Eye-Opening Article: Why Your Home Is Not the Investment You Think It Is

[on-ramp]

http://finance.yahoo.com/real-estate/article/102603/why-your-home-is-not-the-investment-you-think-it-is

Too many people rely on their home as their primary savings strategy. That's a mistake.

Planning your retirement? Don't bet the house on it.

Your home means a lot of things to you, most of them good. Your home gives comfort and protection to you and your family, and it could well embody all your material hopes and dreams.

But houses have become much more than just places to live. Your home is probably your biggest asset, and the price you could ask for it today is almost certainly much higher than what you paid for it back whenever.

As a result, houses have become substitute credit cards, as profligate owners borrow their equity to finance everything from cars to vacations. Among thriftier owners, the equity they have built up in the family home has become a vital part of retirement planning -- a "fourth leg" of the now-unstable "company pension/personal savings/Social Security" stool that was long the model for a financially secure old age.

Unfortunately for both groups, however, houses are not very good investments. For the grasshoppers, there's nothing quite as stupid as paying off your 2002 trip to Orlando in 2032, when you finally settle up your refinanced "cash out" 30-year mortgage. And for the ants, economic studies have demonstrated over and over that houses (1) cost more than most people make when they sell and (2) rarely match the long-term returns of stocks or other investments.

And that's doubly true today, with much of the U.S. well into a real-estate recession. It's unlikely that homeowners in once-booming areas will see a return of skyrocketing prices anytime soon.

"Real-estate investments suffer serious and sometimes prolonged downturns," writes economist W. Van Harlow in a new study of home equity and retirement from the Fidelity Research Institute in Boston. "A real-estate 'bust' could be quite damaging to an investor nearing retirement who relied too heavily on home equity."

It may be late for a lot of homeowners to read this, but here it goes anyway: It's risky and bad planning to have too much of your net worth in your principal residence. No prudent stock-market player would put 60% or 70% of a portfolio in just one stock, but millions will hold that much or more of their total net worth in just one house.

Food for thought:

• If you bought a house in Los Angeles in 1990, just as the real-estate market turned downward, you would have had to wait a decade for your home's value to return to what you paid.

• If you bought in Rochester, N.Y., in 1980, you would have seen only a mediocre 4% annual growth for the next 25 years.

• If you bought in Dallas in 1986, as the oil boom went bust, your home wouldn't have appreciated at all before 1998.

So with all that in mind, here's a question-and-answer rundown of some financial issues of home owning.

Q: My home is my largest asset. Why shouldn't I rely on it to provide my nest egg?

A: Because a house can be an inefficient means of investing, and it costs far more to buy and operate than you think. Homeowners can easily end up paying more to live in their houses than the supposed "profit" they make when they sell them.

When most homeowners figure their returns, they don't do much more than subtract the price they paid from the price they received. Then they come up with a really big return because they paid only a 10% or 20% down payment. So they figure they made a huge "profit."

But they didn't. That's because the costs of owning a home -- buying it with a long-term mortgage and then paying taxes on it, insuring it, repairing it, renovating it -- sap most of what most homeowners think they make in price appreciation.

Houses are nice financially because there are not many other things you buy that actually go up in value, and not many things can put a six-figure check in your pocket when you sell them. But don't delude yourself: You've already spent most of that check, and you are likely to spend the rest in just a few days when you buy a new home.

Think of your sale proceeds another way: not as a true profit, but as a huge rebate. Some of the thousands of dollars that you paid into the house over the years are being returned to you -- sometimes with a bonus, often without.

Q: But it's certainly better to buy a house than to pay rent.

A: That depends on when you buy, and how long you own. Buy at the wrong time -- like during the kind of buying frenzy that much of the country has just experienced -- and you could well end up wishing you had rented instead.

Boom market or bust, home buying has so many extra costs -- from upfront "points" paid to a lender to title insurance and appraisal fees -- that over the first five to seven years, a renter who invests the equivalent of a down payment in stocks could easily do better overall than a house buyer. Compounding that problem: Most homeowners move within seven years.

As the ownership timeline stretches out to 15, 20 or 30 years, however, the buyer will almost certainly do better than the renter, especially given the tax benefits of paying mortgage interest over traditional rent and the big rebate when the owner finally sells.

