Investment Real Estate vs. Home Ownership

“Owning your home is a smart investment.”

I hear people say those words all the time, and whenever I do, I think that whoever came up with that phrase didn’t really know what they were talking about.  A distinction needs to be drawn between investing in real property and home ownership. They are not the same thing!

A young acquaintance who analyses bonds for a living mentioned a discussion he’d had with his father recently.  Being a father myself, my ears perked up.  He said that his father was investing in gold.  I said, “What’s the problem with that?  Plenty of people invest in gold.”  He said that gold is not an investment because it doesn’t throw off an income stream; rather, it’s a hedge against inflation.  It occurs to me that owning your home might fall into the same category, with one major exception.  If you want to exchange gold for currency or another investment, it is a fairly easy matter.  If you want to exchange your home’s equity, it’s a much more cumbersome process.  You either need to sell it and find somewhere else to live, or refinance it and take on additional debt.

Investment is defined as: the investing of money or capital in order to gain profitable returns as interest, income, or appreciation in value.   The important part here is “in order to gain profitable returns.”  The only way to see a return on your home as an investment is when your home is liquidated, i.e. sold.  (If you mortgage or remortgage your home you can get cash out, but at a premium that must be paid back with interest.)

Case in point: a few years ago, some people were convinced that it was okay to purchase more home than they could afford because they viewed their home not only as shelter, but as an investment.  It seemed as if all property was constantly increasing in value, and that they would have a home that was always worth more than what they paid for it.  I think we’re all well aware of the consequences of that type of thinking! 

Most homes fall into the expense category; they usually are not income generators.  When you take out a home mortgage, you are paying both the interest to the bank plus some of the “principal” or cost of your house.  Over 20-30 years you will pay this amount fully, and by that point, your home will have a lot of equity.  So in a sense, your house is your “live-in” piggy bank, your mortgage as the savings mechanism that causes you to build equity.  During the time you’re paying it down, you have to earn money to pay taxes, insurance, utilities, repairs, and interest. Buying a home only really pays when you are able to retire your mortgage.  Then your cost of living goes down – but you still have to pay to live.

There is one situation that fits the “home as an investment” criteria.  Some people – often young people – will buy and live in a multi-family homes.  This makes the property more affordable, because the rental income is counted as additional income for their loan qualification.  Instead of buying a $150,000 single family home, they might be able to purchase a $250,000 two-family home.  Ideally, in a rising market, the rents rise and pay more of the home’s expenses, and the property appreciates in value.  Additionally, since the loan they are paying is larger, their equity grows at a faster rate.  Of course the downside to this is that in a declining market, rents can go down and ownership costs can increase.  This is why it is important to make sure that you plan and save so that you can handle the “rainy day” cash flow if things go wrong such as your mortgage rate or taxes increase, your water heater dies or your rents go down.

Over the long run, values and rents typically increase in good areas.  The first home my wife and I bought was a two-family home.  The rent we received on our first floor, one-bedroom apartment ended up paying most of our costs after a few years of ownership, which made our living expenses more affordable.  We also put a lot of ‘sweat equity’ into that home and increased its rental value.

This is an example of how your home can also be an investment.  Multifamily homes  bring with them the burdens of being a landlord, but they can really pay off in the long run.

HAPPY NEW YEAR TO OUR “AT HOME IN NEWPORT” READERS!!