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I PURCHASED MY FIRST home in 2005. At the time, I was a Major League Baseball prospect with the New York Yankees organization. I had always been taught that homeownership was part of the American dream. Looking back, I’m now much more skeptical.
Purchasing a home on my salary was difficult. Minor leaguers don’t land big contracts like their counterparts in the major leagues. In fact, I had multiple years when I made less than $10,000 as a professional baseball player. I was only able to afford the house because I also worked other jobs.
I bought my first home for $106,000. It was a discounted foreclosure property and only required a 5% down payment. The house was relatively new and the bank had done some renovations while it was in foreclosure. It was 1,573 square feet, with three bedrooms and two bathrooms, and sat on a 0.28-acre lot.
I stayed in the house for almost 12 years and sold it in 2017 for $180,000. This might seem like a great investment. If we only look at price, the value of the property appreciated 4.51% a year. But we can’t judge the investment return by price alone. We also need to consider cash flow.
My original mortgage was for 30 years at 5.25%. I paid roughly $980 a month, including taxes, insurance, interest and principal. In 2011, I refinanced with another 30-year loan at 4.25%, cashing out $20,000 in the process. Even with the cash out, my monthly cost dropped to $870.
I also made home improvements. I bought new wood floors that cost $5,000 and built a patio that cost $3,000. These expenses need to be considered as well.
When I sold the house in 2017 and paid off the mortgage, I pocketed roughly $86,000. When I consider the total cash outflow during the time I owned the place, I calculate an internal rate of return of -5.08%—and the return would have been even worse if I adjusted it for inflation. That isn’t the sort of performance anyone would want on an investment.
At first, I wondered if I had done something wrong in my pursuit of the American dream. After all, conventional wisdom says that a home is a great investment. But I suspect my experience is pretty typical.
My contention: Many homeowners don’t realize how expensive owning a home can be from a cash flow perspective. To be sure, you get to live in the place, and that’s undoubtedly valuable. But what about a home’s value solely as an investment? Depending on how long you stay in the house, you could see cash flow returns that are flat or even negative.
I suggest that we rethink the notion that homes are investments. I would argue that they should instead be treated as places to live. Someone can build net worth in their primary home, but they shouldn’t view it as a growth asset, like they might view stocks or bonds.
I had an epiphany after selling my home in 2017. If I, the seller, didn’t make a positive return on the home—and if the buyer’s return was also uncertain—then who’s really benefiting from this version of the American dream? Cynically, I think we all know the answer to that one: the banks and the real estate industry.
Kevin Thompson is a former Major League Baseball player and now CEO of 9Innings Capital Group LLC. He is a Certified Financial Planner® and Retirement Income Certified Professional®. Kevin graduated from the University of Texas at Arlington in 2011 with a degree in finance. His previous article was Big League Lessons.
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You are spot on, in my experience and observation. Thank you.
You are right to point out how complicated this topic is. There is the value we derive from our living space, and there is the financial impact. Both are important to consider.
When including everything – all payments, taxes, maintenance, equivalent rent benefit, insurance, etc. our first house had an IRR around 20%. We bought while many homes were still feeling the California housing recession of the early 90’s, and sold in late 2004. Notably, the value has languished in the time since we sold.
Our subsequent house carried a breakeven IRR for a decade or so. Now it’s sitting around 7% thanks to the recent wild surge in home values.
I don’t claim any kind of credit for sussing out good deals… I think we mostly just had more than our fair share of good luck.
Unless we are still living rent free in our parents’ basement, we are paying for our housing, either in the form of rent or a mortgage.
I bought my first house in 1975 and the house in which I currently live is paid for and worth many more time than what I paid for my first home. Having said that, I’ve also invested a large amount of additional cash in various homes over the years in the form of taxes, repairs and improvements.
All of these expenses will no doubt reduce my ultimate rate of return on my investment, but when I eventually sell my house, I will receive cash. Had I rented, I would receive nothing.
It would be fun to figure out how much I would have if I had been able to invest my cost of housing in mutual funds over a long period of time, and no doubt, it would show a greater return than my house. However, as I needed a place to live, I bought a house instead. All things considered, it still looks like a reasonable investment to me.
What a fortuitous message from credit karma. I received this from my credit karma app:
Congratulations, Kevin. Your home’s value is higher than members in Tarrant County.* That means your investment is paying off. Cue the applause.
Come see how your home’s estimated value measures up to members in Tarrant County and how home values are trending overall.* Snap on over to Credit Karma.
This is what plagues us as individuals. Just real life at its finest.
9innings Podcast YouTube interview with Jonathan Clements is Live https://youtu.be/uUIGp0LcRwQ
I agree pretty much with your assessment from the buyers perspective. But to slight the financial services that facilitated your purchase is a little short sighted IMO.
