Housing, as we all know, is a combination of necessity, consumption, and investment. Though a house is indeed an investment, you should be clear-eyed about the risks and rewards of owning one.
Despite the numerous risks of investing through home ownership - and acknowledging that it's neither always a slam dunk nor an appropriate step for everyone - long-term home ownership as an investment is always a good idea for a host of important reasons. No other investment offers such a variety of positive factors stacked in its owner's favor. Forced savings, tax-advantages, and potential for improvement all make home ownership the most important wealth creating vehicle widely available to almost anyone who is willing to invest.
Though a little bit heavy on the math that we'd like, drilling down the numbers and crunching all the possible potential outcomes of where your money would go is the best way to evaluate whether you're more inclined to just keep hoarding your cash and risk using it for random purchases, or conveniently tuck it away and invest in your own home. It's exactly because of that that we've rounded up the most important advantages of home ownership from an investment perspective, both for personal wealth enrichment as well as financial freedom in the long-run:
Forced savings - It turns out that for most people, voluntary savings is tough-to-impossible on a monthly basis. This is especially true for the younger generation who are on the cusp of asking themselves whether it's a risk worth taking. What seems to effectively generate a personal financial savings surplus each year are personal as well as bank programs that 'force' people into saving, such as excessive income-tax withholding or automatic paycheck deductions for a retirement / 401K plan, or a financial institution savings program.
Contrary to the belief that this is a burden similar to those mentioned above, monthly mortgage payments - which include a portion for paying down principal and purchase small increments of home equity on a monthly basis - work in a similar fashion. Most of us have a hard time accumulating a few hundred thousand dollars in investment. But through the forced-savings method of paying down a mortgage every month for a period of 15 or 30 years, and believe it or not, millions of people do manage it since they actually get to use and enjoy what they're paying and saving up for. Not a whole lot of people know this, but the 'magic' of wealth accumulation through home ownership can be attributed to this fact precisely because if you think and analyze it really hard, the psychology of forced savings matters tremendously, and would figure into your plans more than any other factor that you would consider.
Capital gains tax exemption
The mortgage interest tax deduction is what we think of when we think of tax-advantaged investing in our home, but the capital gains tax exemption for home owners overwhelms the mortgage interest tax deduction - when it comes to wealth generation.
A simple mathematical example illustrates this point.
Let's say you bought your house for $200,000 15 years ago and just sold it for a gain.
Factoring in various elements such as current inflation and the compound interest rate of your mortgage, and the fact your property only tend to increase over the years and it being sold within the next five years, you could end up already adding as much as $115,000 to your equity in a matter of a few short years - that's with or without improving and upgrading the site. Imagine almost doubling your initial investment in such a short period of time.
In comparison, your money - assuming that you currently have the cold hard cash that is equivalent to your purchase price - is put on a money placement savings account. The taxes alone that will be tied in on the "capital gains" you'd be making form that investment placement would already equal almost half of the amount that you could've made by just increasing your equity through homeownership. That's already eaten up a quarter of your potential earnings.
Why? Well, money put into investments and savings and the like will be tied in to your income, and would eventually increase your income tax bracket, and get bundled up with all of the compensation you've made through labor and employment. In contrast, your home equity is taxed separately, and is completely exempt when the IRS calculates and factors it in to adjust your income tax rate. Viola! Instant money savings right there.
Not only that, but as you roll your gains into let's say another property, the gains on your next house also remain completely exempt from taxation. Most homeowners can continue to build home equity over a lifetime and a series of houses and never pay taxes on their capital gains, making it a viable option to earn more without actually paying more tax. This is a legal and legitimate way to increase your wealth. Think Donald Trump and Warren Buffet.
In fact, this "trick" is so amazing and so awesome that a smart number of middle class households turn to this tactic to accumulate tax-free wealth. The capital gains tax exemption gains on your house as an investment is a really cool money saver! But wait, there's even more:
Mortgage interest deductibility
The tax deductibility of mortgage interest gets a lot of attention, and it's worth acknowledging this important advantage of home ownership as an investment. In fact, certain finance geeks view have this opinion that home ownership's an unfair tax break, and that it's also overvalued in the popular sense.
