So, I have been amused by the arguments for and against owning a primary residence with this niche market known as the FIRE (Financial Independence/Retire Early) community. It seems that there is a lot of traction on the side of not owning a home. So, let me give you some perspective of my own before I launch into some thoughts on this.
I have owned 2 homes. They (and what I have used the profits for) are responsible for the majority of my wealth (not the stock market). I have made $100,000 in 2 years off the first one and about $80,000 in 2 years off of the 2nd one.
This scenario is obviously wonderful and not the average. That’s ok…because, averages are not a good metric for real estate.
What You Don’t Want
So, secondly let’s look at a different scenario.
Scenario: I have a friend named Sally. Her parents managed to do the following. They rented the same house for the past 20 years. Effectively, they paid for the entire mortgage of the owner of this home, or at least the worst 2/3 of years interest-wise. Sadly, they moved and are renting in a new place now because the rent got too expensive.
Math-Wise this is True Insanity.
See, the argument that is usually paraded around for non-ownership of a primary residence is the fact that you won’t live in it (a rental) long enough…
…but, what about 20 years?
Would that change your mind?
Another Scenario: I just bought a 4-plex. One of the tenants that I evicted had lived there for the last 10 years.
They basically paid for 1/3 of the mortgage of the previous owner. It isn’t cheap either. The new tenants monthly rent in that unit is more than I have ever paid for a mortgage.
Here is the problem I see with these articles as well as my solution…
…which of course is the best:)
JL Collins in an often quoted post has said the following:
“Hey I’ve got an idea. We’re always talking about good investments. What if we came up with the worst possible investment we can construct? What might that look like?”
…SPOILER ALERT (It’s a House).
In other words, if we look at a house from an investment perspective we should obviously notice that a house is a terrible investment. The argument is essentially that when we look at the typical investment scenarios, then we will notice that the house doesn’t match up well with other investment classes, i.e., it’s expensive to buy or sell, it is dependent on location, it is illiquid, etc.
The 2nd type of argument comes from these young people over at Millennial Revolution. In their article they basically claim to “Math This Shit Up” and proceed to do a very poor job of characterizing what home ownership looks like. They basically take a bunch of average statistics and compile them about the Toronto housing market to show how much they would’ve lost if they had bought a house based on the averages of the market.
They take no account of the fact that housing is an imperfect market (meaning you can get houses under market value), nor that the person looking for a home as an investment (read: EVERYONE IN THE FIRE COMMUNITY) would never buy “the average”. The average is also never right in Real Estate and this demonstrated month after month in my own market. The median home price is always about 20% less than the average home price because there are high outliers that skew the average, whereas the bottom side doesn’t have outliers that can go infinitely…only to “0” theoretically.
They even go as far to sort of insult everyone who considers buying a home when they say:
“Clearly they [sic] people that chant “House! House! House!” do not understand the real costs of owning a home. If you just punch some numbers into the mortgage calculator (like the real-estate agent told you to), and ignore the real costs of owning a home, you have NO IDEA what you’re doing.“
What we need is someone to clearly state the facts.
Fact #1- Some people should own homes and some people should not.
Fact #2- There has got to be a way to figure out who should.
Let me answer #2 so that you can answer #1 for yourself.
The Better Way
Here is the definitive answer to this question of home ownership…once and for all:)
First, Let us make a couple of presuppositions:
- You are viewing your home (at least partially) as an investment. Not simply a “lifestyle choice”.
- You have money to buy a home (no “0” down loan or PMI ruining things).
- You cannot look at averages, because in real estate they will always be high. You need to look at a specific home (see comment above).
What you need to do is compute the following. You need to figure out what your mortgage payment will be every month on the house that we are going to talk about. For purposes of this example let us consider a house that costs $200,000 dollars.
If you were able to put 20% down on a house like that, then you are in a position to buy it. So, the PITI (Principle/Interest/Tax/Insurance) mortgage payment looks like the following.
Interest rate of 4.25%
1% Property Tax
$1,000 per year homeowners insurance.
Total monthly payment on a 30 year mortgage would be: $1,037
Now, should you buy this home is the question…
Let’s look at this a different way. Part of the implied objection (read hidden agenda) to owning a home by Millenial Revolution and JL Collins is that the only exit strategy of said investment is to sell the home…on the market…for the current market value.
However, one point ignored by both articles is that every investment we make can be made stronger by having multiple exit strategies. This is one of the fundamental problems for stocks. There is ONLY ONE exit strategy. But, what if we add an exit strategy for this house that we consider when we are buying. Let’s add the dimension that when you “exit” this investment that you may not have to sell it. What if you move and rent the house at some point in the future. What would that look like?
It would look like cashflow, appreciation, deprecation, and loan pay down!
It’s fairly simple to see the point, it means that there is another consideration apart from APPRECIATION and the raw sale of the home when we consider what we are buying AS AN (potential) INVESTMENT.
This is how I have managed to make money on homes 2x in a row. I bought both with an eye to whether I could rent them in the future if I was unable to sell them or the market turned. What this does is force us to look at the intrinsic worth of the home, and not just a house for our lifestyle.
To me this is the metric that fixes everything about this debate.
The Only Number That Matters
Question: Could you rent the home you are considering for more or less than 15% over the PITI mortgage payment?
If the answer is MORE, then buy the home. If the answer is LESS, then don’t buy it…at least not as an investment opportunity for where the current market is.
This number is known as the price-to-rent ratio and is indicative of where we are in market trends at any point in time in a given real estate market. I don’t want to explain it too much as it gets boring, but the point is that it gives you a way to measure where any given housing market is. You need to look at a lot of other things, but this is a key metric that should be considered.
My contention is simple. If you can buy a house in which the PITI payment every month is 15% below what it would rent for to a renter in your market, then buy that house every time. It guarantees 2 things.
- The price-to-rent ratio is at a fair spot relative to your market.
- You have multiple exit strategies and are not at the mercy of the market in the future.
Hope this helps. No more silliness of calling people names for wanting to buy a house. Just do the math for yourself.
Great post! I don’t like the “One Size Fits All” perspectives on home ownership that some of these people have either. Your analysis was really good.
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Thanks a bunch! Are you a homeowner? I saw that you posted a blog to ChooseFi. What’s your perspective?