If you've read Rich Dad Poor Dad (the bible for real estate investors) you'll have heard the contrarian view that buying a house is actually a bad investment. The author, Robert Kiyosaki, believes a house that you live in is a financial liability, not an asset. After I read the purple book, this point stuck with me. It was so contrary to everything i'd learned growing up. If you haven't ready Rich Dad Poor Dad, I recommend it.
A key factor in this debate is what 'good' means to you. First we need to understand that 'good' is subjective, and whether an investment is 'good' depends on the investor. Buying a home may be a good investment for some folks, but a terrible one for others. Why? Because we all have different goals and opportunities. There isn't a one-size-fits-all solution to investing.
I'd like to also note that if you are lucky enough to consider buying a home know that your individual values, beliefs and upbringing will probably influence your decision heavily. Even though we're tackling this from the investment perspective, your personal bias will naturally factor into your thought process. If you're interested in the truth, i'd recommend challenging your assumptions, and focusing on the facts.
So, is a house a good investment?
This answer to this comes down to two simple factors:
Cost of housing: is your annual cost of housing cheaper if you rent or if you buy? Buying isn’t inherently better than renting. Your annual cost of housing will give you an objective way to compare the financial benefits of renting vs buying.
Return on invested capital: what rate of return can you expect on a house? Can you achieve a higher rate of return by investing in another asset or business venture?
If your cost of housing will be lower by buying a home, and you think you can achieve a higher rate of return on the house than through other investment opportunities available to you, then it is a good investment for you! However, if the annual cost of ownership of a home is higher than if you rented a comparable property, and you can achieve a higher return on your money elsewhere, then buying a home is not a good investment for you.
Why? Because you are spending more than you need to on housing expenses, and you're ignoring a higher potential return on your money at the same time.
Now I know there are other considerations that go along with buying a house that contribute to your quality of life, like; being able to make improvements to your home without approval, not facing rising rents, and not having to deal with unhelpful property managers. But that's not what we're talking about here. Those factors may sway you to buy a home, but they shouldn't factor into an investment decision.
Deciding whether buying your home is a good investment is as simple as comparing the actual cost of living in a rental vs. owned property, and then comparing your expected rate of return on the home appreciation to other investment opportunities.
Keep in mind that the cost of owning a property include many expenses beyond just the mortgage payment. You'll need to factor in taxes, insurance, repairs, replacing appliances, landscaping, and the list goes on!
More detail
Asset vs. liability
A house is an asset. Although it’s great clickbait to call a house a liability, it is a bit misleading. When you go to the bank for a loan, they will count your home as an asset on your balance sheet, and the equity in your home as a part of your net worth. Property is an asset, as defined in accounting terms.
However, if you're living in the house and it is not producing rental income, then it's what we call a 'non-performing asset'. This means that while it is an asset on your personal balance sheet, it's not generating any income or returning any value to you unless you sell it in exchange for cash. This is the main downside of treating your primary residence as an investment.
In general, real estate appreciates over the long term. We can debate individual markets, but overall, the price of homes goes up each year, on average How much does it go up? It's completely market dependant. It's frankly useless to quote the US average home price because, well, no one will ever buy the average home because it doesn't exist. You should refer to the historical data for your local market as your guide. Redfin has some great housing market data you can access.
Leverage
Given that real estate appreciation is generally slow, debt is what makes it an attractive investment. Because real estate prices move slowly, they're also relatively stable with low price volatility. This is why banks love to lend money for real estate. It's also what makes real estate an interesting investment. What is unique about real estate is that you can use relatively cheap (low interest) loans to safely lever your investment 5:1, multiplying your buying power by 5x.
Let's say you buy a property for $500,000, and you make a down payment of $100,000. We'll assume that house appreciates to $600,000 over the next 3 years, at a 6.4% compound annual growth rate. Because you used debt, you just doubled your equity from $100k to $200k! Although the house only went up at 6.4% per year, you achieved 26% compound annual growth on your money. That is the power of leverage, through debt, and it's what makes real estate so attractive.
