Most of us have our hopes, dreams, and emotions attached to owning a home. I have even said earlier that owning a home should be the primary objective of a small investor beginning his career. Now I am contradicting that statement by saying that once you have learnt the basics of investing and has become an ardent investor, your primary objective should be to grow your capital rather than investing in a house (real estate)! Why? Find below the reasons:
A House is a Depreciating Asset
A structure or a building has a finite lifespan unless you build it with rock to last centuries or concrete and masonry to last at the most 100 years. You have to demolish it at the end of its lifespan to build a new one. Therefore, the value of the structure decreases over time with relation to its age at a rate depending upon the material with which it has been made. Same principle applies to the appliances inside, whether it is electrical, plumbing or any hardware for that matter. Hence, a house is a depreciating asset.
(I am not including the land here. Land is a nonproducible asset. It may become scarcer as the population goes up and its value may increase with relation to the growth of the economy and inflation.)
Cannot Avail the Power of Compounding
One of the greatest techniques in growing your capital is by taking advantage of the power of compounding. Money makes money. However, you invest money in your house for lifetime, and you never take it out but keep further investing on it. Where could the power of compounding do the math for you then?
Capital Appreciation is Often not Realized
Even if the value of the house you have invested gets appreciated due to overall appreciation of values in the community you live and depending on the state of economy, you are still not going to enjoy the cash or the value that has appreciated. You may sell your home but would be tempted to buy another one for the same value! Whatever cash you have paid for your home has been buried deep for lifelong!
Not a Cash Equivalent Asset
Investment in a house or rather real estate in toto is not an investment in a cash equivalent asset. You will not be able to liquidate your equity in your house at the instance you need cash, as you could do with the investments in stocks, bonds, or certificates of deposit. (May be, even gold as an investment could be liquidated easier than a home!) It is harder to find a buyer that matches your expected price; that likes your home and community/neighborhood. Furthermore, with the real estate bubble bust, it may take decades for you to recover your costs, forget appreciation.
Maintenance Costs
In order to keep the house in a livable condition and to protect it from weathering, you need to spend a sizable chunk of cash on your house yearly. Wherever moisture can seep is a matter of concern. Cleaning, repairing, painting… the list goes on until you say “Oh God! Why did I end up buying a house? To spend time and money, or to lose my peace of mind?” Of course, opening the wallet for repairing appliances like air conditioner or furnace that might go out of order, lawn mowing, snow/leaf blowing, penalties and a host of other maintenance costs should disturb your peaceful sleep.
Rental Income Not Equal to Interest on Capital
Another interesting fact that I find is people buy/build homes to just let it out! Now sit down and workout the rent earned as a percentage of return on the total capital deployed. It won’t fetch you even the interest that you earn with your cash lying idle in your savings account at a bank!
You End Up Paying More Than What You Own
Most of us invest our whole savings in owning a home. If we do not have enough savings, we borrow to the maximum extent possible to buy a home. Suppose you buy a house for 150,000 by paying a down payment of 15,000. For the borrowed amount of 135,000, you pay just the interest for 20 years before you pay anything significant on the principal. At the end of the mortgage period, roughly you would have repaid twice the amount borrowed for your home! Isn’t it paying more for what you get? Isn’t it wise instead to pay the interest as rent and live peacefully, growing the principle and future savings by investing smartly than bearing the brunt lifelong?
Very Low Capital Appreciation
Historically, inflation adjusted home prices have increased by only a mere 0.4% per year for the period 1890 to 2004 or 0.7% if you consider 1940 to 2004. If that is the case, don’t you have other investment options to fetch a higher rate of return?
Hidden Costs in Owning a Home
Property taxes, private mortgage insurance, homeowner’s insurance, legal fees, closing costs, pest control, homeowners’ association fees, and a host of other hidden costs in owning a home which I might have forgotten to include here could haunt you throughout the ownership of the house.
Tax Rebates on Mortgage Interest
Yes, you are bound to ask that question! Won’t I save taxes for the mortgage interest? May be; instead I would pay the taxes and invest that money in a growing asset rather than in an emotional asset bearing all the aforementioned headaches.
Advantages of Living in a Rented House
If you choose to live in a rented house than owning a house, you don’t have to bother about the recurring costs and expenses discussed above. You are the boss and your landlord your servant on call! Know your rights as a tenant and what all things your landlord has to take care of. Make him do all that for you and fix up any appliance that fails to cooperate with you. May be you can enjoy the latest amenities by renting a brand new house! You choose where you want to live. For example, you can avoid commuting by moving close to your workplace or close to the school for the convenience of your children. (I let out my house and chose to move near the school of my son thereby saving time and money! I am a work-at-home dad, you know.)
Conclusion: Many of us place all the eggs in one nest, a home! The tax rebate gained on interest paid on mortgage is definitely going to be minuscule as compared with the interest outgo, property taxes, insurance costs and maintenance costs mentioned above. All of these favor living in a rented house than owning a home! The aforementioned observations are with relation to myself owning a home, and I’m not going to own another home either as a second home to let out or as a vacation home. As an investor, emotions have no value. Now as an investor, think of the above facts on whether buying a home is a bad investment or good, and decide yourself whether you want to be intelligent or emotional.
And that’s why Germans don’t buy a home. They are smart! Read here: http://goo.gl/S5PH5l