Homes are both a good long-term investment and a good financial decision, right? Many people accept this as common knowledge.
Robert Shiller, a Yale economist and Nobel Prize winner who has done extensive work on the history of residential real estate, challenges this idea:
"Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. If you think investing in housing is such a great idea, why not invest in cars? Buy a car, mothball it, and sell it in 20 years. Obviously not a good idea because people won't want our cars. It's the same with our houses. So, they're not really an investment.” Robert Shiller
According to Gallup, residential real estate is Americans' top choice for the best long-term investment. Further, according to the National Association of Realtors 2017 National Housing Pulse Survey, 84% of Americans believe purchasing a home is a good financial decision.
Why Buying a Home Is Not the Best Investment
Shiller’s work has found that over the past 120 years, homes have appreciated at just 0.4% per year after inflation, making it one of the worst long-term investments. As you can see in the image below, the price of a residential home, highlighted in green, was rather consistent for about 100 years, and then in the past 20 years, we had a boom, crash and current boom highlighted in red. It’s a good idea to ask why the price of a home, which is simply a combination of materials and location, shot up to such a tremendously high valuation relative to history in the early 2000s (Hint: Government home purchasing policies and easy money monetary policies, but that is a topic for another article).
Even with that boom, the real returns (with costs/benefits/inflation factored in) of residential real estate are woeful (This article will not be looking at owning a home and renting it out, we will be focusing on the home you live in.). The image below shows residential real estate across the United States, from 1975 until the peak of the boom in 2006, had an average annual return of -8.7% per year.1 During just the boom years, it was a meager 3.9%. California, the best real estate market in the United States fared better, but outside the boom years, it still sported a negative real return and paled in comparison to simply investing in an S&P 500 index fund.
*1975 data began in the second quarter
Comparing Residential Real Estate to Other Investments
Now that we know the real return of residential real estate, we can compare it to other long-term investments. In Wharton professor Jeremy Siegel’s book, Stocks for the Long Run, he calculates the real returns of a variety of assets starting in 1802.2 Since residential real estate data doesn’t go all the way back to 1802, we will combine the data for illustrative purposes, allowing us to display the relative returns of long-term investments. The chart below should make it evident that investing in residential real estate is quite undesirable, given our other choices. (For related reading, see: Moving up: Dream House or Money Pit?)
*Data starts in 1975. Simply an illustration of long-term investment real returns, relative to each other.
Yikes! Our dollar invested in residential real estate becomes basically nothing over time, while our dollar invested in stocks grows exponentially well. It should be clear now that residential home ownership is not a good long-term investment, especially when compared to the alternatives. What makes matters worse is most Americans are borrowing money to purchase an asset that loses them money in the long run. This is simply not a good strategy for building wealth, as it compounds your losses.
Buying a Home vs. Renting
So, if buying a home isn’t a good investment, is it still at least better than renting? Let’s do the math on what a lifetime of homeownership looks like compared to a lifetime of renting and find out. We will run several scenarios, with all costs and benefits factored in, to see which strategy is best. To equate buying a home to renting a home, the renter will invest in the U.S. stock market whenever the buyer places a down payment on a home that requires outside capital. This way, the “investment” in the home is equal to the investment the renter makes. We will use historical averages for all inputs and calculate the real return. A full list of assumptions can be found at the end of this article. (For related reading, see: To Rent or Buy? The Financial Issues.)
As you can see, both buying and renting lose you money over your lifetime, but renting loses less in every scenario. This is due to the real return advantage that investing in stocks has over investing in a home. Thus, the down payment on a home doesn’t grow to become as much money as investing the down payment in the stock market. Visually, we can depict the difference using the bar graph below.
The math certainly suggests renting a home and investing what you would have used as a down payment into stocks, is better than buying a home. Yet, buying a home is often described as a wise decision and a good investment, while renting a home is often described as foolish and throwing money away.
This article shows the common “wisdom” about home ownership and renting is not right. Homes are absolutely not good long-term investments and should not be viewed as investments. Instead, homes should be viewed as use assets (like a car, but better), and if you want to buy one, be sure you want to live in the house for at least 10 years, keep the purchase price to 2.5 times your gross income and minimize the amount of debt you take on, since borrowing money to invest in an asset that loses you money is not a good long-term wealth-building strategy. If you want to maximize your future wealth, rent and invest in a portfolio of stocks. (For more from this author, see: Why Investors Need to Focus on the Long-Term.)
1Richard Marston, Portfolio Design. FHFA and Federal Housing Board. Inflation Rates from IMF, International Financial Statistics.
2Jeremy Siegel, Stocks for the Long Run;” Richard Marston, Portfolio Design.