Misleading claims by the so-called "Real Estate Gurus"
Most of the gurus out there (especially the guy with "two dads") espouses that you cannot live in an asset. They spout nonsensical, yet convincing reasons why you primary residence is not ever to be considered an asset. I assure you, they are wrong.
They usually cite the returns of housing and real estate in terms of rental property income. They argue that real estate investing does not include your primary residence. This notion is supported with anecdotes of expected returns in excess of 10% annually for rental real estate. But wait, 10% is the goal, it's not necessarily the average expected return of real estate.
According to data collected by Jorda et. al. (2019) from the time period of 1870 to 2015---over a century's worth of data---equities (stocks) beat real estate returns 8.46 to 6.10% respectively after being adjusted for inflation.
That 2.36% difference (8.46 vs. 6.10) in returns is actually attributed largely due to the inclusion of rental yields into the equation. The reality is, capital appreciation is much closer to 1% over the long term, according to Shiller (2000).
Many will argue that the measly 1% capital appreciation on homes is bringing down the real number associated with rental yields. They insist that rental yields are much higher.
Here is the problem, rental yields are very wide ranging and very difficult to predict or forecast.
Why? The expenses associated with owning this property are variable and largely unknown. Many self-proclaimed real estate gurus will cite things like the 1% rule, depreciation, interest deductions, insurance, and refinancing all as tools and strategies to use against these variable expenses. Not sure about you, but this hardly sounds like a solid strategy.
If somebody is coming to you reporting they can tell you how to get your first 30 rental properties, all with $0 down and zero recurring maintenance, I have advice for you... run. This whirlwind strategy deals with highly leveraged properties and more mortgages than you can count.
Further, there are simply too many unknowns associated with rental real estate. Consider any one of the following unexpected costs associated with rental real estate:
Regardless, we are talking home ownership here, not rental real estate.
To evaluate a home as an investment, we will need to know how much a house appreciates over time. This will allow us to measure it's monetary value as an investment.
How much does a house appreciate over time?
Well, this is a tricky one. To find the real answer we should look at the Case-Shiller Home Price Index. There are several indices but the one we focused on was the national home price index.
This index primarily excluded new home construction (there is a separate index for that) and focused primarily on resale of existing homes within a given time period.
When digging through Shiller's website data (available on his website for free), I found historical data---measured with a 3 month moving average---since 1953 (I chose 1953 as a starting point because that appears to be the year they began updating the index on a monthly basis).
Now, the data is broken into real and nominal values. The difference is crucial. The real home price index is adjusted for inflation and is updated for "today's dollars". The nominal price index does not adjust for inflation.
Why worry about the difference between real and nominal values on homes?\
The real home price index from 1953-2019 increased by 54.16%
That's a huge difference!
So why is there such a difference? Well, the nominal home price increase is much larger in the bullets above because it fails to account for the fact that the market value of $1 in 1953 is not the same as the market value of $1 in 2019. This is primarily due to inflation. In other words, a single dollar went "much further" in 1953 than it does today. Plain and simple.
That is why the real home price index is a more useful tool in calculating the expected annual rate of return of housing. This is because it equates yesterday's dollars with today's dollars by adjusting for inflation.
By evaluating the change in real home price index figures from 1953-2019, I calculated an annualized rate of return of 0.81% per year of capital appreciation on your home.
Now that we have calculated the expected annual rate of appreciation of your home, let's dive into the discussion of seeing your home as an investment.
Plenty of confusion surrounding the word investment
Most people simply do not even understand the basics of what is considered an investment. An investment is something that you attain now with the prospects of benefit in the future.
Typically, this is referred to in terms of financial gain. However, this is entirely misleading due to the fact that there are many types of investments don't even generate a positive return.
Some examples of investments that fail to generate positive returns over the long-term:
These are all acknowledged as investments, yet they lose money. So sure, your house can still "lose money" if you sell it at the wrong time, but it's still worth something.
Technically speaking, an investment is simply something that you anticipate will be worth something in the future. You hope it will be worth something in the future that is of benefit to you. But remember, beauty is in the eye of the beholder. Your definition of "benefit" is not a universal definition, it is unique to you only. Many would simply be happy knowing that their house will be worth something someday, regardless of how it compares to the original purchase price--especially if it's paid for.
But can your house make your rich like other investments?
Yes. At least indirectly it can improve your overall net worth.
One of the best write-ups I have seen on this conversation is found here, written by Michael Bluejay. This guys does a great job of analyzing the entire circumstances of a home ownership in a simple, one-page article. He breaks down the concept of "Rent we didn't have to pay" as line item in expenses.
Rather than reinventing the wheel, Bluejay discusses how the average person will have to pay hundreds of thousands of dollars in rent over a 30 year period---which is also the length of the average mortgage.
He breaks down the difference in value of two scenarios:
The math is extraordinary but the numbers are very practical and they do check out. See them for yourself here.