But the typical buy vs. rent argument clouds the more important point: A house is an inefficient way of building wealth.

costs_buying_home.gif

Q: But I have to live somewhere! And I have to pay something for a place to live. Certainly it's better to pay "deductible" mortgage interest than rent.

A: Buying a house with a long-term mortgage is just another form of renting.

Mortgage interest is rent that you pay to your lender for the use of its money rather than to a landlord for the use of his house. Yes, the government picks up a portion of that with the tax deduction, but most of your monthly payment neither builds equity nor is deductible. It just goes down the same black hole that sucks up any other renter's money. And it takes 20 years before a typical borrower pays more principal each month than interest.

"I have to pay something" is a rationale that home buyers use for going deeply in debt and paying tens or hundreds of thousands of dollars in interest to buy a house that, they mistakenly believe, will make a big profit for them down the line.

Q: So how much does a house really cost?

A: You can easily end up spending three times the purchase price of a house. Today's buyer of a typical $300,000 single-family home who takes out a 30-year loan will end up paying the price of the house again just in interest. Add 30 years of property taxes, homeowner's insurance, regular maintenance and a couple of big-ticket repairs or improvements, and the total cost of buying the home could easily top out at well over $1 million.

Q: Yes, but the house will be worth much, much more.

A: Maybe, maybe not. Whether you come out ahead depends on where and when you buy. Even cash buyers might be surprised to see that they can't be assured of making a profit.

"The Costs of Home Ownership" table is a simplified rundown on a typical single-family home -- a house that was bought for $50,000 in 1977 -- based on national appreciation rates as reported by the Office of Federal Housing Enterprise Oversight (OFHEO). Included are modest estimates of other home-owning costs (not adjusted for inflation). To keep things simple, there are no transaction costs, no additional borrowing to finance improvements and no refinancing costs, all of which would drive the expenses even higher. It's not a pretty picture.

costs_home_ownership.gif

Q: Those numbers don't seem realistic for where I live. You can't buy a house here for that kind of money.

A: To be sure, not everyone did so badly as the national average. OFHEO's Home Price Index calculator puts the average 30-year appreciation for a house in the ever-pricey San Francisco metropolitan area at 1,125%, compared with the national average of just 481% (http://www.ofheo.gov/HPI.asp). So if you bought that $50,000 house in San Francisco in 1977, it would be worth about $613,000 today and, assuming much the same costs of ownership, you'd make a true profit of $219,000.

You would have done well in other coastal metro regions, too. The comparable house would be worth about $593,000 in Los Angeles (up 1,085%), $549,000 in New York (998%) and $432,000 in Washington (763%).

But some other big cities didn't fare as well. You'd be in the red in Chicago, where home values rose 463% and the house would be worth $282,000. Your house would be valued at only about $176,000 (252%) in Dallas and just $147,000 in Houston (193%).

Q: But even if I had bought in Texas, I'd still essentially break even. Buying let me live "rent free" for 30 years.

A: Living "rent free" is moving in with your parents or your wealthy lover in Tuscany. You didn't live rent free. You had some of your rent money subsidized and then some more rebated.

Yes, you are sitting on a lot of home value, but you've spent a lot -- probably more than the house is worth -- getting what you have. And you almost certainly lost some investing opportunities along the way while you were spending your money buying the house.

And that's assuming everything breaks your way. If you don't sell at the top of the market, you could see stagnant or falling values for a while. There have been real-estate bubbles before. In San Francisco, where it looks like prices may have hit their high mark in the third quarter of 2006, home values peaked in early 1990 before falling for the next eight years. Houston saw a modest surge in the '80s, followed by an equally modest decline and then two decades of grindingly slow appreciation.

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continued...

Q: That's still money that I wouldn't see otherwise. Even getting just some of my money back is better than getting none.

A: But there's another kicker. You haven't gotten any money back yet. All you have is a house that's 30 years older than when you moved in. In order to realize your windfall, you'll have to borrow against it or sell it.

If you borrow against a house you've paid off, then you will start mortgage payments all over again.

If you sell it, what are you going to do with that big check in your pocket after you've walked around for a couple of hours feeling richer than you've ever been? You'll probably spend most of it in just a day or so buying another house.

