To Buy or Not to Buy a Home?

Yes! Just kidding. Woof…if only it were that easy! I’m a home owner and pro home-ownership but this is one of those “personal finance” is as much “personal” as it is “finance” situations. Let’s break down the pros vs. cons before you make this huge life step. 

Check out our main blog post on everything home-buying to learn more about how much home you can afford, how to save up for a home, and more here!

Pros of home-ownership: 

Home-ownership comes with five major pros: 

• Home value increasing (aka appreciation)
• Access to leverage 
• Home-owner tax perks
• Forced lower-stress long-term savings 
• Quality of life

‍

Home value increasing (aka appreciation) 

One of the major pros when it comes to homeownership is that your home will increase (or appreciate) in value as time passes. This return will hopefully keep pace with inflation and maybe even outpace it! 

 We are taught from a young age that our best bet for investing our money is putting it in real estate. In fact, nearly 1 in 2 Americans thinks that real estate is the best returning long-term investment. But it’s time for some myth-busting. Let’s look at the hard numbers.

‍

Research by Yale University economist and real estate guru Robert Shiller, shows that on average, residential real estate can keep up with inflation but offers little more return above that over the long-term. In plain-English, that’s ~0% returns, after inflation. Contrast that to investing in the stock market, which historically returns ~7% after inflation. As Jason Zweig of the WSJ writes, “The 10% annual rate of return that realtors often used to cite to homebuyers is as mythical as a hippogriff.” So were we lied to about how valuable home-ownership is?

‍

Well, there’s two caveats here: (1) there are definitely some temporary swings above and below the zero-line (with a very notable bubble-looking swing upwards recently) and (2) there are certain cities where appreciation outpaces inflation and increases faster in value compared to other places. See this index tracker to compare how home values appreciate in different cities. Do this by typing city names after clicking on “Compare”. For example, the 5 year average annualized return for Boston homes is 9.11%, for New York is 7.33%, and for San Francisco is 10.38%. Based on this, your home would appreciate more over 5 years if purchased in San Francisco than New York.

‍

Access to leverage 

The personal residence is one of the only assets that most Americans buy, with leverage. In other words, we borrow money to buy the asset. In point of fact, it's a process we've institutionalized in this country; how many people do you know who have ever bought a house and paid 100% of the price in cash? I'd venture to say virtually no one, and to say the least the few who have done so are usually already older and wealthier; a full-cash purchase for someone's first home is a true rarity!

Borrowing 80% (i.e., a 20% downpayment) is the norm in real estate in the US. In stark contrast, the max you can borrow in the stock market is 50%. Why? Real estate is less volatile than the stock market. 

How does that help you build wealth? Let’s explain with real numbers. For example, let’s say you put $200,000 down on a $1,000,000 house, or a standard 20% down payment. The home appreciates to $1,030,000 in the next ten years (3% return, keeping place with inflation). Your original $200,000 investment in the property now becomes $230,000, which is a nice 15% return on what you spent out of pocket vs. the actual 3% return on the home’s value. 

‍

Home-owner tax perks

There are two main tax deductions Uncle Sam offers to encourage home ownership. The higher your income (finance-speak: marginal tax bracket), the greater the potential tax advantages of home ownership.

• Capital Gains Tax deduction: This is the big kahuna—these come into play when you (fingers crossed) sell your home for a profit. A capital gain is the difference between the value of the when you bought and when you sold, and typically the government taxes you 15-20% on that gain. But for homeowners, Uncle Sam gives you a special exclusion. You don’t have to pay capital gains tax for up to $250K of gains for single folks and $500K of gain for married couples. That could be an up to $100K tax break! Strings attached: only works for your primary residence (no vacation homes or houses you rent out) for at least 2 of the last 5 years, and you can only use this perk once every two years.

• Mortgage interest deduction: You can deduct from your income what you pay in interest on your mortgage! The fine print: only the interest paid on the first $750K of a mortgage is tax-deductible. This perk is off the table if you take the standard deduction (which 90% of Americans do because it makes the most sense) instead of itemizing your deductions. In real numbers, if you were to buy a $1M house today with 20% down, you’d be eligible for only $750K of your $800K mortgage to get this deduction. 

Forced lower-stress long-term savings

Unlike the stock market, real estate more naturally forces you into (a) automatically “investing” into your home by paying down your mortgage and (b) holding for longer periods of time since it’s way harder to sell a house than dump stocks on Robinhood. Plus, you aren’t seeing daily updates or headlines on the ups and downs on the price of your home like you do with stocks! Note, this pro is waning in value as it gets a lot easier to set up automatic investing into the stock market given tech advances, but it’s still worth the mention.

Quality of life

At Steward, we’re big believers in “value-based budgeting”. That means identifying your top values and then cross-checking that your major expenses line up with those values. Are stability, independence, control, and community some of your top values? A home could have a lot of intangible benefits that excel spreadsheets alone couldn’t capture. The symbolic value of a sense of permanence (“the settle down” factor), steady neighbors and school district, the ability to renovate and modify your home and make it truly yours, no landlord and their rules (e.g., no pets, no painting walls), and more space. When my husband and I were looking for a home, even though the math tipped in favor of us renting vs. buying—it was almost impossible to find rental inventory for the multi-bedroom house we were looking for in the location where we were looking. 

One note here—I’ve seen a lot of the highly educated working professionals we serve feel pressured to buy a home because it is seen as such an important life milestone. For whatever reason, that’s even more intense for the Indian-American, Asian-American, and Black-American families we serve. Maybe it’s cultural or the immigrant “hangover”, but sometimes purchasing a home can lead to financial distress for families like these. That’s why it’s extremely important to take your time, do your research, and to be aware of all of the cons that come with the pros of home buying. 

