Why Buying A Home Is Rarely A Smart Investment

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Most people are convinced that buying a home is a very smart investment.

After all, real estate has always appreciated over time, and with cheap mortgages available, why wouldn’t you buy a home with the bank’s money and build equity instead of paying a monthly rent? On the other hand, paying rent is often seen as the equivalent of throwing money in the trash.

To be fair, in some cases, owning a home can be a very smart investment. Some markets are much stronger than others and if you can buy a discounted, rapidly-appreciating asset with a cheap mortgage, the returns can be very compelling over time.

But in most cases, that isn’t the case. In fact, I would argue that buying a home is rarely a good idea from a financial perspective. There are 5 reasons for that, which I will highlight below, but before I get into it, let me be clear that I am still a proponent of homeownership because there are many non-financial benefits. As such, even I own my home.

However, the main point of this article is that you shouldn’t see a home as a smart investment. Rather, you should see it as an expense, which also implies that you should be really careful as you determine what you can truly afford to pay for a home.

In what follows, I present 5 reasons why buying a home is rarely a good investment:

Reason #1: Huge Opportunity Cost

I have read many articles on the topic of buying vs. renting and noticed that most people forget about an important detail.

That’s the opportunity cost of buying.

When you are renting, you pay a fixed monthly payment and that’s all.

However, when you are buying, you need to inject a significant amount of capital into the property, even despite taking a mortgage.

Assuming you are buying a $500,000 home and financing 20% ​​of it with equity, that’s $100,000. Then you put another $100,000 in the property for fixing and furnishing, resulting in $200,000 being stuck in the property.

If you were renting, this $200,000 could have been invested in the stock market, earning a ~10% annual return. Therefore, your opportunity cost is $20,000 per year. This $200,000 would have compounded over time, turning into $1.35 million in 20 years!

That’s the main benefit of renting.

Investing in stocks has historically generated far higher returns than buying a home, on average. This is particularly true when you consider that buying a home will inevitably lead to lifestyle inflation and there are many additional hidden expenses that only increase the opportunity cost of owning. That brings us to our next topic:

Reason #2: Inevitable Lifestyle Inflation

If you are renting a place, you will probably be more reasonable about what you can afford. You probably also won’t spend much money on things like furniture, designing and fixing.

But when you are buying a home, it is the opposite. It is a very emotional purchase because you will see yourself living there for a very long time to come, and therefore, you won’t want to cut corners and sacrifice living quality.

In most cases, this will lead you to the path of lifestyle inflation. You will spend more than you can really afford, leaving you with a tighter budget that prevents you from investing in the end.

You will spend a lot of money on fancy expensive furniture to impress your family, friends, and neighbors, but that will only lose value over time.

All that extra spending that results from lifestyle inflation could have been invested, earning a return, increasing the opportunity costs discussed earlier.

Reason #3: Significantly Hidden Expenses

Typically, people compare their monthly rent with their monthly mortgage payment and quickly assume that owning is cheaper.

But that would widely underestimate the true cost of owning, which includes:

  • Property taxes

  • Insurance

  • Trash removal

  • Maintenance

  • Major occasional repairs

  • Lifestyle inflation expenses

  • Etc…

Property taxes alone are often 1-2% of the property value each year!

Then all it takes is one bad surprise like a leaking roof, and you could get stuck with $50,000 of repairs and water damage. Again, all that money could have been invested, increasing the opportunity cost further. It will also take a lot of your time and energy, which could have been used to work a job, earning you additional income that you could have invested.

Moreover, when you are buying a home, you will need to pay a lot of transaction costs. These can easily run at about ~5% of the property value. That’s money that is 100% lost on day 1. Again, that could have been invested.

Finally, all these costs will only grow over time.

Often, people only track the growth in value of their home, but they don’t properly track all the expenses incurred to achieve this growth in value.

If your property grows in value from $500,000 to $700,000 in 5 years, but during this frame, you also bought $100,000 in furniture that’s lost half of its value, paid $50,000 in property taxes, another $50,000 in repairs, and $30,000 in various expenses, your real appreciation is far less than you may think.

Reason #4: Loss In Flexibility Reduces Your Earning Capacity

Your main revenue generator is your career/business, and whether you want to admit it or not, owning a home will also cause you to miss a lot of potential career/business opportunities.

You will lose flexibility because you will be more tied to a specific place, whereas if you were a renter, you could much more easily move from one place to another.

It is hard to quantify how much this flexibility is worth, but in many cases, it could be very significant.

Let’s assume that you are working as a plumber in city X and earn $70,000 per year. But now you receive an offer for a similar or better position in city Y with a large pay raise because that city doesn’t have enough plumbers.

If you own your home in city X and put a lot of time, effort, and money into that home, it will be much harder to justify the move to city Y, even though it would make a lot of sense from a financial perspective.

There is a massive difference between earning $50,000 post-tax and earning $100,000 post-tax, and renting could help get into the higher brackets faster since your universe of job opportunities will be far larger.

Reason #5: Your Time Is Valuable

Finally, another major expense that’s rarely considered by home buyers is that you will need to invest a significant amount of time into:

  • Researching the market

  • Finding the right properties to visit

  • Visiting them

  • Asking questions and double-checking answers

  • Negotiating a deal and making an offer

  • Getting financing

  • Interviewing contractors and planning fixes

  • Designing and picking the right furniture

  • Monitoring the progress

  • Etc.

When I bought my home, I hired an interior designer to help me with all of that, and it still cost me a lot of time and effort, which I could have used more productively on my business.

The time and energy invested in buying a home have a cost, and it needs to be taken into account. If you could earn $30 per hour working a job, then that’s the opportunity cost that needs to be added into the renting vs. buying comparison.

Moreover, these costs won’t end once the house is bought. You will still need to deal with a lot of time-consuming things that you wouldn’t if you were a renter. Time is money and renting allows you to use your time more efficiently on higher returning tasks.

Bottom Line: Buying A Home Is Not A Smart Investment In Most Cases

Exceptions exist, but in most cases, you won’t earn a great return by owning a home, if you properly account for the opportunity cost, the lifestyle inflation, the hidden expenses, the loss in flexibility, and the value of your time.

In most cases, it is actually a very poor financial investment.

However, owning a home still makes a lot of sense from a non-financial perspective. It will give you full control over your own residence, which can give you great joy and peace of mind. Moreover, if you are poor with finances, which is the case for most people, then the forced monthly savings from the mortgage payment may also help you in the long run.

The bottom line is this: you should see buying a home as a luxury that has a cost, and not as a smart financial move that will really put you ahead. In most cases, renting, investing, and preserving your time and flexibility for your career will get you much further.

Best of all, today, it is easier than ever to invest in real estate with publicly listed REITs (VNQ).

Therefore, you don’t need to get your real estate exposure through your home. You can also get it by buying shares of large real estate investment vehicles that are now publicly listed.

Historically, REITs have generated ~12% annual total returns and outperformed most stocks (SPY), including even tech stocks (QQQ) over the past 20 years:

REITs vs.  stock vs.  bonds

REITs vs. stock vs. bonds (NAREIT)

If you are selective, you may of course do even better than the average. There are a number of high-quality REITs that have managed to compound investors’ capital at closer to 15% per year over the past decades.

This includes blue chips like AvalonBay (AVB), Mid-America Apartment (MAA), Invitation Homes (INVH), Realty Income (O), American Tower (AMT), Prologis (PLD), and Public Storage (PSA).

I own a home, but realistically, I know that my returns will have to come from REITs, and not from my home. REITs are far smarter investments.

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