Q: So I'll downsize, find a smaller, cheaper house, buy it and then invest the rest of the money.

A: Prices tend to rise or fall across an entire market. So if you want to stay in the same metropolitan region and save a big chunk of your rebated nest egg, you should be prepared to go significantly downscale -- move to a much less desirable neighborhood.

Consider a hypothetical Washington-area couple who bought their home for $55,000 in 1977.

With improvements and market appreciation they appear to have done quite well. If they sell their house today, they could expect to get something in the neighborhood of $860,000. And they would walk out of the closing meeting with a rebate check of about $550,000, of which about $175,000 would be profit.

But they're facing a tough market where the median price of a condo is two-thirds the cost of a single-family home. They don't have enough money to make the most obvious move down -- from their house to a comparable apartment that would cost around $575,000.

Q: Then I'll move to someplace cheaper, like Houston.

A: You still face borrowing or spending all or most of your cash on your new house -- and you will still have maintenance, property taxes, insurance and other "I have to pay something" costs.

If our Washington couple chooses to leave and move to a cheaper housing market, they will still have costs greater than they think. Popular retirement communities are usually cheaper than big metropolitan areas, but they are not so cheap that sale proceeds will plant them on a country-club fairway and pay for the lifestyle that goes with it.


According to Coldwell Banker's often-cited home-comparison calculator, a house comparable to the place in Washington would cost $439,000 in Fort Myers, Fla., or $407,000 in Orlando. The couple would do a little better moving to Tucson, Ariz., where the comparable house costs $281,000 -- leaving the sellers with less than half of their rebate windfall.

So yes, cashing out in Washington -- or San Francisco or New York -- will give you enough money to buy a nice place on a golf course somewhere in the Sun Belt. And you might have $200,000 or $300,000 left over.

Q: So what can I do if I've planned too much of my retirement around my investment in my home?

A: If you already own your home, you can still rein in your expenses, and diversify your investments. Unfortunately, there's not a lot you can do about reducing many of the costs of home owning, such as property taxes or replacing a roof.

But you do have control over two of the biggest home-owning costs: interest and renovations. Both are big money losers. Even with the tax deduction, most of your mortgage interest is still just wasted rent money. So accelerating your principal payment will result in huge savings down the line. Add $300 a month to the payment on a 6.25%, $300,000 loan, and you'll save 10 years of payments and $83,000 of after-tax money -- enough to put a kid through a public university.

Few, if any, renovations make a profit. A new kitchen or family room might raise the resale value of a house, but rarely as much as they cost to build. And if the homeowner borrows the money, the renovation work could end up costing two or three times what the contractor charged.

If you don't already own your own home, do the math. Don't buy if you think you'll be moving in just a few years. Don't buy a house that's too big for your needs or so expensive that you will strain to pay for it simply because "it's a good investment." It's not.

[Nathans_Dad]

A house is a place you live, not a place to stash your money. I have always been an advocate of putting as little money into your house as possible for the simple reason that the percentage of equity that you have in your house has zero to do with whether your house appreciates in value or not.

The idea of paying off a house comes from a time when mortgages rates were much much higher than they are today. If you were paying 12% on a mortgage you would pay it off too. Not so when you are paying 6%.

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Originally posted by Nathans_Dad
A house is a place you live, not a place to stash your money. I have always been an advocate of putting as little money into your house as possible for the simple reason that the percentage of equity that you have in your house has zero to do with whether your house appreciates in value or not.

The idea of paying off a house comes from a time when mortgages rates were much much higher than they are today. If you were paying 12% on a mortgage you would pay it off too. Not so when you are paying 6%.

exactly right... our mortgage rate is 5.25% fixed for 30 years. we can pay off our house but we can get a better rate of return on our money somewhere else.

[legion]

I have four times in my 401k what I have in equity in my house.

[the]

Certainly the theme of the article is beyond dispute:

"Too many people rely on their home as their primary savings strategy."

If you are relying on your home as your PRIMARY savings strategy, you're nuts.

But I think a lot of people are doing that. Esp. in the last few years. Remember the LA Times article from a couple of years ago, where something big % of people said they believed their house would continue to appreciate 20% per year indefinately?

