Recently a local realtor said to me that homes have been and are the best investment her clients ever make. I said to her, “I don’t know about that. I bought my house 21 years ago and it hasn’t even doubled in value, so it’s returned maybe 3% on average per year.” If I’d put money in the US stock market over that time I would have earned around 10% per year. And I don’t have to pay property tax, maintenance, and loan interest on a stock investment.”
When I said that, I was sincere in saying ‘I don’t know,’ as I know the equation is not that simple. I resolved at that time to do a study. In working with the financial planning software that I use, I often run tests. And because the software is accounting for all the factors simultaneously, I’m often surprised how things turn out, and I’ve learned a lot through the years through these inquiries.
I chose for my example a 34-year-old couple wanting to live in a 3 bedroom, 1 bath home in my neighborhood (suburban Boston). (Disclaimer: this is the first of many things that may not be the same where you live and in your situation. However, this could all be translated to your situation to see how it works for you.) I looked up a nearby home for rent that is 3 bed 1 bath, it’s a duplex, and it is renting for $4000/month. The estimate to buy that property is $750,000. (See full set of conditions and assumptions at bottom.)
The 2 charts below show clients' liquid assets (i.e. not including real estate) in the 2 scenarios. The 1st one is continuing to rent for the rest of their lives. The 2nd is buying a home and holding it for the rest of their lives. Differences from the 1st to the 2nd chart are highlighted by gray (negative) or green (positive). This couple’s liquid assets go down by $150,000 to start because they put that money into the house as a down payment. But over time they catch up and then far exceed their results when renting.
Owning a home is a huge win for these clients, to the tune of more than $10 million net worth difference at age 90 (which you can't see directly in the charts as shown here). In today's non-inflated dollars that would be about $1.5 million, still quite remarkable.
When I discovered this, it seemed impossible to me. Like I said earlier, I really didn’t know the answer, but I imagined if owning a home was better that it wouldn’t have been worth millions of dollars to a middle class couple. This of course begged the question of why?
What’s going on here? To understand what was happening, I looked at the yearly cash flow dedicated to real estate. Below is a table at selected ages for the cash flow devoted to housing. For renting, it includes the rent. For owning, it includes mortgage principal and interest, maintenance, and property tax.
Notice that the Buy cash flow starts out significantly higher than the Rent cash flow, but then years later the Rent cash flow exceeds the Buy and that gap continues to grow. Why is that? After all, my property tax continues to grow and so does my maintenance expense when I own a home.
Here’s the answer: when I own a home and have a 30-year fixed interest rate mortgage, the monthly payment for principal and interest stays constant for that 30 years. Furthermore, after that it goes to 0. What you are effectively doing when you buy a house with a fixed rate mortgage is to fix your cost for mortgage and interest at the point in time when you purchased the house. Meanwhile if you are a renter, your rent continues to increase at 3.5% (assumed) per year for your life.
As a renter your $4000/month rent went up to $27,000/month at age 90. And as a homeowner your $3700/month for principal and interest stayed constant for 30 years and then went to 0. Effectively you removed inflation from that portion of the equation when you bought your home. And that is very powerfulwhen compounded through the years.
Have you been considering which option is best for you and your long-term finances? Let’s chat and see what it looks like for you.
One other thought in light of ruling came to mind….
As I was discussing my findings with my associate, we got to discussing how long people own their homes and the impact that might have on this. I found it didn’t have an impact if you sold your home and bought another of comparable value and I kept other variables the same.
However, in light of the recent ruling against the National Association of Realtors - I thought it would be interesting to look at the impact of repeated fees and closing costs on my hypothetical couple. I found that if they sold and then bought a different house 2 additional times, each after 8 years, that the additional costs would impact their net worth at age 90 by approximately $1,000,000. In present dollars that’s around $150,000. I was using a 5% number for closing costs and fees. I found that if I dropped that to 3%, the loss of net worth would be halved to about $500,000. I’m someone who believes a good realtor is a valuable asset to have and worth their fee. However, in a world where technology and other factors are helping to reduce costs, we’d expect to see fees come down over time. It’s not clear what, if any, impact the court ruling will have on these fees, but it’s worth paying attention. It never hurts to educate yourself and negotiate.
I hope you found this interesting and valuable. Please email me any comments or suggestions you have for other experiments. As I mentioned in the article, your situation may be much different and if you’d like to understand how this and much more impacts your life, you can schedule some time to discuss with me here.
Assumptions
- Couple earns $200,000/year between them growing at 3.5%/year, and they retire at 65.
- Spending outside of housing costs $6,000/mo. Growing at 3.5%/year
- Property tax of purchased house $9000/year growing at 3.5%
- Maintenance of purchased house $10,000/year growing at 3.5%
- 20% down payment on home which equals $150,000 of their current $200,000.
- Assets rate of return 7.5%
- Home purchased for $750,000 assumed to be growing at 3.5% annually
- 30-year mortgage for $600,000 at 7% interest
- Clients live to age 90
Aha Financial offers fee-based planning, wealth advisory services, and securities through Park Avenue Securities LLC (PAS) and insurance through The Bulfinch Group Insurance Agency, LLC. Fee-based plans may include tax and wealth planning suggestions, but we do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation. Investment Advisor and Registered Representative of PAS and insurance broker of The Guardian Life Insurance Company of America (Guardian), supervised from: 160 Gould Street, Suite 310, Needham, MA 02494, 781-449-4402. PAS is a member of FINRA & SIPC and a wholly-owned subsidiary of Guardian. Aha Financial and The Bulfinch Group are affiliated, but neither are an affiliate or subsidiary of PAS or Guardian. 2024-179906 Exp 8/26
For illustrative purposes only. This hypothetical is not intended to suggest a particular course of action or represent the performance of any particular financial product or security. Guardian and its subsidiaries do not issue or advise with regard to mortgages or real estate.