NO! Houses are great places to live, but generally houses are not great investments.

Houses are great for developing a sense of ownership, an attitude of belonging, a feeling of home.  And a house can be the least expensive form of shelter.  But houses are not great as investments.

With all the obviously desirable benefits of owning a home why would I say houses are poor investments?  The whole idea runs contrary to what nearly everyone believes.  I point this out because many people – way too many people – use the rationale of houses being great investments to spend far more on a house than they should.  When the owner overspends on a house then the house does not become a great place to live.  The house does not develop a sense of ownership, an attitude of belonging, a feeling of home. In fact it does not even become an inexpensive form of shelter.  When there is too much house for the income the owners begin to look at it as a burden, a worry, a prison.

My purpose in this article is to separate two things with respect to home buying i.e. needs and wants.  If these get confused we can unwisely burden ourselves with debt by financing our wants for the next 30 years.  Distinguishing between needs and wants is a constant problem for nearly all of us with all sorts of buying decisions.  It can be particularly difficult with a house when it is so easy to rationalize that our wants are really investments.

Over spending on houses is not a theoretical problem.  For many years my Church callings put me in position to know what was going on with the collection and disbursements of fast offerings in the area I live.  In the early 1980’s a rather dramatic change in those receiving assistance emerged.  Young and middle aged professional families who, from all outward appearances, seemed to be well off, were suddenly in desperate need of large amounts of assistance.  Nationally, two things were happening.  Families were pushing their borrowing to the very limit and beyond to get into bigger and better homes.  Often they sold perfectly adequate homes to buy larger ones.  These families were well-educated with promising careers.  Never had any generation tried buying so much house with so much borrowed money.  Then job security for these same people fell apart.  Corporate mergers and downsizing struck these young professionals hard.

Here then was a family with little or no equity in the home because they had taken a high ratio loan.   They had little or no savings because mortgage and other house related expenses had them living off their credit cards.  Their fixed cash outflow for the house was frequently $2000 to $4000 a month before they began to buy food.  It takes only a very short time without a job to create a very very big problem.  Generally, these people were employable.  But often that new job took many months to secure.  Now consider this, the typical fast offering donation for even affluent wards is generally less than the monthly payments, taxes, insurance and utilities on just one $300,000 house.  What was a bishop to do?  The bishops assisted people, of course, and the fast offering account plunged into the red.  Please understand I was seeing only a small part of the Church and I am in no way attempting to comment on the whole Church.  However, I have reason to believe the problem was wide spread throughout North America and that it persists to this day.

Still the fact that some people over buy does not qualify houses as poor investments.  Everyone knows many people who have made a bundle on their house.  Everyone knows people who arrive at retirement with their home as their only real asset.  Everyone knows houses go up in value.  But not everyone knows the true cost of home ownership.  Consider the following typical situation.  A $150,000 house purchased with 20% down.  The house can be sold in 10 years for $247,376, which represents normal appreciation.

Original Cost	$150,000
Down Payment	$30,000
	________
Mortgage	$120,000
Selling Price – 10yrs	$245,734
Commission and Selling Costs	($19,659)
	________
Net Selling Price	$226,075
Payoff on Mortgage	($103,561)
	________
Equity	$122,515

The owner put in $30,000 and at the end of 10 years had equity of $122.515.  This means the owner’s money more than quadrupled.  This sounds like a great investment – but it is not.  This simple analysis is typical of the way many people, and real estate agents, evaluate a house purchase.  But this analysis leaves out most of the costs associated with owning the property.  When evaluating an investment all the costs associated with the investment must be considered.  These costs include mortgage payments, property taxes, insurance, closing costs, maintenance and even utilities.  The following cash flow analysis reflects all these costs.