If you believed that to be true, you would feel no need to save anything.

Which is exactly what I think a lot of people have felt. And which is why I think this housing collapse is going to tank the economy.

As Greenspan noted today, 2/3 of GDP is consumer spending. And consumer spending the past 4 years has been red hot, driven mainly by the feelings of "wealth" most people have, because of their bubblicious paper equity in their house.

That feeling is quickly disappearing, even among the most dense. Not only is the disappearing feeling going to cut consumer spending, but the Home Equity ATM is most definately closed, so even if people wanted to keep spending, many can't anymore.

Less spending/less GDP/less corporate profits/less employment . . . can you say long recession?

[74-911]

The article is 100% correct in my case. Bought a house in San Antonio, TX in 1980. Watched it appreciate nicely for 5 years then watched it loose 25% of value in 1986-1987. Couldn't have sold it for what I paid for it. By the late 1990's it had appreciated back to the pre-bust valuation. Sold it in 2003 when I retired (the house was paid for). When I added up what I paid for it, improvements, repairs, etc. I at best broke even. When you throw in the interest, taxes, insurance paid over those years all you see is red. There is no retirement nestegg here.

As for the mortgage deduction, despite what realtors tell you it really benefits very few people (mainly those in the coasts where real estate is exorbitantly priced). With the standard deduction what it is many homeowners don't pay enough interest with the low interest rates to even deduct it or they may be able to deduct it for part of the loan term at best. As one financial writer put it, us hicks out here in the hinterland are subsidizing housing on the coasts.

Jack

[Joeaksa]

Bought my house here in Phoenix five years ago for $205k. It went as high as $595k in the balloon market last year and now has stabilized at $400k and is now increasing in value again. I owe around $160k for the house.

Good friend of mine bought her house four years ago in a better area than mine is in (around a shopping center that is going wild) for $251k. Value went up to $690k last year then stabilized at around $590k. Its now on the raise again.

Please tell me where you can live in a house and make money like these two houses have done? I am ok with breaking even as its better than ever paying rent but when you can live in a house and double or almost triple your money in 4-6 years thats hard to beat.

[lowyder993s]

I just paid off my house and HELOC last week...500k. Bought the house 8 years ago for 400, neighbor sold his last year for 1.4M. I'd say we're @ 1.2M value right now. Was able to do it by investing in a former employees family start-up. 50k to 1M in less than 2 years. Felt like I hit the lottery. Still have some shares of the company, plan is to go public in the next 2 years. After riding AOL, IOM and others up and into the ground in the 90's...it feels good to take a bunch off the table and be able to lose that nut every month.

[Porsche-O-Phile]

It's an easy decision for me: I can't afford 20% of anything I'd want to live in out here and I refuse to take a sucker loan like so many other dip****s have done in recent years. As such, I pay down my debt and continue to put money into savings and investments. Seems to be working okay - I'm wealthier now than I've ever been in my life. Still much room for improvement, but I'm glad it's moving in the right direction (finally) after years of getting screwed.

[on-ramp]

Originally posted by Joeaksa
Bought my house here in Phoenix five years ago for $205k. It went as high as $595k in the balloon market last year and now has stabilized at $400k and is now increasing in value again. I owe around $160k for the house.

Good friend of mine bought her house four years ago in a better area than mine is in (around a shopping center that is going wild) for $251k. Value went up to $690k last year then stabilized at around $590k. Its now on the raise again.

Please tell me where you can live in a house and make money like these two houses have done? I am ok with breaking even as its better than ever paying rent but when you can live in a house and double or almost triple your money in 4-6 years thats hard to beat.

there is no profit unless you realize a gain from a sale and bank it. go back and read the article in detail.

we bought our house several years ago for 400K. Let's say, for arguments sake, our house appreciates to 1 Million $ in the next couple of years. so what? if we sell, we have to go somewhere. to make a "profit", we have to downsize, which usually means living in a less desirable neighborhood or moving to another part of the country. The only difference in the 1 Mill $ valuation is the joy of paying higher RE taxes.

Don't get me wrong, I'd still own over renting, given all the joys of home ownership. However, our house is not an "investment",a profit-maker. It's a money pit. It's an asset for the bank. To us , it's a liability.

