Tuesday, October 17, 2017

Cheerleading for Home Ownership

I’ve been a happy homeowner for many years now. I prefer owning my home to renting. But I have no illusions that this is the better choice financially. Price to rent ratios today mean I’d very likely come out far ahead if I sold my house and started renting a comparable house. But I’m not going to sell because I choose to pay the price of ownership. Unfortunately, many homeowners need to believe they will win financially, and they come up with poor analyses to justify this belief.

One such example comes from Sean Cooper’s book, Burn Your Mortgage:

“Let’s say you bought a home a decade ago for $250,000, with only 10% down ($25,000). You later sold it for $400,000, making $125,000 in profit (for simplicity’s sake, we’ll ignore associated costs such as mortgage interest, mortgage insurance, property taxes and closing costs). Even though your home only went up in value by 60%, that’s a 500% return on your initial investment (down payment) of $25,000. Try finding that kind of return in the stock market!”

For accuracy’s sake, let’s sacrifice some of the simplicity of this analysis. Let’s assume your mortgage rate was 3% for the past 10 years, and you had to add CMHC insurance of $5000 to your mortgage. This gives mortgage payments of $13,060 each year on a starting mortgage balance of $230,000. After 10 years, your mortgage balance dropped to about $157,800 so that your equity was $242,200.

Let’s say your annual property taxes were $4000, total maintenance costs averaged $6000 per year, and insurance was $1000 annually. When you bought the house, the closing costs were $10,000, and when you sold it, the real estate fees and other costs totaled $20,000.

It wouldn’t be fair to stop here because you are getting the benefit of living in the house. So, we have to factor in rent. In my area, a place that would have sold for $250,000 a decade ago and is worth $400,000 today would have rented for an average of about $1500 per month over the 10 years. Let’s say the extra utilities an owner has to pay that are usually included in rent come to $2000 per year.

Grinding these numbers through a spreadsheet, we find that the internal rate or return on this investment was 8.7% per year. Somehow we went from an eye-popping 500% return to a pleasing, but down-to-earth return, despite a 60% increase in house price and 10:1 initial leverage.

What would have happened if your home’s value had only risen to $300,000? The internal rate of return would have been -1.2% per year. That’s right—even if your house appreciates by 20%, you can lose money on the investment.

Never trust simple analyses of the investment value of owning a home. The reality is almost always much worse than it appears. Having said all that, I own my home and don’t plan to sell. But I don’t own with the expectation of making a profit.


  1. Wait, what? Property taxes? Insurance? Maintenance? these concepts have little to do with Real Estate (I have heard more than one person comment ��. I usually reply, NO, but they they do have a lot to do with HOME OWNERSHIP?

    1. @Alan: When many different factors all make a small difference we tend to ignore them, even when they make a huge difference collectively. I think people know about all these different costs, but they find it hard to believe that the costs add up to such a huge total.

    2. The cheerleading industry was born in post-war America (c.1950) and has been on full-ahead steamroller mode for the last near-70 years (no matter the state of the market). The pinnacle is when the President stands up and announces everyone deserves to be an owner. Forcing real estate buying instead of financial stability across society is fully irresponsible.

      It's a deeply emotion-driven sector, the players on the sell-side know this and do all they can to eliminate logic from the equation. Of these players is people like the mentioned author. Selling his very contextual (thus non-reproduceable) story does nothing more than fatten his own wallet (and ego) and propagate the decades-old sham. Skipping detailed analysis in favour of "simplicity" is an insult, and danger, to those wanting/needing guidance and/or proper information on the matter.

  2. We should treat home ownership as we do buying art: “But I don’t own with the expectation of making a profit.”

    1. @Deborah: Interesting comparison. While it's nice if some art happens to appreciate in value, that's not something we can count on.

  3. Michael, thanks for reading my book and sharing your opinion.
    As mentioned, I was trying to present a simplistic example for readers. If you want a fairer comparison on renting vs. owning, be sure to check out Alex Avery's book the Wealthy Renter.
    My views on homeowership are simple. A home is a place to live first and foremost. It can be a good long-term investment, but that shouldn't be the main reason for buying a property. You shouldn't be buying a home with the expectations of profit. While you may be able to come out further ahead by investing, a lot of people lack the willpower to save the extra cash flow from renting. (Want proof? Less than 25% contribute anything to an RRSP.)

    1. @Sean: I appreciate you taking the time to comment. Unfortunately, by making your example simplistic, you also made it highly misleading. You're right that Avery's The Wealthy Renter is a good book. I reviewed it here: http://www.michaeljamesonmoney.com/2017/09/the-wealthy-renter.html

      I agree that a home is a place to live first and foremost. The other side of "It can be a good long-term investment" is that it can be a poor long-term investment. It's also true that many renters just spend extra cash flow. Back in the days of less access to credit and lower house price to income ratios, the pressure of somewhat higher spending requirements of owning vs. renting had a positive effect on people's saving. Today, people are paying so much for homes that they grow other debts to be able to pay mortgages. Many aren't saving much at all.

  4. The exchange below is reproduced to remove broken links.

    ----- BHCh October 18, 2017 at 6:23 AM

    1. Maintenance of $6k every year certainly possible but does not have to be this high.
    2. If you are in GTA the price increase would have been higher in the last 2 years. 10 years, we are talking more than double.
    3. While it’s possible to rent at a relatively low cost the quality is a lot lower.
    4. Going forward we don’t know what will happen over 10 years to prices. But rental in Toronto will become far more difficult due to more extensive rent controls.

    Michael James October 18, 2017 at 8:47 AM

    1. Maintenance of $6k every year is certainly possible but is often higher.
    2. Over the next 10 years, price increases this high are unlikely.
    3. As I said, the rent figures are for a comparable property. Lower rents are possible.
    4. To anyone who tells me there aren't that many rentals available, I ask "how many do you need?"