Are you like my buddy Chad who often says : “I am very happy with with my house, I love it and it’s such a great investment!”?
I am always appalled to hear the latter! Chad is not the only one saying this, I have heard many times around me. Of course buying your home is a major financial and personal choice, I sincerely hope you will feel great every time you enter it (if you have been home hunting recently you know when the feeling is right) and as written previously I recommend buying your home instead of renting.
But please stop telling me you have made a great investment, honestly it hurts. For the simple reason that your home is not an investment. Yes, repeat after me : “My primary home is not an investment”.
Before we dig in the subject further let me point out to you what makes an investment an investment.
An investment is, as defined by Investopedia, “An asset or item that is purchased with the hope that it will generate income or will appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will be sold at a higher price for a profit.”
So now that you know my basis for discussing here are the 5 reasons why your home is none of the above :
1. You are not generating revenues from it
Does your house provide you with a monthly cash-flow Chad?
– Errr, no.
– I thought so too. Your home does not generate revenues that will pay your bills, support your lifestyle nor pay for your kid´s higher education tuition fees. There are no dividend payouts as with stocks, no interest payments as with bonds, nor any rental income while the value of your asset increases as time goes by.
2. Your return on investment is close to nothing.
Imagine the home of your grandparents : Let us assume they have not moved out between the time you were sitting on your Grandad´s lap listening to his stories and last Sunday´s perfect home-cooked steak with fries. This house may have increased significantly in value during all those years. Maybe even a couple of hundred thousands of dollars, how can you say they have not benefited from the value appreciation Jonathan?
– You are right Chad, let´s do the maths. Numbers do not lie.
Imagine your grandparents purchased the house at 100 000 EUR, 30 years ago at a 5% interest rate. Today that house got appraised at 300 000 EUR. Look at that, they have gotten themselves a total return of 200%! Now that is what I call an investment, right? Let´s dig a little deeper,…
Over 30 years they paid 93 255,78 EUR in interest to the bank. This is a total price of 193 255,78 EUR so far (100 000 EUR + 93 255,78 EUR). If we consider 2000 EUR/year for taxes and insurance, we add another 60 000 EUR to the total. Let us not forget the ongoing maintenance and repairs : 1% per year is a popular rule of thumb (hence 1 000 EUR for each year). That brings the grand total investment to 283 255,78 EUR. We took out the inflation here (3-4% a year). My annual return is now very close to nothing : 0,19% annually (6% over the 30 years) instead of 3,73% annually (200% over the 30 years). It´s even worse than leaving your cash on your current/checkings account!
3. The total cost of ownership can be far higher than the asking price.
There are significant carrying costs that you need to take into account in order to hold and maintain your house – mortgage repayments, housing board expenses, water and utilities, not to mention repairs and routine maintenance. An investment does not require ongoing costs and these costs would make it a worthless investment in the first place as demonstrated above.
If you live in a recently built house or apartment the major repairs (roof, driveway, flooring,..) should be rather limited in the first years, however the carrying costs will still come every month. Over the course of the years your needs and wishes may also change, you might want to remodel your kitchen or bathroom for example. By taking all the various costs into account it is easy to see that your house will cost you tens of thousands of euros during your time living there.
And do not misunderstand me, I am not saying you should not buy a house, nor modernize it, or remodel it as much as you want, etc. This is your casa where you will unwind, play with your kids, live great moments, paint the walls in pink if you wish so, etc. Just make sure you do the maths and take into account all of these costs when making the biggest purchase you will probably ever make. And this brings me to my next point :
4. Your home´s primary function is to be the “roof above your head”
What is the primary reason of buying a house, Chad?
– I know this one! Providing shelter!
Correct and that is the single biggest reason why it is not an investment. An investment provides you with the ability to control the timing of your ownership. You buy a house to live in and you cannot just sell it when it has increased in value just to make a profit, where will you move to next? Are there houses for sale within your preferences and budget on the market at any given time?
A house is thus far less liquid than a stock or a bond you can simply buy or sell online after you finished reading this article in order to maximize your profit.