The other reason banks love to lend money to homeowners is due to the US governments involvement in the real estate market. Most Americans don't realize this, but US investors have a unique advantage of government backed loans and long-term fixed rate debt that most countries don't have. A 30-year fixed rate mortgage is unheard of in other countries. Even developed countries like Australia only have fixed rates up to 5 years. 30 years is insanely long. Why does the US offer this? Because the US government backs most residential mortgages issued by banks. This means that the bank is protected if the homeowner defaults - the government will cover the loss. This allows banks to take more risk and offer competitive low and long-term fixed rate loans.
Inflation
Let's also talk about inflation becuase, well, it's definitely here. By the last inflation reading, American's are now losing 6.8% of their puchasing power per year. So it's safe to say that holding cash is not a good investment strategy. Almost anything else is better than a -6.8% return. That makes real estate even more attractive. Property is scarce, and historically maintains and increases in value over time. This makes it a good 'hedge' against inflation - better than cash anyway. And just as a fixed-rate mortgage magnifies your investment returns through leverage, it also has the added effect of helping to hedge against inflation.
Why? Because when you acquire a long term fixed rate mortgage, your principal and interest payments do not change over the life of the loan. This means that the bank will give you $400,000 in todays dollars, and you will pay them back over time with your future dollars. Here's the catch - because of inflation, those future dollars are going to be worth less than your current dollars. So the bank will give you future dollars now, and you'll pay them back in the future with devalued dollars.
To break this down, if inflation is 6.8% per year, and you can buy property with a 3% fixed-interest loan, then you are profiting 3.8% on that trade each year. How? Because you’re essentially paying 3% interest to the bank to get the cash up front in todays dollars, to purchase an asset. Inflation is devaluing your future cash at 6.8%, so the cost of the mortgage actually decreases as inflation devalues the currency.
It's a pretty good deal, right? As long as we have inflation, it sure is. The scarcity and demand for property, plus fixed rate debt makes real estate quite an effective way to protect your purchasing power against inflation.
Why you shouldn’t buy a home
Now we get into the practical downsides of buying a home, as well as the potential psychological factors that play into this question. The problem is that how most people buy homes make them average investments at best. To put it bluntly, people overpay for their home, and then they continue to spend on upgrades, appliances, maintenance, landscaping, the list goes on. These are emotional decisions because most people don't really see their home as investment, they see it as their home where they want to be comfortable, safe, and proud.
The problem is, that much of the money spent on home upgrades are a sunk cost and don't increase the value of the home above and beyond the cost of what was spent. Put simply, it's a poor return on investment. I'm not saying you can't increase the value of your home through thoughtful and strategic upgrades, because you certainly can, but typically people overspend relative to the value being created.
For many people their home is their primary investment. However it's worth looking at what the rich invest in. For the rich, their home is not their primary investment. The rich invest in businesses. Public equities or private companies. They invest in rental real estate that is performing, and generating positive cashflow each year. They invest in other asset classes as well, but they do not see their home as their primary investment. Why? Because they know they can get a better return on their money elsewhere! For the rich, a house is something to be used and enjoyed, it is not an investment.
On the flipside, a house is a bit like forced investing. For people who would otherwise not invest, it is good to have a home as an asset because it holds them accountable to pay their mortgage payment each month, incrementally increasing the equity in their home over a long period of time.
Recap
To recap, here are the key factors to decide if a house is a good investment:
Putting a down payment on a home is betting that money will appreciate faster than other investments you have access to. What other investments are available to you? What is the rate of return you can expect from those investments?
If you can get a higher return on your money in another investment, then investing your money in a home isn’t your best investment.
If you can rent a comparable property at the same or less cost than buying, and you have a higher annual rurn investment available elsewhere, then buying a home is not a good investment for you.
You may still want to buy a home, because of the emotional benefits of ownership, but at least now you know it may not be a good investment.