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Thursday, October 11, 2012

Was a Home a Good Investment?

Even before the bubble collapse, it turns out homes were pretty low return investments, contrary to popular belief. Over a century, from 1896 to 1996, in real terms a $10,000 home investment turned into $10,600: a 6% return over 100 years! (Source: The Signal and the Noise, p. 30)

3 comments:

  1. This issue confuses me, possibly because I'm not a good enough economist. (Not actually being an economist, for one thing.) But doesn't the picture look different if you take the opportunity cost of rent itself into account?

    I have to pay $1400, arguendo, to live somewhere. My choice isn't, "Spend $1400/month on a mortgage, or put that same $1400 into index funds." My choice is, "Spend $1400/month on a mortgage, or spend that same $1400 on rent." In that case, my rewards are, a) get my entire principle back plus 6% in real money in only 100 years! or b) wave it bye-bye.

    Now, the picture complicates if rents are materially below mortgage rates, in which case I can theoretically rent and invest the difference. Of course, that picture complicates yet further depending on whether the equity premium still exists, and management fees on my investments. As a rule of thumb, around here rents don't seem to fall significantly below typical monthly mortgage payments for equivalent domiciles, as a rule.

    What am I missing?

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    Replies
    1. Jim, you're leaving out taxes, maintenance costs, as well as other liabilities associated with owning a home (rather than renting); these will eat up that 6% within just a few years.

      Also, if you are borrowing in order to purchase a home, you must also consider the rate of interest on that loan. For instance, if you have a standard 30 year at 5% interest, you are going to pay roughly double the purchase price over 30 years. So, if you finance $100,000 for 30 years at 5%, you're roughly going to pay a total of $200,000 by the end of the loan term. So, while you do enjoy owning the full principal of the capital, you mustn't forget that you payed double the purchase price for it.

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    2. Jim, I'd say the issue is more with the advice we used to hear to max out one's mortgage. So here the choice would be between $1500 a month mortgage and $1000 in other investments, and $2500 a month mortgage.

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