CASH FLOW ANALYSIS
CASH OUTFLOWS
PURCHASE COSTS
Down Payment		($30,000)
Closing Costs		($2,250)
OPERATING COSTS   - 10 YEARS
Mortgage Payments
Principal		($18,847)
Interest	($84,142)
Less Tax Deduction	$25,243	($58,899)
Insurance		($5,400)
Property Tax	($30,000)
Less Tax Deduction	$9,000	($21,000)
Maintenance		($19,877)
Utilities		($36,000)
SELLING COSTS
Commission & Selling
Costs		($19,659)
Mortgage Payoff		($103,561)
		_________
TOTAL CASH OUTFLOWS		($315,493)
CASH INFLOWS
Selling Price		$245,734
		_________
TOTAL CASH INFLOWS		$245,734
		_________
NET GAIN (LOSS)		($69,759)

The owner of this investment experienced a net cash loss of -$69,759.  Great investments experience positive cash flows.  This is not a great investment.

Note that it cost this house owner only about $581 a month to live here. That is less expensive than renting a house of this quality.  This demonstrates the point that houses can be an inexpensive place to live.

Additionally, the homeowner did walk away with quite a bit of cash at the end.  The $122,515 belongs to the owner.  It may seem a little confusing that the first table shows an equity of $122,515 and the second shows a net cash outflow of -$69,759.  Home ownership has an element of hidden forced savings associated with it.  Savings you must make whether you want to or not.  Permit me a small analogy.  Many Americans have more tax withheld from their paychecks every month than necessary.  Then at tax time they receive a refund.  This clever government scheme almost makes people forget they are paying taxes.  Getting a refund is fun but this is a poor savings plan.  It is very inefficient to let the government hold your money interest free all year then force you to fill out complicated forms to get it back.

Generally, forced savings are very poor investments.  However, I concede that forced savings are not entirely bad. Sometimes nearly all of us lack the discipline to save as we should.  So the involuntary, even hidden, nature of the forced investment means we have something at the end.  This is definitely true when it comes to homeownership.

One final illustration of the nature of houses as investments is to compare this house to an identical house that is actually owned as an investment.  For the sake of comparison assume the owner can rent the house for exactly the cost of the mortgage payments, taxes, insurance, maintenance and for the sake of easy comparison we will even include the utilities. The rent on the property would be $1,605 a month including utilities. Without forcing another lengthy cash flow table on you this is the comparison after all tax considerations including depreciation.

HOUSES
OWNERSHIP vs. INVESTMENTSHIP
	OWN	INVEST
CASH FLOW – NET GAIN (LOSS)	(-$69,759)	$103,309
EQUITY	$122,515	$122,515

Assume a family wants a home and an investment.  Assume they buy identical properties.  They live in one and invest in the other.  At the end of 10 years they will have experienced a -$69,759 cash drain from the one they live in and a $103,309 cash infusion form the one they invest in.  The positive cash flow on the investment is a result receiving cash from renters and various tax deductions the investor receives.*  Both the owner and the renter will have $122,515 equity when they sell.

Again the point here is to avoid buying more house than can really be afforded using the rationalization that houses are great investments.  This leads to another consideration not built into these numbers.  More expensive houses require more expensive everything.  A bigger house needs more furniture, for example.  A bigger lot may require a riding lawn mower instead of a cheaper walk behind mower.  The list goes on.  The list often gets purchased by going deeper into debt.

Of course, we all need places to live and there is an unavoidable cost associated with it.  Owning a house is cheaper than renting.  Further, home ownership is part of the American dream.  And when it comes to where we want to live those dreams are generally pretty vivid.  The purpose for this article is not to throw cold realism on anyone’s house dreams.  Rather it is to help people consider all their dreams at once. For most people the American dream also includes sufficient financial flexibility to be self sufficient, debt free and enjoy a worry-free retirement.  Many people living in those gorgeous homes you drive by ogling over are not nearly as happy as you think.  Sometimes their dream home is a nightmare.

*True real estate investors realize the government has taken a lot of the fun out of rental properties.  Often any loss goes to reduce the tax basis in the property deferring potential gains until the property is sold.  Further, there are tax advantages associated with the capital gain in your principle residence versus a rental.  Typically, there will be no tax on the residence but a capital gains tax will apply to the rental.