Since I'm in the market for a house, I've been writing a bit more about housing and real estate lately. In particular, I'm most fascinated by the returns on real estate as compared to stocks and with the financial advantages or disadvantages of buying a house versus renting. So when I ran into Knight Kiplinger's latest column and saw that he was addressing similar subjects, I dived right in.
In the June issue of Kiplinger's, Knight discusses the realistic expectations we should all have when it comes to the financial return on our homes (primarily, we shouldn't expect it to be a big earner in our portfolio.) Here's the last paragraph of the piece where he summarizes his thoughts:
My bottom-line advice: Don't over-invest in your home either when you buy it or when you make subsequent improvements. Buy only as much house as you need. Plan to stay a long time. Don't view your home as your primary retirement savings. Instead, invest regularly in asset classes with the best long-term results -- the stocks and bonds of dynamic businesses, both in the U.S. and around the world.
Here's my take on his suggestions:
1. I'm not sure what "over-investing" means in this context. If it means not buying more house than you can afford, I'm in 100% agreement with him. If it means it shouldn't be too much of a percentage of your net worth, I MAY be in agreement with him depending on what that percentage is. Personally, my house is 20% or so of my total net worth and that seems fine to me.
2. Again, I'm with him on the "buy a house you can afford" idea. I'm not sure if that's different than what you "need." To me, if someone wanted to buy more house than they "needed" and could afford doing so, I'd be fine with that. Our house is probably more than we "need," but we like it and the room it gives us.
3. Yes -- stay a long time. Buying and selling over and over again can be a big hit to your net worth. That and it's a real pain to move your stuff. Moving the contents of our house from one place to another is something I'm not looking forward to.
4. I'm not looking at my house as any part of my retirement savings -- other than rent free living space during retirement. I am saving in my 401k and other investment accounts to pay for our retirement.
5. Of course -- stocks are the way to go. For me, this means investing in index funds.
How about you? Do you have different views on this? Do you look at your house as a major part of your investment portfolio?
I don't look upon it as a part of my portfolio, partly because its not actually purchased yet, but also because I'm always going to need to live somewhere. On the other hand, when I retire in 40 years time, I'll have paid off the house and could get a reverse mortgage to access the capital which would add to my standard of living. At that stage hopefully I wouldn't have any dependents who would need the money (although they might want it).
Posted by: plonkee | May 15, 2007 at 09:09 AM
It is clear that over long periods of time homes appreciate approximately 3% annually. Stocks appreciate 10% annually. In most cases, particularly the present time where the average cost of renting a sq.ft. is much less then the cost of buying a sq.ft. (due to housing boom), renting is cheaper than owning (you must consider property taxes, mortgage interest, closing costs, and maintenance - all of which cost you, despite what you think when you itemize your deductions each year).
If you were to take the difference in cost between renting and owning and invest it in stocks (even conservatively in index funds as the host recommends), you would have more net worth at the end than if you owned the house that you lived in during that time.
Sure, you may get lucky and buy a house in San Francisco in 1990 and sell it in 2006, just like you might get lucky and buy Microsoft in 1980 and sell it in 1995 or Cisco in 1998 and sell it in 2000. Chances are you won't.
This does not mean we don't want to own our own home, or that we shouldn't own our own home, it just means we shouldn't think of it as a good investment, but rather as a low-returning investment, and allocate the appropriate resources to it in our portfolio.
Posted by: Joey | May 15, 2007 at 09:39 AM
Housing is typically a major expense for folks (although medical & long-term care can often overshadow it in the "golden years"). If you pay off your house, that's a big chunk out of your monthly expenses that can be spent on something else.
So of course it would be foolish to expect that your house is going to be a major income producer to fund your retirement, but owning a home seems like a great way to reduce your expenses once that day comes.
Posted by: Rich Schmidt | May 15, 2007 at 09:40 AM
Well, I don't own a house, but I think that houses aren't a good investment if you don't actually own any of it (have any equity), which unfortunately is a situation that many people are currently facing (http://moneycentral.msn.com/content/Banking/Homefinancing/P148861.asp). How do you realize your investment without selling, and as plonkee said, you have to live somewhere. You can extract equity (the great House ATM), but again you're on the hook for that money if you can't sell at your needed price. If you plan on holding the house for a long time, I think that it can be a good thing, so long as you can still afford to take care of other financial responsibilities and you can get out from underneath your mortgage if necessity (family health issues) or opportunity (job relocation) would make it prudent to do so.
Posted by: cami | May 15, 2007 at 10:36 AM
We bought a house that we could afford at the time and have been lucky that the value in our town has exploded since we have lived there. While we could technically still afford to buy in our area, it would likely be beyond my comfort level as we wanted something economical.
While we don't view our home as an investment, we are currently investing some money in improvements that are needed as we also tend to stay here for the long-term. We are replacing the windows right now and have a few other projects planned. Our current home is large enough where we can stay put until our kids are out of the house and we are ready to downsize.
From a retirement perspective, we do not look at our home as part of our savings either. Our retirement funds are in index funds and have not factored the value of our home into any of our retirement calculations.
Posted by: My New Choice | May 15, 2007 at 12:20 PM
I'd curious to hear what your opinion is on this article:
http://www.smartmoney.com/home/living/index.cfm?story=rent&cid=1012
It argues that people should rent rather than buy, then pour the difference between rent and what a mortgage would be into stocks. I had never heard anyone give that advice before.
Posted by: Stephen | May 15, 2007 at 02:39 PM
Stocks do offer better returns than real estate, on average, but it is a mistake to view real estate on average. Leverage can make real estate better than stocks, but only in certain metropolitan areas. In most of the country, leverage is neutral or even negative. Renting is cheaper than owning, as it always should be. This is rather extreme now and will likely moderate in the future, but over the long run, inflation works against renters and for owners and for this reason, owning is always cheaper in the long run. You may not want to buy now, but you will be much better off if you own by retirement. Real estate is closest to inflation linked bonds and offers steady benefits, low volatility, and diversification making it a complement to stocks.
Posted by: Lord | May 15, 2007 at 04:35 PM
Funnily enough, the rule of thumb over here in the UK is that renting is more expensive than owning (landlords have to make money) and also historically house prices have risen at approximately 2% above inflation.
Posted by: plonkee | May 16, 2007 at 08:31 AM
I find it interesting that one of the arguments for home ownership is that you will be better off when you retire if you own your own home. I assume this has something to do with the notion of not wanting to pay mortgage or rent when you are on a "fixed income".
Given the disparity in cost between home ownership and renting, if you were to invest the difference in cost over your lifetime, at retirement you would either have a) enough money to continue paying rents as part of your living expenses, or b) enough money to purchase a home that met your 65-year-old needs.
If you have saved and invested before you retire, you are no better off if you own a house than if you don't. Actually, if you don't own a home but rather have a large investment portfolio, you have more options.
Again, I'm not saying people shouldn't own homes (I do), but we should recognize the "investment" for what it is.
Posted by: Joey | May 16, 2007 at 09:27 AM
This would be true if you didn't have to contend with taxes, but taxes will shred stock returns with marginal rates often exceeding 50%, so instead of 10%, you just might be lucky to see 5%, or about 2% over inflation.
Posted by: Lord | May 16, 2007 at 04:02 PM
I do not really consider a house as an investment. Although it increases in value, it's used as a place to live and I I'm not planning on it for retirement.
Posted by: Dy Phan | May 16, 2007 at 04:36 PM