“Purchasing power is a license to purchase power.”
“The only honest dollar is a dollar of stable, debt-paying, purchasing power.”
–Senator Robert Owen
How many of you have heard this one?
Your house is your biggest investment.
With the burst of the housing bubble in the 2008 timeframe, a lot of people who had “invested” in their houses were left feeling like this:
However, very broadly speaking, real estate values do tend to go up over time. The population is growing. Land is not infinite. Neither is wood, tile, shingles, or even nails. So, theoretically, we have a limited supply and a possibility in which demand could exceed supply, which would increase the price of housing.
There’s a further argument about the benefits of buying a house. You can get a mortgage, and then some portion of each mortgage payment will be put towards equity in your home – money that you get when you sell the house at some point in the future. Be patient enough to wait 30 years (or 15 if you’re a smart mortgage borrower, which, alas, is not the preponderance of borrowers), and you’ll not owe anything to the bank and own your house free and clear.
In order for this narrative to be true, we need to look at three variables and see how they play out.
- Mortgage interest rates
- Changes in housing prices
Why the last one? you might ask. Because, as we saw in “Getting Your Money Back in a Safe Investment is Not Enough,” you make an investment with the minimal goal of being able to purchase the same amount (and hopefully more) goods and services in the future as you can currently purchase. Your investments have to beat inflation for you to achieve your goal of having enough money in retirement to live the lifestyle you want, unless you’re planning on significantly scaling down that lifestyle.
So, over time, the changes in housing prices must exceed the mortgage interest rate at the time of purchase plus inflation over time in order for you to wind up with more purchasing power than you started out with, making your house a reasonable investment.
Does That Happen?
In order to answer that question, I took the historical inflation rate, historical mortgage interest rates for 30 year mortgages, and the average growth rate of median housing prices to see what has historically happened.
First off, we have to make a couple of assumptions. The first is that the average home purchaser lives in a house for 13 years, as this research shows. Then we looked at aftcasts to show what happened to home buyers who bought from 1972 through 1998 (the last year through which 13 years’ later data is available).
We assumed that the purchaser bought a $100,000 house and put 20% down. That purchaser got a mortgage at whatever the average 30 year interest rate was at the time of the purchase. Then, the purchaser held the house for 13 years, paying mortgage payments along the way, and the house’s value tracked the growth or decline of national median housing prices. At the end, the purchaser sold the house, paid a 6% commission to the Realtor, and paid off the mortgage.
I compared the purchasing power, e.g. the inflation-adjusted value, of the money that the former homeowner received at closing to the original $20,000 to see if, indeed, the homeowner was better off for having owned the home – making the home a better investment. I annualized the returns and compared them to each other.
How did the average homeowner do over that 28 year period?
As we can see in the chart above, the average homeowner beat inflation 2 out of the 28 observations and underperformed inflation.
Does this chart suddenly create a screaming endorsement of renting? Not necessarily.
However, it should put to rest the idea that a house is a great investment.
No matter how you slice it, you’re unlikely to make money off of your housing.
You also don’t make money on buying food, paying for electricity, buying life insurance, and the like.
Instead, it would help to reframe your thinking about housing into an expense rather than as an investment, because as this chart shows, in general, your own house is a terrible investment.
What typically happens when you go house shopping with a Realtor? The Realtor frames the discussion in terms of the maximum amount of house that you can afford with your income (usually some outrageous multiple of your income).
That’s because you’re thinking about that house as an investment.
If you think about it as an expense, you start to think of it in terms of minimizing that expense.
You also probably don’t get as emotionally attached to that house (another downfall, as we saw in “Hoarding, the Scarcity Mindset, and an Unnecessary Attachment to Your House”). How often do you get emotionally attached to your water bill?
Thus, in thinking about the house in terms of expenses (and minimizing them), you are more likely to steer that Realtor towards lower priced houses that meet your needs rather than trying to justify purchases that will likely stretch your budget, reduce your retirement contributions, and cause you to depend on future pay raises in order to make the household economics work.
The upside is that the less you spend on your house, the more money you have for saving and for spending on the things which will truly make you happy.
Did this surprise you? Did you realize how much of a drag a mortgage has on your future purchasing power? Did you think about houses as an investment before seeing this article? Does it change your thinking about the place that you’re living in? Why do Realtors attempt to steer you towards the most expensive house (almost a rhetorical question)?