Readers Write: Housing as an Investment

The great thing about having an engaged and intelligent readership—besides being able to publicly flatter them—is that they catch you when you fall short.  I recently attempted to discuss the value of an owner-occupied house as an investment.  My efforts to simplify a complicated calculation caused a number of you to point out some factors that were not included in the original piece.  Thank you for your assistance.

Please note that you will not be quizzed on this topic.  In weighing the distinct possibility of confusing you even more, I decided that it was still worthwhile to explore the matter a bit further for those so inclined.  For the rest of us, please skip down to the "Words of Wisdom."

The comments I received centered around two basic concepts: leverage and imputed rent.  Applying these concepts can cause the return on housing to be higher than I stated, but they won't necessarily allow a house to keep pace with other forms of investments.  As the articles cited later on indicate, the actual results will vary based on a number of factors.  The bottom line is that your house will not likely achieve returns commensurate with other investments even factoring in these concepts.

Leverage:  Most people don't pay for their house with a wad of cash.  The vast majority of us make a down payment and take a loan to finance the balance.  Because you are only paying a percentage of the purchase price up front, the returns you receive on the modest down payment are magnified when the house appreciates.  The problem, of course, is that losses can be magnified if the house depreciates.  Leverage in any investment situation exaggerates both the upside and downside.

Imputed Rent:  When you buy a home, you do not have to pay rent for a place to live.  This "imputed rent," or rent you save, can be considered part of your return on buying a house. 

For those wanting to dig deeper, excellent descriptions on how to calculate the returns on a house can be found in blog postings by the Oblivious Investor and Michael Dubis  as well as an academic article entitled "American Dream or American Expression?  The Economic Benefits and Costs of Home Ownership." 

These articles also consider tax-related comments from readers, such as the tax consequences of mortgage interest. 

This discussion is meant to introduce you to some additional concepts that reflect the complexities of the matter.  The devil is in the details.  I am, of course, always interested in your feedback.

Words of Wisdom

If I had to live my life again, I'd make the same mistakes, only sooner. —Tallulah Bankhead