It will be a benefit to our kids and grandkids one day in 30 years after it's all paid off. they can sell it and buy a motor yatch or something.

[vash]

Originally posted by Nathans_Dad
A house is a place you live, not a place to stash your money. I have always been an advocate of putting as little money into your house as possible for the simple reason that the percentage of equity that you have in your house has zero to do with whether your house appreciates in value or not.

The idea of paying off a house comes from a time when mortgages rates were much much higher than they are today. If you were paying 12% on a mortgage you would pay it off too. Not so when you are paying 6%.

rick, you been reading my diary? i feel the same way. in the bay area, my mortgage is the same amount as the last rent i payed. the down payment was a miracle, but i did it. my house is just one of my durable goods.

[Rick Lee]

Originally posted by Porsche-O-Phile
It's an easy decision for me: I can't afford 20% of anything I'd want to live in out here and I refuse to take a sucker loan like so many other dip****s have done in recent years. As such, I pay down my debt and continue to put money into savings and investments. Seems to be working okay - I'm wealthier now than I've ever been in my life. Still much room for improvement, but I'm glad it's moving in the right direction (finally) after years of getting screwed.

If you really think you're gonna save up a 20% down payment in So. CA, then more power to you. You'll be renting for a very long time. A loan of above 80% LTV is not necessarily a sucker loan. If you plan to live in the house for a long time OR if it appreciates nicely OR if you can pay down the 2nd trust quickly, you'll be ahead of the game and you'll be a homeowner. Even a 100% loan is not a sucker loan, unless you make the minimum payment and/or accrue negativity equity. You have to live somewhere. Might as well take that tax write-off and knock down your principle if you can't stand debt.

[hytem]

California is probably a bit different than most places for real estate, since housing prices tend to be higher, and the market may be more volatile because of it.

In my experience, real estate is still the best investment you can make. My house which I bought new has appreciated 400% in 20 years. A big chunk of that is the 1.2 acres of land. You can't do that well in stocks long-term.

Despite all the media hype about housing downturns, mortgage rates remain low and the market has shown resiliency against a lot of downward mental pressure. Vacation housing has been lagging, especially in Florida, where the media has overhyped hurricanes the past two years, despite none last year. But even that is coming back some.

Peoples' buying and selling attitudes are influenced by what they sense and see on TV. And there hasn't been much good news lately. So a lot of buyers have been holding back--some waiting for prices to bottom.

The key to housing has always been mortgage rates, and the market will be OK as long as rates stay low and money is available.

As for loans against your home equity, it makes sense at current rates, as long as you don't overdo it. You get a tax deduction, and rates are only a point or two higher than CD rates. That's cheap money. What to do with it? Buy more real estate--in a good location.

[Porsche-O-Phile]

Originally posted by Rick Lee
If you really think you're gonna save up a 20% down payment in So. CA, then more power to you. You'll be renting for a very long time. A loan of above 80% LTV is not necessarily a sucker loan. If you plan to live in the house for a long time OR if it appreciates nicely OR if you can pay down the 2nd trust quickly, you'll be ahead of the game and you'll be a homeowner. Even a 100% loan is not a sucker loan, unless you make the minimum payment and/or accrue negativity equity. You have to live somewhere. Might as well take that tax write-off and knock down your principle if you can't stand debt.

I agree with you to a point. I see 95% (or even 100%, in some cases) financing as fine - IF (big if) it involves a fixed-rate, no neg-amortization, etc. The big sucker loans are the option-ARMs, 2-1, 3-1 or even 5-1 ARMs and certain I/O products. I'd consider an I/O product if it were fixed for about 10 years and allowed for 95% or 100% financing and no PMI. That would open doors. The crapola option-ARM products I wouldn't touch with someone else's 10-foot-pole.

In a perfect world, I'd simply say save up the 20% for a down, a fixed rate, 30-year fixed and forget about it from there and live worry-free from there on. Problem is, ANY place worth living in around here is about $300k. Minimum. 20% is $60k. I don't exactly have that available in liquid assets. Plus costs. That's about $70k - or the cash purchase price of a brand new 911. With nothing in reserve for repairs, fixing up, etc. The 20% requirement is a barrier to entry that simply can't be overcome without winning the lottery, having a big inheritance, or living on Ramen for 10+ years. None of which I'm able (or willing) to do. It's not worth it.

