, and social success. In contrast to renting, buying a house is also the superior financial decision since monetary contributions theoretically remain within the physical structures of the building. Furthermore, according to conventional wisdom, a buyer can even expect the value of their purchase to increase over time.

While it is true that owning a home is an important thing to do, it is by no means a rational long-term investment. If you want your money to grow over time, you need to put it in the stock market, not the housing market. The misconception behind housing growth is stimulated by two factors: The housing bubble of the 2000’s and unrealized inflation.

As we now know, the massive growth in the housing market between 1997-2006 was highly artificial, stimulated by unsustainable sub-prime lending. Since its crash in 2008, the market has rebounded slightly, but remains on a slow, unsteady incline.  With the exception of that decade, in reality, when adjusted for inflation, the American housing market actually experienced very little growth in the entire past century, as demonstrated by the chart below (©Motley Fool), created by Yale economist and Nobel Prize laureate, Robert Shiller.

home prices 01

Inflation is often what guides the misconception behind housing growth. Since the 1970s, the Consumer Price Index has increased six-fold. Therefore, if you purchased a home in 1970 for $30,000, it should be worth approximately $180,000 today (Housel, 2014). To the average homeowner, this seems like quite the investment, but the reality is, your capital gains has simply curtailed inflation, which typically grows between 1.5% – 3% annually. In comparison, if you were to invest that same $30,000 into the S&P 500, which had an annual average growth of 7.54% between the same period, your portfolio would likely exceed $380,000 today, excluding taxes and fees (very rough estimate). Individuals who are looking at the housing market as a long-term investment also need to take into account the cost of mortgage interest rate, property tax, insurance, and maintenance. When all financial costs are factored in, the value of your home is likely increasing below the rate of inflation.

Another problem with real estate investing is its lack of liquidity; that is, how easily your assets can be converted to cash. Unlike the stock market, which you could buy and sell on the fly, it is much tougher to sell a home.  Furthermore, market fluctuations rarely exceed 1.5% on a single trading day,but consumers could vastly negotiate down the value of your home based on market trends and your eagerness to sell.

Although a house is not the best long-term investment, it is still something crucial to own. Renting leads to the exodus of capital that never returns. The key is to live small, but comfortably. Bigger is not always better. Larger homes cost more, require higher maintenance costs, and restricts opportunity cost. A home should be a place of shelter, not a place of investment. By reducing the financial contributions into the home, the investor could instead redistribute the capital into the stock or bond market, which yields a far greater return. – Ping Zhou

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