After 8 years of saving and investing, my wife and I finally bought a home!
Over the long term, we expect our home to appreciate at ~4.5% annually (~1.5% adjusted for inflation). But despite the expected appreciation, I can confirm that my house is not an investment.
I have heard the saying “Your home is your best investment” from many people. The statement is not only incorrect, but dangerous. Here’s why:
- The belief can cause people to buy more house than they need, reducing freedom and providing excessive exposure to interest rate risk.
- The belief tilts people away from actual investments with higher expected returns, like stocks, bonds and rental properties.
Your home may be an investment in a psychological sense but not in a raw financial sense. For example, a home provides security, a place to build memories with your family and the ability to customize.
This post will cover five reasons why your home is not a financial investment.
1. A Home EATS Cashflow, Investments PAY Cashflow
An investment increases in value, just like your home. But unlike a home, an investment also provides a positive cashflow.
- A business, owned via stocks, shares it’s earnings with you. These earnings come in a dividend (or future expected dividend). The dividend is a positive cashflow.
- A bond provides cash flow in the form of interest.
- Rental properties pay you rental income.
Has your home ever paid you a chunk of money? Perhaps if you have a tenant paying rent, but then you are approaching a rental property, which is an investment.
Unlike an investment, your home takes money away from you—negative cashflow.
For example, here are the costs my wife and I will incur in the first four months of owning a home.
Most of the work is done ourselves, with my father-in-law’s help (the man is a machine). I find it helpful to place value on time, so I use a conservative estimate of $25/hr.
Property Tax, Home Insurance
Property tax and home insurance are negative cashflows. They do not increase home equity. Once the money leaves our account, the money is gone.
Even when your home is paid off, property tax and home insurance expenses persist. Property taxes, equating to 1% of the home’s value, will increase over time. I expect property taxes to grow at 4.5% per year, in proportion to the value of my home.
I expect long-run maintenance costs to be about $6,000 per year, about 1% of the home value. This assumes I do most of the work myself. Most of these expenses come as large lump sums … appliances, roof, driveway paving, new garage door, new furnace, etc.
“But home maintenance increases the value of the home.” Wrong (except for a fixer-upper).
What happens without home maintenance? Drywall dents, damaged paint, failed caulking, broken switch covers, drafty windows, leaking roofs and damaged hardwood.
Maintenance is needed to retain the value of your home’s building. I like to think of my home in two separate categories when it comes to appreciation:
- First, is the plot of land, which appreciates in value over time.
- Second is the building itself, which depreciates without home maintenance.
Your home can be expected to appreciate over the long term, and so can investments. But a home eats cash flow, while and investment asset pays cash flow.
2. An Expensive Home Is Not Better
More money invested means more long-run wealth.
Houses are different because of the negative cashflows. A bigger place is not always better. To see why, let’s consider a $1,000,000 home (3,500 ft^2) vs a $600,000 home (2,000 ft^2).
I’d take the smaller $600,000 home any day, provided it meets my basic functional needs. The $600,000 home would free up about $26,000 per year, which could be invested or used to buy a nice home gym.
In addition, the bigger house must be filled with stuff, which must be acquired (shopping), cleaned, organized and maintained. It will also take longer to clean the gutters.
You may say, ” the bigger house will result in more home equity down the line”. This is true. But to use that equity, you must sell the house and give relators 5% of the home’s value. Finally, home equity has a hidden cost, which I will discuss next.
3. Home Equity Can't be Invested!
I expect home equity to grow at 4.5% annually (real-estate appreciation). Not bad. This assumes I’m forking out cash for home maintenance, to retain the value of the home’s structure.
I also expect a global index of stocks to appreciate at 8.2% annually, as they have for the past 123 years.
Consider $300k in home equity vs $300k in a global index fund (like VT) for 30 years:
- Index Fund in 30 years: $3,191,000
- Home Equity in 30 years: $1,120,000
Money tied up in home equity is money that cannot be invested in stocks. And stocks have higher returns than your house. Therefore, a bigger home (with more home equity), will result in a greater opportunity cost.
Homeowner: Bigger Emergency Fund
A bigger house calls for a bigger emergency fund.
Money in an emergency fund cannot be invested and is unavailable to receive higher investment returns. The result is another (small) opportunity cost associated with a bigger home.
4. Mortgage Interest is an Expense
At the time of writing, my wife and I are under a 5 year fixed mortgage at a 5.2% interest rate. In the first five years, only 32% of our payments go to the principal. The other 68% is interest … enriching the bank.
Reading the 65 pages of mortgage terms makes it clear that the lender owns me. “The borrower is a slave to the lender.” – a saying is over 2000 years old. When something has survived 2,000 years, it is likely true.
For this behavioral reason, my wife and I will pay down the mortgage, even if it is not the wealth-maximizing decision.
You may say, “The mortgage is leverage, which amplifies returns.” You’d be right.
20% down amplifies house price increases by 5x. And it also magnifies house price declines by 5x.
Leverage increases returns, but it also increases risk, as many have come to realize in 2023. Finally, you can borrow money to invest in other assets, like stocks.
Overall, the interest portion of your mortgage payment is a negative cashflow. It does not contribute to net worth and does not increase wealth.
5. Illiquid: Relator and Lawyer Fees
Selling your home? Say goodbye to 5% of the value of the house, $2,000 of lawyer fees. Unless you are renting or moving into a tent, you will also need to pay land transfer tax on your new home.
Consider selling a $650,000 home in Canada:
- $35,000 in realtor fees
- $2,000 of lawyer fees
- $8,000 of land transfer tax on the new home.
$45,000, gone, to move. That’s why we bought a bigger house than we need now. There will be no “upsizing” when kids come along, no moving, no lawyer fees, no land transfer tax, no realtor fees.
To access wealth in your home, you must find a new place to live and incur costs to move. There is an exception if you use a reverse mortgage, but the bank will still account for the costs of selling the home.
Property tax, home insurance, maintenance and utilities eat cashflow. Investments, on the other hand, pay cashflow.
In addition, money tied up in home equity cannot be easily accessed unless you say goodbye to 5% of the home’s value. Further, money tied up in home equity can’t be invested in assets that provide better-expected returns, like stocks.
I believe it is best to view one’s home as shelter, rather than an investment. Owning a home has many benefits, including security, a hedge against increasing rent prices, memories of a growing family and a place you can customize to your desires.
This perspective makes it more likely to live within your means and maximize wealth by investing in true investment assets like stocks.