Cons of home ownership

Owning a home isn’t all rosy. It comes with four major cons: (1) “hidden costs”, (2) lowered flexibility, (3) added work and hassle, and (4) risk. This is why many white-glove wealth advisors call a home, a “purchase first, and an investment second”.

Three types of hidden costs  

Many  people talk about rent as throwing money down the drain, but a home has multiple “down the drain” expenses too. 

Transaction Costs: Closing costs for both buying and selling—appraisal fees, tax service fees, title insurance, taxes, prepaid expenses, and real estate agent fees. Roundtrip, these transaction costs add up to about 10-15% of your home’s value. On a $1M house, that’s up to $150K in transaction costs! These aren’t a deal breaker, but it’s worth going in eyes wide open. It generally takes about 5-7 years of real estate appreciation to “earn back” your transaction costs. This means you need to own a home for ~5 years to hit breakeven. Do you feel comfortable committing to that long a time-frame? Real estate site Zillow found that millennials move once every 2-3 years. If you’re not at a point in your life where you can confidently say that you’re going to remain in this home for at least 5-7ish years, you probably shouldn’t buy.

Ongoing costs: This includes mortgage interest, insurance, utilities, HOA fees, annual property taxes, and routine maintenance (...whew! Those are definitely not on the home listing.) ‍

• Mortgage interest—now that interest rates are back up at 6% (sigh), the high cost of borrowing can mean renting is actually cheaper than owning. Check out the NYTimes website for a good calculator for comparing the costs of renting and owning. Adding to the pain, outside of the housing bubble that led to the Financial Crisis in ‘08, homes are at their worst affordability since 1991. That’s according to Bill McBride, who shares this terrific yet awful chart on his substack.
• Homeowners insurance—protection for your home that varies from location to location; there is also specialized insurance for floods, hurricanes, earthquakes etc. that you may need depending on location and private mortgage insurance (if you’re putting down less than 20% in downpayment)
• Utilities—water, electricity, gas, internet, cable etc.; varies by location and home size. You can get an estimate from the prior owner via your realtor.
• HOA fees—condos, townhouses, and certain communities usually have fees that cover general landscaping, security, trash service etc.
• Annual property taxes (notoriously high in NJ, NY, IL, and NH)—often about 1% of your home’s value each year. 
• Routine maintenance—leaky roofs and faucets, heating system breaks, etc. add up to about 1% in your home’s value each year. These also often fluctuate quite a bit, and can add stress of costs popping up out of nowhere (like when our full heat/AC system had to be replaced).

Many families find themselves “house poor” when these expenses add up more than they realize ahead of time, and put them in a financial crunch.

‍

Upgrade costs: Awesome interior design (furniture, home decor, etc.) costs money as do major renovations many families desire when they move in. Some ballpark figures: ~$50K for a kitchen renovation, ~$20K for a bathroom renovation. 

‍

Lower flexibility

When you buy a house, you lose the ability to quickly move wherever and whenever you please. Do you want to change careers? Go back to school? Take a sabbatical? Take unpaid leave to take care of yourself or loved ones? Move closer to family or to where your quality of life will be better? These will be a lot harder thanks to your fixed housing expense that you’ve got to pay, every month, somehow. Buying a home usually brings a huge debt, and usually the money tied up in your home is very illiquid, meaning you can’t quickly and easily get money out of it. Home ownership can force folks into a narrower set of career choices to maintain their current incomes, and to pay more attention to your other expenses.

‍

Hassle Factor

Home ownership brings with it all sorts of work—researching and haggling with vendors when your AC stalls out or your roof leaks, landscaping yourself, hiring all the necessary people and cleaning up leaks in the basement, painting the garage, ensuring you get the home insurance and property taxes paid on time, choosing a new dishwasher when yours breaks… You get the jist. You can outsource some, but not all of these tasks. If you’re the next Chip and Joanna Gaines from HGTV, this could be a pro not a con, but if reading this makes you wince…worth factoring in!  

Concentration Risk

It’s so utterly unknowable how this one home in this one neighborhood in this one city will perform over time. Yes, your home might end up gaining a lot in value. But you can’t know ahead of time what this one asset is going to do. (By contrast, in an investment portfolio, we recommend diversifying across thousands of stocks, so the fate of your money isn’t tied to a single asset.)

• Opportunity cost: Whenever you put your money into an investment, you have to consider the opportunity cost—what potential return could you be missing out on? At the end of the day, a home is an illiquid asset. While the majority of people’s net worth’s lies in their property, that money is not easily accessible. There’s no guarantee that your house is going to sell when you want it to or if it’s going to sell at all. When it comes to home buying, you end up hearing more success stories than nightmares because people are more likely to brag about their success than fess up about their failures. So we have to consider what we could do with that money instead of tying it up in a house, such as investing it instead, before making the decision to buy a house.

If you’re looking for a specific yes / no answer, and want  to walk through this decision with us?  Reach out to me at help@oursteward.com and schedule a call to set up a no-cost, no-obligation process for prospective clients. 

Read more about all things home buying here:

1. How Much Home Can I Afford?
2. Where Should I Save Up For a Home?
3. How to Approach Financing Your Home Purchase
4. How to Make Your Offer Stand Out in a Crowded Market

‍

Interested in learning more about whether a home purchase is right for you and how you can best save for it?

 Steward ‘s mission is opening up the 1%’s wealth strategies to America’s up-and-coming families with a combination of 21st century tech and trusted advisors. We help families determine how, where, and when to invest and save on taxes in plain-English, with minimal time and effort. Steward can help you determine if a home purchase makes sense, how much home you can afford, and how to invest and save in the most efficient way. Give it a try here.

‍