There is something very emotional about how we think about the value of our own home compared to other investments. Conversations like the one my wife and I had a couple weeks ago are happening everywhere it seems.
“Did you see the house behind us went up for sale this week? They have it listed at 141% of what we paid for our house.”
“Well, there’s no way their house is worth that much!”
“Oh really? I just talked to our neighbor who is a realtor and he said they had five offers on the first day it went up. It sold for more than the list price within twelve hours.”
“Wow, our house is much nicer than theirs! I wonder how much we could get!”
For many home owners, the next step is to visit Zillow to get an estimate on what their house is worth. And, my true confession, while I know the limitation of Zillow, I did just that. And sure enough, Zillow estimates our house to be worth far more than we would have guessed.
I follow the Montana housing market closely and things are crazy here. We have minimal COVID problems and we’re seeing lots of west coast migration. The chance to enjoy the quality of life in Montana, while keeping a high paid job working from home, is driving up real estate prices. Bozeman, for example, has seen the median house price jump from $435,000 to $575,000 in the last year. That’s an increase of over 32% in one year.
But the boom appears to be everywhere. Redfin just put out a report this month that shows asking prices are at an all time high, up 10% from last year. And if you’re thinking about building instead of buying, CNBC has a report out that says some lumber prices are up 112% compared to a year ago.
These types of reports about increasing home prices get everyone’s attention. Our home isn’t priced every day on a stock exchange like our financial assets. So, when we suddenly realize the value is much higher than we thought, we can lose proper context of how to think about our house. I would suggest six ideas on how to think rationally about housing.
How to Think about Housing
First, it’s really easy for some to boast about how much they made, or could make, on their house sale. That might make us envy them. But, in reality they may just be bad accountants.
Real estate taxes, homeowner’s insurance, HOA dues, utilities, and repairs are a few of the costs that a non-accountant might forget to include in estimating housing gains. And then there are the home improvements that we regularly make that could escape inclusion in someone’s estimate of how much they made on their house sale. Did they add that $50,000 downstairs remodel in their cost?
Additionally, consider the impact of inflation on house prices. How much of the estimated profit would disappear on an inflation adjusted basis? According to the Bureau of Labor Statistics since 1967 house prices have increased 4.19% annually, barely more than the overall inflation rate of 3.94% over that same period. These numbers don’t point to housing as being a stellar investment.
Second, put into perspective how your house performs as an investment compared to your other assets. For example, over the same period we’ve lived in our house, I calculated the increase in one of our Vanguard investments, VBK. While I’m moved emotionally when I suddenly realize how much our house value has gone up, I hardly ever think about the over 400% rise in VBK since we bought it. To think clearly about your house as an investment requires us to dial down the emotion and think about it in the context of other investments.
Third, while housing has not historically been a great investment compared to alternatives, it is a great forced savings vehicle that will give options in retirement. In fact, for most older Americans, home equity is the biggest single asset they own. Here are some recent Census Bureau statistics according to Newretirement.com that show average home equity by age:
- 45-54 have $70,860 in home equity totaling 64% of their net worth
- 55-64 have $103,400 in home equity totaling 61% of their net worth
- 65-69 have $136,670 in home equity totaling 61% of their net worth
- 70-74 have $153,300 in home equity totaling 72% of their net worth
- 75 and older have $149,860 in home equity totaling 75% of their net worth
In addition to Social Security, the home equity that the middle class has built up looks essential for retirement. There are a variety of ways to tap into this equity piggy bank including downsizing, reverse mortgages or a traditional home equity loan. However, many of these methods are expensive or cumbersome. I’m hopeful one or more disruptive FinTech companies will come along and make extracting this home equity cheaper and easier.
Fourth, with the politicians spending money without any fiscal restraint, I like having an investment in real estate to mitigate the risk of rapid inflation. A house may be a great way to hold value if the Federal Reserve misjudges monetary policy and inflation starts roaring like it did a few decades ago.
Fifth, the biggest payoff to own a house? You get a place to live. Think of it as renting the place to yourself. If you had to rent the house you own, you might be paying up to 6% to 8% of its value in rent. A Zillow article suggests as much as 12% of the house value is a fair rent. This, in my opinion, is the most fundamental financial concept to think about in your housing decision.
My advice is to look at your housing costs as you would any other consumption expense. The investment gain opportunity and forced savings are secondary considerations.
Finally, there are many non-financial reasons to own a house. It’s the American Dream after all. In fact, part of my time is spent working on affordable housing issues for financial institutions. It’s satisfying work helping others feel more a part of a community because of home ownership. Those intangibles that come with home ownership must be heavily weighted alongside the financial considerations in any decision to take the plunge.
I’d love to hear your thoughts on housing and any successes or failures you’ve had in this area.
Joe Kesler
There’s another side to this as well. Remember the great real estate crash of 2008? Our house declined in value considerably back then. There was a temptation to sell, so we wouldn’t lose more. (Some of our neighbors actually succumbed to that temptation.) But we realized that if we sold we’d still need a place to live, so we’d have to buy a comparable house at a comparable price, after taking a big loss. We decided that we still needed a place for the family to live, and that our mortgage was a contract the bank couldn’t break just because we were “upside down”. So we kept making the payments… and 11 years later we sold the house for much more than we originally paid.
But of course, then we had to buy another house….
(SIde benefit of the 2008 crisis… no junk mail about refi’s and HELOCs for a whole 2 years!)
Great lessons from recent history! Thanks for the perspective from a 2008 survivor. Today the whole conundrum of cashing in on the big rise in prices, but then having to buy another house at an inflated price is real. You seem to have mastered both scenarios. Appreciate the comment!
Joe, I also think about my home in some of the same ways I do investing in stocks, bonds, and savings accounts. Can I sleep well at night with this investment (or mortgage)? My wife and I are in our 2nd house in 32 years. We rented for over a year while saving for a down payment. Our mortgage payment, taxes, insurance, etc. were about 50% more then our apartment rent. Our 1st house was 2x the size of our first apartment. For some reason I slept better with a mortgage then with a rent payment. Much was the feeling I was building equity by buying vs renting. In reality, renting and investing the savings from a pure accounting exercise was absolutely the better choice. We were fortunate to live in a growing community that thrived making selling a home at a nice price possible. It certainly isn’t a given that will always happen. We opted to pay off both houses early for peace of mind and cost savings. That also helped us sleep better. In any case, if you choose another path, the important thing for us is to be willing to accept the consequences of ur choices, both good and bad. We find most choices end up being a little of both.
Brian, I like the way you include in your analysis which decisions helped you sleep better. Our housing decisions are similar to other investments, but having a house paid off to live in is a psychological lift that we don’t get from a stock market investment free of leverage. I think it’s good to consider the “sleep well at night” dimension of the decision even if it doesn’t fit in a return on investment formula. Thanks for sharing that aspect of your decisions. It sounds like you’ve had great success in this area of your finances.