But using the example given above, the interest rates you pay on your property are a deductible expense to the check you'll cut to Uncle Sam come April. Truthfully, the higher the mortgage amount, the bigger you're actually deducting from your income tax and conversely, the more money that you keep to yourself.
Nominal increase in home equity
The value of your home - $200,000 in our example - should at least keep pace with inflation in the medium and long term. If inflation ticks up from an ordinary 2% per year to a less comfortable 9% per year, you can reasonably expect your home, like other hard assets will increase in price at a comparable rate. The only thing you need to remember with this point is that even though prices climb up and get more expensive, your property also increases its price tags. Inflation is good in this case since this will all be tax-free capital gains on your end.
Another great thing about home ownership with a mortgage coupled with inflation is that your mortgage has a fixed value. Assuming you paid the mortgage on time, your mortgage balance at the end of 10 years would be almost half of what you completely own.
Your nominal 'home equity', under the inflationary scenario, would increase your total debt but also likely double what you've already put into payment, and at the same time, you've already paid down a significant amount of your loan. This indicates that your net worth is rather beefed-up, and you have your home to take credit for that.
Purchasing your $200,000 home with let's say a $40,000 down payment and a $160,000 mortgage offers you, in financial terms, 4-to-1 'leverage,' also known as the ratio between equity and debt. For the average middle class person engaged in investing, banks and brokerage companies provide very little leverage.
In many ways zero leverage is appropriate for the average investor, as leverage exaggerates investment returns, both up and down. A review of financial history shows that leverage has a way of periodically punishing investors, and small-time investors are the least prepared for the catastrophic consequences of a systemic credit crunch.
For middle class folks fortunate enough to weather a few decades of home equity gains amplified by leverage, however, small nest eggs become meaningful accumulations of wealth through the magic of 4-to-1 leverage.
Yes, it increases your risk and the volatility of outcomes, especially in the short run. If you can sustain a longer holding period, however, the debt helps you accumulate wealth. And if you can use the debt responsibly - an acknowledged big 'if' - you can continue to access this home-equity-based leverage for other investment purposes.
Local knowledge is useful
Few middle class people can effectively apply local or personal knowledge to investing in securities. We are all at an extraordinary information disadvantage when purchasing stocks, and even bonds. Hundreds to tens of thousands of the smartest people in the world are - right now - following the same stocks we might buy as individuals, making moot most individual stock-picking efforts to find unrecognized value.
When buying a house as an investment, however, specific local information can make us 'experts,' to some degree, in what we buy. This local, personal knowledge helps even the playing field in a way not generally available in other investment areas.
Any home buyer can investigate or intuit neighborhood trends, school quality, demographic shifts and hidden aesthetic potential in homes. As home buyers we become long-term value-investors in a way totally unavailable to most people in other investment spheres.
Home Improvement & 'Activist Investing'
Home improvement, although not for everyone's enjoyment or range of specialties, can lead to fruitful outcomes. There are those though who would rather hire than do the work themselves, negating what savings they could have had in the "hard labor" and monetary investment they put in
But for many, home maintenance and improvement allow us to physically enhance our investments. We can personally work on a low-value or under-valued asset and make it more valuable.
Think of it this way: when hedge fund investors purchase shares in a target company and then agitate to make that company more valuable for shareholders, they're acting like home improvement guys with a different set of tools. Most of us can't bring our toolbox to a company board meeting. Owning your own place makes you an 'activist investor', with the ability to improve and add equity to your existing investment.
Taken in combination, these seven factors greatly stack the investment aspect of home ownership in your favor. Of course anyone can lose money owning a home - like any true investment, it's risky - but most of us can accumulate long-term, real wealth through long-term home ownership.
There are also interactive calculators and graphs out there that can show you how much more you're getting out of your property purchase compared to just renting. Check out CNN's calculator and see whether your home was a good investment; Trulia's estimator allows you to see whether it was better to have rented in your current residence than it was to buy; and finally the New York Times also does the same.
For more tips and tricks into how you can make your investment grow, call us! (617) 505-1781