I’n the past, I’ve defended real estate ownership as a way to create long-term wealth, versus renting, which gradually destroys your wealth (but more specifically, prevents you from ever creating wealth, because you’re constantly bleeding cash every month).
Usually, the same people who advocate the conspiracy that the government is under-reporting inflation are also opposed to home ownership, but if the rate of rent exceeds inflation (which it obviously does), wouldn’t a 30-year fixed rate home mortgage be a good hedge against rent inflation, especially considering that rents are increasing at a faster rate than mortgage interest?
Regarding the stock market vs. real estate debate, a common argument is that stocks outperform real estate, and this is true over the long-run, but there are major advantages of real estate that stocks do not offer:
1. Cheap, significant leverage. A fixed 30-year mortgage on a $200k mortgage with $20k-down and a 740 credit score is 4% (10-1 leverage). Stock brokers will charge clients 6% a year to get maximum 2-1 leverage leverage. So that means, a 1% gain in the $200k home = $2k profit, vs. $400 profit from a 1% gain in your 2-1 stock account. (I’m excluding interest in both instances.)
2. Stability. Stocks are much more volatile than real estate. Only once in the past 100 years did the US housing market make a significant correction (2007-2011), but the S&P 500 has fallen 20% or more during multiple occasions: 1973,1987,1998,1999-2002,2008. On a risk-adjusted basis (returns vs. variance), real estate is better, even if the absolute returns are less than stocks.
3. Tangible value. Stocks can go to zero (which is why indexing is such a good idea). A home can’t just vanish.
4. More negotiating power. If you use leverage in a stock account, you have virtually no negotiating power if the trade goes badly…the broker will simply close your positions, usually at the worst possible time, to protect their own capital (because you’re using the broker’s funds when buying stocks on leverage). With real estate, however, there are is often generous financing and assistance if you are unable to pay. This is because banks lose money when homeowners default, so they generally want to work with the homeowner. Whereas stocks can be sold in seconds, eviction and then resale of the home can take years.
5. Shelter. Rent is very expensive, and it adds up over many years. If you put all your money in stocks, you will still need somewhere to live. $2,000/month in rent adds up to $240,000 after a decade.
Using the example above, if you purchase a home for $240,000 outright instead of renting, after a decade, you will have indirectly ( in terms of opportunity cost) made 2x your money on the home in terms of not paying rent, even if the home didn’t appreciate.
6. Income. Real estate can be rented out, boosting returns, although stocks can pay dividends.
From James Altucher : What are the most useful money investment and saving tricks?
A) Don’t buy a house.
Lets say you buy a $500,000 house.
You put $150,000 down (30%). You pay another $30,000 real estate commissions.
You put another $50,000 into maintenance (I’m making it up but that seems very conservative).
That’s $230,000 GONE.
The down payment is equity…it doesn’t just vanish, as astute readers in the comments noted. The typical maintenance rate is about 1% a year…buying a $450k home that immediately requires $50k in maintenance seems exaggerated. $30,000 in commission is also exaggerated.
In the ownership case, you might gain money if the house gains. But from 1890 – 2004, housing prices gained 0.4% a year over inflation. There are much better investments. And your investment is tied up in an asset that is 100% illiquid (i.e. you can’t get your money out).
This .4% figure is cited a lot, and it’s wrong. Here is Case Shiller home index over the past 40 years, including the housing bubble:
It doubled, representing a compounded return of 1.7% a year, more than triple the .4% figure.
What we have is a failure to do math.
Homes in many regions of California and New York have increased 3-4x since 1996, for an annual compound return of 7%. Unless you bought at a really bad time (2005-2007), almost anyone who holds real estate comes out ahead after a decade, versus renting. Of course, there is no guarantee these gains are sustainable, but there are also a lot of fundamentals behind the enduring resiliency of the Bay Area housing market.
Also, the major purported advantages of renting–inexpensiveness and flexibility–may also be oversold because you very often need a very large deposit and a credit check in order to rent.
What if you wait 20 years and pay off your mortgage? Then good for you. But average house turnover in the United States is four years.
But it doesn’t matter…some people sell their home for a profit before they pay off the entire mortgage…that’s how ‘house flipping’ works.