The punchline in Bluejay's article is that by renting you lose over $300,000 over a 30 year period, even if you invest the difference between renting and buying. He recognizes in his example that home ownership may appear to lose money as well, but that's if you forget to include "Rent you didn't have to pay". Basically, this is what he considers to be an objective measure of "having a place to live".
Paying rent over 30 years--at $1,200 per month--would cost you a total of $432,000. At the end of that 30 years you have nothing to show for the $432,000 spent in rent. What's even worse is that this calculation does not even account for the fact that your rent will most assuredly increase over the course of the next 30 years.
Even if renting costed you $300 less per month than buying---which is lunacy because in many desirable areas renting is actually just as expensive, or even more expensive, than buying---and you invested that difference over 30 years with an 8% return. You would have $407,819. You didn't even break even! Not to mention that you also don't have a place to live after 30 years of hard work. That's a terrible trade-off.
So yes, home ownership is considered an investment.
Why Your Primary Residence is the Best Real Estate Investment out there.
First and foremost, let's address the intangibles. Home ownership, subjectively, is:
Objectively, a home is a place to build equity. To realize appreciation, even if it is only 0.81% per year. Further, the faster you pay off your home, the less interest you will ultimately pay.
Many will argue that mortgages and home ownership will leave you paying nearly 2.5 times the original purchase price. I agree with that math if it takes you the full 30 years to pay off the house. That is why I recommend early and aggressive principal reductions---or buying your house in cash if you are in a position to do so.
Your home is definitely an investment. Case closed. Show this to your pals who insist they have a helicopter leverage strategy to take out a second mortgage on their home to buy a 300 unit apartment building because it is a great investment. I feel sorry for your friend, I really do.
1. Shiller, Robert J. 2000. Irrational Exuberance. Princeton, N.J.: Princeton University Press.
Do you really know what a mortgage is?
A mortgage is a loan used for the purchase or refinancing of a home. Basically, it is the amount of money given to you by a lender for the financing of a home.
The mortgage loan typically has many variable parameters including, but not limited to:
Mortgages are typically used when you do not have all of the money upfront for the sale of a home. If you do happen to have the entire upfront cost, you might still choose to mortgage the property if you do not want to give up such a large sum of money, all at once.
Is a mortgage the same as any other type of loan?
Yes and no.
A mortgage is specifically a loan given as financing for a home purchase, or refinancing. As collateral for such a large amount, the home is typically put up against the value of the home just in case you stop making payments to them. If payments should stop, the home could then be used as collateral for "repayment" of the loan. I use the term "repayment" very loosely because you lose more than just a home in this process. In the process of losing a home due to missed mortgage payments (essentially a foreclosure), your credit score will be ruined.
Keep in mind that this black mark--i.e. foreclosure--stays on your record for 10 years. Avoid this at all costs if you ever hope to receive any other loans or favorable terms on lines of credit.
Lenders typically get into business to lend money, not to own homes. They want your money, not the house. I have heard of many people getting away with up to a year's worth of missed payments prior to the lender foreclosing on the property. This is proof of concept that lenders really don't want to be homeowners.
How Does the Whole Mortgage Process Work?
The initial process is pre-approval or pre-qualification. These two terms are often used interchangeably, but they are not the same thing.
A pre-qualification is solely based on information that you provide to the lender. This is simply a way to help you "ballpark" the amount of money you can hope to spend on a home. This is by no means a commitment nor is it a hard number to use when making home buying decisions.
A pre-approval is a much deeper dive into your history including, but not limited to:
How Does a Mortgage Work?
An offer, which almost always includes a pre-approval letter, is accepted by the seller for a specific property.
The next steps, aside from inspections and other contingencies, is to attain final approval for the mortgage financing. This is the part where you are looking to finalize and receive a set amount of money from the lender to help you purchase a desired property.
The lender will now perform any final verification of employment, income, and assets. The lender will also attain details on the specific property for which you intend to purchase following the seller's acceptance of your offer. The lender will look to have the following done prior to fully approving your loan:
If everything checks out and terms are acceptable (interest rates, loan duration, loan type, etc.), you will move towards closing on your mortgage.
Closing on your mortgage involves meeting with the lender and your real estate agent (and any other necessary parties depending on your state's rules/regulations). This is where you will sign your mortgage papers. This is also typically when your down payment and closing costs are due.
This is, by no means, to be considered as financial advice. Check your local rules and regulations as some of the information will ultimately differ according to where you live or desire to live.
Above is a summary of the basic "moving parts" surrounding mortgages. It is important to understand the nuts and bolts of a mortgage since it will likely be the largest financial transaction of your life.
The creation of mortgages permits many to attain home-ownership where it would otherwise be impossible due to limited income and finances.
There are many more things to know about mortgages. Learn everything you can. Knowledge is power.
Best of luck and happy hunting!
Dr. Jon is a physical therapist by day, and a dedicated frugalist by night, deeply enthralled in the thrill of "pinching pennies" and investing the margin.