You obviously wanted to use their services. They provided value which you felt, at the time was worth it. Maybe you could have done a better job shopping for those services, or used alternative service providers.
Very interesting you saw it that way. I see how it can be seen from that way indeed. No slight was meant, although banks are indeed the main profiteer in this scheme (not in the pejorative sense either). When I speak on the real estate industry I am not referencing the agent in particular, I’m referring to the larger institutions making revenue on his/her commissions.
Kevin, thank you for your article. The lesson I learned was that you need to consider purchasing a home with both eyes open. If you regard home ownership as a ticket to financial freedom, you’ll likely be disappointed.
I suspect that too many people view the rapid rise in home prices over the past few years as typical of what one can expect, rather than regarding this period as an anomaly. Tales of people cashing in on rapidly rising home prices tend to cloud our memory of what took place in the real estate market in 2008-2009.
Perhaps the true value of home ownership is the discipline it may instill in some people to save and invest for the future.
Here is the link to the interview with Jonathan Clements. Hope you all enjoy..https://podcasts.apple.com/us/podcast/the-9innings-podcast/id1558127474?i=1000567699273
Kevin, thanks for an interesting and thought-provoking article. The comments show that this is an important and very personal topic in personal financial planning. The fact that the FP world doesn’t have an agreed upon method to evaluate the ROI on a principal residence is evidence of the complexity and uniqueness of home ownership. There are so many variables – location, timing, interest rates, family makeup, … – that make comparisons difficult. My brother lived in Baton Rouge, LA in the 80s as the oil economy was down. Rents on new townhouses went down over the 4 years he lived there. He looked at purchasing a hime, but renting was a far better deal at the time. Co-workers bought houses for $0 down, and ended up taking a bath as they tried to sell a few years later. That was a good lesson for me, that real estate down’t always go up. The crash in 2007 reinforced that. We bought our Jersey shore home in 2012, for about 40 % less than the previous owner paid in 2005.
Rick, thany you for shedding light and a personal experience. The beauty about what you just mentioned is that we all have differing personal experiences. Yours and mine seem to be a bit similar to a degree. All I know, we the people, remain the greatest income source for banks, municipalities, governments and institiutions.
There are four big value-killers with owning a home. First, if you sell your home in the first ten years after you bought it, most of your mortgage payments went to pay interest, not principal. Go look closely at the amortization tables – they will sober you up in a hurry. Second, most states have fairly high property taxes, and over a number of years, you will find that those taxes tend to skim off all the appreciation in value you may have gotten, and then some. Third, we tend to forget all of the new money we spend on homes after we buy them – all the fixes and upgrades once we move in, the ongoing landscaping and yard work costs (including that mower, grass seed and weed treatments), the repairs and replacements that are demanded over the years, and the things we buy to fill up empty rooms. Finally, there are the pure economic facts – every dollar you get out of selling a home is going to be worth far less than the dollar you used to buy it, and in many cases, if you had put that money into a diversified mutual fund with dividend reinvestment, you probably would have wound up with a lot more.
But we buy homes anyway. Most only want to think of the good reasons to do so.
How much of that money you are not spending on a house will actually go into a mutual fund, as opposed to the pockets of a landlord? I just checked, and the rent on an apartment equivalent to my house (three bedrooms) is in most cases several hundred dollars above a mortgage payment on my house (with a 20% down payment) and in no cases lower. But the mortgage payment will stay the same, while the rent will increase, and the increase will be out of your control. I refinanced to a 15 year mortgage a couple of years after I bought my house, and paid it off in twelve years. After that the costs to maintain the house were very much lower than renting. (And I was able to increase my saving rate.)
@mytimetotravel
This is termed “Price to Rent Ratio” and is a measure of how affordable buying is vs. rent in a given area. A number under 15 generally means buying is more favorable and a number over 21 means renting is more favorable. (15-21 is kind of a gray area that could go either way)
You can Google articles on the differences country-to-country or within an individual country like the US. There are some drastic differences by region.
That may be relevant while you are paying off the mortgage, but it is hard to imagine a situation where it is relevant once you own the house free and clear. I have lived in my house for twenty-one years without a mortgage payment, no way would I have been better off renting. It is also a snapshot in time, in five years the ratio might have flipped.
I remember my dad always said, “a home is not an investment—it is a place to live!”
I agree that the majority of folks overestimate their financial return from owning a house. Much of this is likely due to the fact that home ownership is a form of forced savings and, on average, the gross sales price of is substantially more than the purchase price. The fact that the net wealth of homeowners is ~ 40 times that of renters is another reason for viewing home ownership as a path to financial security–even though many factors besides home equity are responsible for the difference in wealth.
