3/14/2010

A Home: An Investment

I found this article in the New York Times called: "Great Time to Buy (Famous Last words)" and I have to say that I do not completely agree with what Frank Llosa,a real estate agent working in northern Virginia, says: “People are frequently buying for the wrong reasons,” . “In most cases, he says, they think that they are getting an income tax break or that their home is an investment.” From my point of view, buying a home as an investment is a good reason to buy a home.
I have been at SUU for close to four years now and, I have never heard one of my economics or finance professors say that buying a home is not a good investment. I ran some numbers to justify my point of view and this is what I found. My roommate and I pay $700 a month for renting a house in Cedar City, UT. We would pay this amount (700*12 months * 50 years) = 420,000 over our life time. Comparing this to if we were to borrow a $300,000 loan at 6 percent equals $367,680. There is a huge difference here, I can buy a home for $367,680 over 30 yrs and save $52,320 over 20 yrs not paying rent. I’m not counting the increase in value my home will gain over 30 yrs or the money I will be saving not making a mortgage payment over the next 20 yrs. What if I wanted to move and sell my house? Yes, the housing market could be in a slump and I might not recoup all the money I borrowed from the bank. So I lost some money but I also lose for paying rent for fifteen years and I decide to move. When housing prices rise rental fees rise, they do not remain the same. My conclusion it is always a good investment to buy a home when you are planning on staying somewhere for a long time.

7 comments:

Eric said...

I found this cool program on the New York Times website that illustrates when it becomes profitable to buy based on appreciation and rental rates.

http://www.nytimes.com/interactive/business/buy-rent-calculator.html

Dr. Tufte said...

Ooh Victoria ... I'm guessing that you never asked me whether buying a home is a good investment. (And, it's a somewhat different subject, but I have said in class that elected representatives encourage home ownership because it ties potential voters to their districts).

So, here goes: under almost no normal conditions is buying a home a good investment idea.

Having said that, there are three non-normal conditions that may make primary residential real estate a good investment in the U.S.

First, there is the mortgage interest deduction. It is bizarre that we allow businesses to deduct interest of any form, but individuals are generally allowed to only deduct mortgage interest. Of course, any decent economics student will also recognize that this will also push up the price of homes as people react to the deduction, so it isn't clear if this is a net benefit to people.

Second, there is the restriction on the use of margin for purchasing most assets. We discourage people from buying productive assets - like stock of Google - with borrowed money, but we encourage them to do this with a stationary, high-maintenance asset.

Third, there are land use restrictions. Virtually all of the counties in the country that have had high returns on residential real estate are ones in which there are severe land use restrictions that discourage new construction.

If you put these together, yes, some people can make money on real estate. But, even then, average real returns on primary residential real estate over the long-haul are not very good (compared to stocks).

Lastly, Victoria's math is ... not so good. It assumes that rent will never rise. It doesn't discount rent or mortgage payments. It takes no account of a down payment on a house; it has no opportunity costs for avoiding that. And, the payment calculation is way off: a 30 year, 6% fixed mortgage on a $300,000 house would have payments of about $1,800 per month. This comparison isn't correct in the first place, but to follow Victoria's example this would add up to $650,000 over 30 years.

The calculator that Eric found is much better, and confirms the point I made above (do make sure that you set the appreciation and rental inflation rates to be about the same, and that you use a 0.5% tax rate, which is about right for Iron County).

Abigail said...

There’s an article in the Wall Street Journal titled “To Buy, Or Rent” that I found interesting. It’s about buying a home in retirement versus renting a home, but I think the calculation they give could make sense to use in most situations. The equation is the price of the home divided by the cost to rent for a year. If the number is above 20, the author recommends renting; otherwise she says buying should be a good option.

http://online.wsj.com/article/SB10001424052748704541304575099882517652948.html?mod=WSJ_RetirementPlanning_MoreHeadlines

Patrick said...

For my work, I regularly hear personal financial planners tell their clients to rent their homes and invest the difference. There are some leveragibility and tax incentives to owning your home as Dr. Tufte mentioned, plus the pride factor, but renting is often the better move in someone's financial plan.

Belba said...

Today interest rates are lower than they have ever been. If you have good credit and a little extra money in your pocket, buying a house to live in or as an investment now is a smart move. Buying a home now is cheaper than renting. Buying a home as an investment, renters essentially pay the mortgage and some of the up keep for you. Concerning an investment home, a comment mentioned above said to reinvest the difference between the rent received and mortgage, but one has to be sitting pretty good financially to do this. It may be smarter to save that money for a rainy day. For example, if your renters move out, you may need to make sure you can make the mortgage payment if new renters are not readily available.

Dr. Tufte said...

I'm not sure how this has added to the discussion above.

Dr. Tufte said...

Belba's worried about what my response to her comment.

Let me clarify.

What I'm suggesting is that this thread never had much to do with the material covered in my classes (which is OK), and that it doesn't seem to be going in that direction either.

That's OK for interested readers and commenters, but the role I've chosen on this blog is to nudge the threads back towards the class material, and I'm at a loss on how to do that for this one.