When it comes to buying a house, gone are the days when it represented the epitome of the American Dream. For years, the amount of renters in America has been increasing.
In my particular case, I prefer to live close to work which is in the heart of Boston. Buying a house or a condo there is just impossible at my current pay grade.
Nevertheless, most people, me included, envision themselves eventually moving to a more affordable area where they can buy a house and build some equity. To do so, a lot of them end up spending way more than they need to. In my opinion, real estate has a weird way of making the outrageous look acceptable.
Part of it is due to the banks using aggressive estimates of what types of mortgages their customers can afford. Part of it is the “keeping up with the Joneses'” mentality that a lot of us experience at some point. But to me, the biggest reason of all is that we don’t think of a house in the same way we do any other purchase or investment. We see it more as a right of passage to adulthood and as a result all rationality is lost in the process.
Some of us see a home as a purchase, some as an investment. I will show you that regardless of what type of homebuyer we are, being careful about how much we spend is a wise decision.
Note: this post is exclusively about primary residences. Rental properties are not part of this analysis.
A house as a purchase, not an investment
If you look at a home as a good you are just buying to achieve a level of comfort or fulfill a certain need, then there is no reason to splurge on it. After all, would you spend a big chunk of your net worth on food, clothes, cars or boats?
The main difference with a home is that it’s generally an appreciating asset. But it’s still important to keep in mind that it’s something we are mostly using for consumption and even if it may be worth a lot money , we don’t actually have easy access to it. We can’t enjoy any of the financial returns of a house unless we sell or rent it.
A house as an investment
Whenever we invest, the first thing we look at is usually what return can be expected based on the history of the asset. The average rate of return on property values is not as well documented as stock market indexes, but it’s clearly a lot lower. Multiple sources cite rates between 3 and 5 %.
If we throw in maintenance, repairs, insurance and taxes, the return gets even worse.
That’s a relatively lousy investment. Based on these numbers, the best option is to buy the cheapest home that can satisfy our needs and invest the rest in better vehicles.
Real estate investing is a much viable option with rental properties due to the fact that actual income is generated every month.
In addition to the rate of return, we often look for diversification. Buying a house is the real estate version of buying a single stock. Imagine allocating hundreds of thousands of our portfolio – which for most people is a huge percentage – to one company. That’s not even taking into account that most of the investment is financed with debt.
I don’t know but borrowing $200,000 to purchase apple stock while I’m only worth $50,000 doesn’t exactly sound like a smart investment to me.
Part of my strategy for early retirement is eliminating the biggest expense of all: housing. In order to do so, owning my home outright will be the only option. Even though I will almost certainly need to take out a mortgage, I will have to make it a goal of mine to pay it off as soon as possible. The math is simple. If I don’t have a mortgage, my retirement expenses go down dramatically, reducing the amount I need to save by several thousands of dollars.
I am not against buying a house. I actually can’t wait to have my own and stop paying someone else’s mortgage. But when I do take that leap, I will make sure whatever I spend pales in comparison to my net worth. I am not in the habit of overspending on consumer goods or investing in underperforming, under-diversified assets. Why start with my home?
My future house hunting budget won’ t depend on how much I qualify for with the bank or how much money I make. It will solely be a function of how rich or poor I am and how much of my net worth I think should be used towards buying a house. If that results in me leaving Boston for a cheaper area or waiting a few extra years, so be it.