A more practical example of not being able to control the timing of selling and buying is the 2008 financial crisis. Just imagine Chad, you bought a house at the top of the market because you needed a house at that exact time and suddenly after the crisis you lost your job and could not afford to pay for your house anymore. You would be forced financially to sell at a low price something you bought at a high price. That does not sound like an investment to my ears.
5. Appreciation is not guaranteed and you do not use it
…From 1890 to 1990 the appreciation in US housing was just about zero. That amazes people, but it shouldn’t be so amazing because the cost of construction and labor has been going down. Robert Shiller, Yale economist
There is a general belief that housing prices are increasing as time goes by, housing prices are cyclic, they can go up for a few years and they may go down a few months/years. If you bought a house in Spain in 2005, your house value has still not recovered since the crisis. In real estate of course difference may arise locally per region, per city, per neighborhood even. If we look at the Norway the housing market of the last 2 years, it has taken different trends depending on the city you live in. Stavanger suffered from the oil downturn back in 2015 and is now recovering while Oslo is still going strong (21,67% growth in 2016!).
By the way Chad, did you plan to sell your house and move or will you stay in your comfy nest for a few years?
If you are not planning to sell your house, you will not benefit from the appreciation at all, the appreciation will be accounted for as unrealized gains. If, on the contrary, you chose to sell the house in the hope to buy another one in your neighborhood, chances are you will not benefit from the appreciation neither. This house will have increased in value at same rate as yours. I actually fell in that “trap” myself as well when my Oslo apartment got appraised with a whopping 600 000 NOK (approx 65 000 EUR with today´s rate) appreciation. I thought: “Hey cool I can sell it and move to a bigger one!” Well I could have but not in my direct neighborhood, I would have had to move further away from the city center in order to truly benefit from the appreciation.
So Chad, I trust the above reasons make it simple to understand why your primary house is not an investment,…but is there a way you could still turn your primary house into an investment?
The good news is : Yes and there are in fact several ways to make it an investment.
- Are there unused rooms that you could rent out on a monthly basis or through Airbnb? Could you build or renovate your basement/attic to make it a small rental apartment? Great you found a way to generate revenues!
- After a few years and if all goes well you should have paid down your fair share on the mortgage and the house may have appreciated in value by a couple of per cents. An idea is to borrow against that “unused” additional equity to purchase an investment property that will create a monthly cash-flow. This is for example how I purchased my garages that bring me additional monthly cash-flows. The bank lent me extra money against my apartment and I have used that money to purchase the garages. My additional mortgage and the little maintenance costs are covered by the garage rents. The same principle could apply to an additional rental apartment. But wait a second Chad, do not run to the bank just yet! Do your homework first, study the market and rental prices. Your tenant´s rent should cover your mortgage plus additional costs.
- Leave your house after a few years and rent it out while you live in another place. This is what I did with my Oslo apartment while I was in Paris, it gave me a landlord experience and my house got paid by my tenant.
- Buy a house in Oslo, sell at a higher price 2 years later and repeat over and over! Let me explain more clearly : Depending on the area you target and the timing, if your goal with the purchase is to make money you could aim at housing as an investment through short-term non-taxed capital gains. It may not be that practical for your primary house but if you enter the purchase of your house with an exit strategy (renovate it and sell when the house can be sold for your target price) you could make actual profit from your primary house. Just imagine you kept that strategy since 2003 in Oslo as per the below graph (source), you would probably live in a fantastic house with sea view by now!
Bringing it all together
With this article I wanted to argue against the common belief that one´s primary house is an excellent investment. Under the assumption that you intend to live in it your whole life and never will move, then it is not an investment. Think of it as your home, a consumption decision and not as an investment. Enjoy it to the fullest and cherish the moments you spend in it. Your home will represent your major monthly expense for the lifetime of your mortgage and might cost you even after the mortgage has been paid down, so make sure you do the maths. Nevertheless there are still ways to turn your house into a profitable investment!
So Chad, are you still convinced that your home is an investment? Are homes in your area considered a great investment? Do you even consider to buy a home at all? Please comment below I am all ears!