While livability should be the first consideration when purchasing a house, I think much is to be gained by also evaluating a home purchase as an investment because it is usually one’s largest expense and many of the considerations that go into other investments also apply to home ownership.
For most folks, a house is a large leveraged non-diversified asset. As such, it has similarities with making a large investment in a single stock. Both investments have the potentially to have a significant positive or negative impact on one’s wealth. In regard to houses, we can see this in the fact that many homeowners lost everything during the mortgage loan crisis while many homeowners have experience large increases in their wealth in the past couple of years.
Our personal homeownership story includes the purchase of one of the original SoHo warehouse to loft conversions in the mid-1980s for $110,000. Livability and affordability were first considerations (SoHo was much less expensive than the West Village then), but it was also viewed as a purchase with much more potential than a similar priced property in NJ. In 1999, we purchased a Brooklyn brownstone after SoHo became overrun with tourists. I never bothered to calculate our IRR when we sold our house in 2019 to the ex-wife of a hedge fund manager. While our case is clearly far from the norm, it nevertheless is the result of taking a risk on two properties that we viewed as up and coming. I hope you will pardon me for continuing to consider home ownership an investment.
No apology needed. This is what this forum is designed to do, engage in open dialogue.
Thank you to all who commented below and for reading the article. We appreciate the opportunity to blog and receive insight for those who are going through what is being discussed.
As for clairty, if you google what kind of return you should expect on your home, google will tell you it is somewhere in the 8% range. You and I know that a home is not an investment, but a place to live. Although we understand this, oftentimes many go in with expectations that are unrealistic. This article is purely meant to show how IRR is different from what your expected price return may or may not be.
All things considered, you must live somewhere and that is absolutely true. You have all been great and absolutely helped me learn in the process.
This is a meaningless analysis unless you also account for the amount you did not pay in rent. I presume you were not planning to live in your car or on the street? There is also an incalculable value in knowing that your mortgage rate is fixed, while your rent can increase year by year.
I bought my current house in 1989, and paid off my mortgage when I retired in 2000. Therefore my housing costs for the last 21 years have been property taxes (maybe averaging $2,500/year), insurance, maintenance and renovations. Since I am planning to sell the house I recently went through my records to see how much I have spent on renovations and maintenance to increase my basis and the total (not all of it deductible, and not including minor fixes) came to $103,000 over 30+ years. Add the property taxes, insurance and yard maintenance and calculate the annual average, and I’m looking at just under three months rent per year – at today’s rates. Even if I am way off, it shouldn’t come to more than six months rent. (A newish two bedroom apartment just up the street from my house is going for $2,200/month.) I think I am way ahead,even without considering that the house should fetch more than enough to cover the entry fee for the CCRC I plan to enter next year (thus saving decades of LTCi premiums.).
Thank you. The meaning of this analysis, to put it simply, is to show how often a 5% annualized return is often much different when using internal rate of return. You are quite correct when you consider I have to live some place, for example, I did live mutliple palces and paid rent while I played in the MLB. So I do understand the value of a home as an asset.
What I think many fail to understand, the average person see’s it as, I purchased my house for X, and will sell it for Y. I made a good decision on this because the price return was positive. The moral of this story is not to say it was a bad choice, it is to say that what your annualized return represents is not the true return on your investment.
I hope this clarifies my anaylsis.
So the entire post could be summarized as “Just because you bought a stock at $X and sold it at $Y doesn’t mean you made a profit. Sometimes there are other costs to consider and your profit may not be as big as you think”? I agree with this but I don’t think that was your intention at the onset.
I think its the last paragraph in your post that is the telling part. It seems you built a straw man to knock down and reading through all the comments have you softening your position a little. Bouncing between your personal account and the 9Inning podcast account here in the comments also is interesting.
Thank you. I am bouncing through multiple accounts due to the fact I’m using multiple devices. So that’s part 1.
Part 2, absolutely no softening and all opinions are well received. This is an incredible forum where wonderful individuals have incredible commentary. Mr Clements provides a wonderful forum for idea sharing.
I recently conducted an interview with Mr Clements to be released next week. It will be on this channel hopefully Tuesday https://youtube.com/channel/UCw9yLfTDBAprrLWvmcT6fFA
We need to hook you up on a password manager, Kevin. Would make it easy to log in with any identity from every device. Holler if you want a hand.
What is funny, when I log into this with my phone it goes through another application. With my computer it uses Twitter. Who knows. I just want to make sure I am responding to the comments to add clarity and reduce confusion.
It has never occurred to me to calculate my rate of return, internal or otherwise. I am not, in fact, interested in it. I bought my house because I was tired of hearing the occupant of the apartment above me, and because I could use the tax deduction. I kept it partly because I enjoyed it, partly to avoid the hassle of moving and partly because it was cheaper than renting once I paid off the mortgage. I valued the security of a paid-off house above whatever my rate of return might be.