I see the wisdom of banks/lenders requiring people to put in a chunk of their own money up front (especially in a downward market) to avoid people saying "this place is losing value - screw it" and walking away, leaving the lender holding the bag. However, I think we've reached a point where it's SO unrealistic to expect people to save up that kind of money just to get in the door of a crappy fixer-upper or glorified apartment "conversion", it's more of a liability to the system than an asset. It prevents a lot of people (like me) from taking the whole thing more seriously. However, the downside of going with lower down payment requirements is people are more and more likely to turn in the keys and say "eff this" when things go south (which they're doing right now).

Should be interesting to see how this shakes out. Personally I'm betting on significant downward pressure on prices. I'm predicting about a 30% drop in values in the SoCal market over the next 2-3 years. It's simply WAY too out-of-whack right now.

[techweenie]

Good article. I bought my Beverly Hills house in '84 for $415K and sold it in '02 for just under a million. Do the math...

House valuation in that time period was a total rollercoaster. The house was a 4bd/2-1/2 ba on a hilltop acre with a long drive, gate and motor court. And on one of the most famous streets in So Cal. And it was a terrible investment.

[Rick Lee]

ARM's are NOT sucker loans!!!! Why would anyone pay for a 30 yr. fixed rate if they are not positive they'll keep the house for 30 yrs.? Those loans are so much more expensive than ARM's and the vast majority of 30 yr. fixed loans are paid off (by refi or sale of house) in seven years. My folks are about to retire to their beach house and THAT is the kind of house that makes sense for a 30 yr. loan, though I doubt either of them will live that much longer. Do you really know anyone under 40 who lives in a house they swear they're gonna keep forever? I doubt it. I have a 5/1 interest only ARM on my house and it makes perfect sense for my situation. My rate is 4.375% and I can pay down principle anytime I want, but have a low minimum payment if that's all I want to or can pay. In the very unlikely case that I'm still living there when the ARM adusts, I'll just refi it. But most likely I'll have long since sold it.

BTW, I took an FHA 1 yr. ARM on my first house and when it adjusted, it actually went DOWN.

[Moneyguy1]

Rick..Maybe I am just old-fashioned, but every succeeding payment of a standard amortizing loan has a tiny bit less interest and a tiny bit more principal. After a few years, the percentage of the principal becomes meaningful. An interest only has no principal payment and at the end of, say, five years, all one has is 60 receipts of interest paid and no equity. Having been in the real estate and financial planning business for decades (retired now), I have never seen someone fail if their goals were realistic and considered. Adjustable rate mortgages can, and do bite people who are unprepared in the a$$. Not everyone is comfortable with no equity in real estate; in essence an interest only loan is equivalent to rent and worse if the market has a downturn. It is the same risk as buying stock on margin and then having the market go through a "correction". And, some of the financial gurus are prediction that what has happened to date is merely the start of the roller coaster ride. I, for one, am happy as a clam to have no debt, a nice place to hang my hat, and a pile of equity should circumstances demand it.

Maybe I am old-fashioned, thinking that it was MY responsibility to make sure my needs would be taken care of in my "golden years".

[the]

Seems the risk with ARMs is you are betting that there won't be much higher interest rates 5, 10, 15 or 20 years from now.

Someone who fixed in at 5.5% on a 30 year will have a lot of options 5 years from now. True, when they first bought the house, they may have planned on only living there 5 years. But if the market rate is 8.5% down the road, they may reconsider staying where they are and keeping their 5.5% rate.

If the market rate is lower than 5.5%, they could always refinance to take advantage. Their is a lot of flexibility.

Someone on an adjustable won't have that flexibility. Whatever the unknown market rate is years from now, that's what they are going to have to eventually pay.

Some people don't like that risk and uncertainty.

[Rick Lee]

Bob, as I said, you can still make principle payments with an interest only loan. You know that. And since I put 20% down on my current house and it has appreciated nicely, I have plenty of equity. So my mortgage and property tax payments sure feel a lot better to me than paying rent did. At least I can write it all off as a homeowner and couldn't write a dime of it off as a renter.