Trust me, I understand that for sure. I had mutliple apartments where I grew tired of listening to tenants dogs barking or shouting matches. HAHA. But of course all of those places were temporary housing, for example, in NYC that is bascially all you have. Unless you move to Jersey or one the Boroughs
The reality is no one see’s their homes like this, and I did not either until I began studying for my CFA exam. Gave me an entirely new way to look at cash flows.
Based on the CPI the house i bought in 1975 for $59,000 should be worth about $319,000, but i sold it for $530,000 (not the $500,000 I previously stated). On the other hand over the 43 years I paid roughly $322,500 in property taxes. In addition, I put at least $200,000 into improvements, maintenance, etc.
Today a two bedroom apartment where I live goes for about $3,000 a month. Over the next 43 years that would equal $1,548,000 without increases.
Someone smarter than me can do the math😁
Again, this is not a debate just for commentary. You may be comparing today’s cost to yesterdays price. This commentary is purely a cash flow exercise denoting the difference between annualized and internal rates of return. When cash flows are involved, it has a definitive impact on return.
So if I use your example above:
CF0=-59k
CF1=-12,153
F1=43
CF2=530k
IRR= (-.388)
This is just a simplified example showing the value of IRR (-.33%) versus showing a 5.23% average return.
Did your analysis include what it would have cost you to rent an equivalent home? That is real value that you got from the home.
I agree that most homeowners do not realize the cost of ownership and its effect on the value of their. But of course most homeowners do not see their homes as investments.
This is purely a cash flow exercise showing how a positive market return of 3-4%, can become a negative internal rate of return provided the cash flows.
The benefit of home ownership is the equity that is built up in your home, and it being an asset on your balance sheet. I have to disagree with the comment ” most homeowners do not see their homes as investments”. I come across it everyday where homeowners indeed see their homes as investments.
Don’t you have to offset the equity by the expenses associated with the accumulation of that equity?
Actually no, if you look at a balance sheet of assets and liabilites, the liability side represents what is owed or not owed on that asset. What you are referring to is a cash flow statement showing expenses and income.
So the equity would be offset by the amount of liability on that asset.
Homes are a luxury purchase, but I seriously doubt most people have a negative rate of return like you did. I also doubt very many people do better than maybe keeping up with inflation. One statistic that is clear though is that most millionaires own homes and are not renters. There appears to be something about people who are financially successful that leads them to buy rather than rent.
The standard rate of return was actually positive. The real purpose of this article is to help people understand the difference between annualized returns and internal rate of return. Most people do not factor in all things considered when selling a home such as; property taxes paid, annual maintenace, insurance, etc…When you factor in all of the true cost of home ownership, I would venture to guess many of the people that have stay in their homes longer than 7-10 years have a negative internal rate of return. Of course things are all relative, and this was my experience.
This is an illogical way of looking at things. You are using your experience to justify a position that isn’t rational.
All people, including renters, pay property taxes, annual maintenance, insurance, etc. The cash flow is the same whether one owns a home or just rents it. The homeowner has these expenses broken out where the renter has all these costs combined into what becomes their monthly rent.
You need to come up with similar calculation for all the same expenses for the house but pretend you were a renter with annual rent, insurance, and maintenance increases to determine your internal rate of return.
I think you are structuring the discussion to ensure the outcome you seek.
This is not an argumnet, but an experience that I indeed encountered. IAD, I hope you are doing ok. Seem a bit defensive which is not why this forum was created. Wishing you the best.
I agree, you need to think of it as housing (a necessity) and a home (an emotional luxury, albeit a valued one) first, and investment second.
I also think it’s better to analyze as an opportunity cost. If the alternative is to rent, estimate what total rental costs would have been, and what investment returns would have been for any savings during that period. Worth noting that a fixed rate mortgage acts very much like rent control, which may or may not exist in your area.
You are correct. I think that may be offset by property taxes and maintenance perhaps. I live in the Lone Star State where property taxes range between 2-3%. Although you can deduct property tax it’s an itemized below the line deduction.
We bought our first house in 1971 for $29,000. We sold it for $42,000. We bought our second in 1975 across town for $59,000. We raised our family there and sold it for $500,000 in 2018.
I never thought of either as an investment and they were both more than a place to live. They were home to our family of six. As the saying goes, home is where the heart is. There are nearly unlimited memories associated with those houses from bringing babies home from the hospital to seeing them off to college – and returning for awhile.
An investment is an investment and a home is a home. I think the family home is still part of the American dream, a different kind of investment.
You are absolutely right. A home is definitely a different kind of investment. Money cannot replace memories.