Hi Reader,
Buying a house is one of the biggest financial decisions you make in your life. Sometimes it’s a decision you make multiple times. But the first time usually feels like the biggest and scariest. So of course you want to make sure you’re making the right call.
Often what we lean on in order to judge or justify this decision is the perceived investment value of what we’re buying. We look at a house, or a condo, or a property, or a neighborhood as either a good opportunity, or maybe something we settle for because we feel we need to. The more analytical among us may compare their rent payments to their potential mortgage payments. The disgruntled future homeowner might argue that they’re choice to buy over rent is one they have to make because they’re just plain sick of paying for the right to live in someone else’s income property. The “I’d rather pay myself than them” line of thinking is one I’ve regularly come across.
Each of these prisms can prove useful when weighing your decision. It’s important to be pragmatic over impulsive here. But the biggest thing a homeowner or potential homeowner should keep in mind is this – a house is a home, not an investment. It’s a place to live. It’s a place to make memories. It’s shelter over your head, and maybe a future family heirloom. In some situations, it’s a moneymaker. But not as frequently as you might think.
Let’s break it down.
Joe and Jane bought a house in a desirable part of New England in 2015. They paid $410,000 for the home and used a mortgage to finance the purchase.
Eight years later it’s 2023 and they’re looking to move to a new neighborhood. Following their realtor’s advice, they list their home for $770,000. The market is strong and they’re expecting a small bidding war. They end up accepting an offer for $820,000, double their original investment.
Joe and Jane are ecstatic! Turns out that house they stretched for in 2015 was a great investment, one that averaged a 9.05% annualized return.
Of course, as much as it might serve Joe and Jane psychologically to believe this is true, in reality, the return on this investment is much, much smaller. Here’s why:
When they purchased the home, they paid realtor fees and closing costs, totaling $12,300. Because they used a mortgage to finance the purchase, they paid interest on the loan along the way. They were fortunate enough to be able to refinance during the pandemic, and even caught the lowest point of the interest rate decline, locking in a 2.75% rate (and with no additional closing costs). The blended rate on their mortgage has been 3.3%, which is very solid. But over 8 years they’ve paid $91,924 in interest!
Along with their principal and interest payment every month, they’ve paid property taxes and homeowners insurance. That’s totaled $52,283 for the former, and $16,000 for the latter.
Adding all that up, including the home purchase, they’re into the property for $582,507.
But okay, that’s not so bad. They’re still walking away with $237,493 in proceeds, a roughly 4.5% annualized return totaling 40.77% on the initial purchase price. We could leave it at that and feel pretty good about it.
But… I’m feeling particularly realistic today, so we’re not going to do that. We’ll ignore all the furnishing costs, utilities paid, and little home improvement purchases at Home Depot over the years. But what we can’t ignore are the significant improvements they made to the property, those that really helped them get that final sale price.
It started with a fence. That was $10,000 early on. Then the heating system needed to be replaced, and HVAC was installed. That was another $24,000. Bathrooms were given a facelift. Rooms were painted. That all totaled $18,000.
Then came the big one, the kitchen renovation. Walls were taken down. Cabinets were replaced. Appliances, a new laundry room, new floors. That all ran the price tag to $120,000.
Then it was time to work on the exterior. The roof was aging. The paint was chipping. Every so often these things need to be addressed. The exterior ran another $37,000 all in.
Finally, it was time to sell, and pay $24,600 in realtor fees to boot. When all was said and done after they paid off the remaining balance of their mortgage, that $820,000 sale netted the couple roughly $3,893 in profit. A 0.47% total return on their investment (annualized ROI .0095%).
Down Payment ($40,000.00)
Mortgage Loan ($370,000.00)
Closing Costs ($8,500.00)
Mortgage Interest ($91,924.00)
Property Taxes ($52,283.00)
Insurance ($16,000.00)
New Fence ($10,000.00)
HVAC ($24,000.00)
Bathrooms/Paint ($18,000.00)
New Kitchen ($120,000.00)
Exterior Work ($37,000.00)
Selling Costs ($20,000.00)
Home Sale $820,000.00
Profit $3,893.00
This house wasn’t a money pit. The couple was never underwater. The costs were spread across many years. Many memories were made, and a roof was always over their head.
There are other ways this could have played out. They could have gone without the renovations and maybe got less in return. They could have lived there for 30 or 40 years, increasing the amount of interest, taxes and maintenance paid, but perhaps getting an offsetting increase in valuation along the way. It could have proved to be a slightly better investment over time. But again, the difference between the purchase price and the sale price is defined by what happens in the messy middle.
This house was a home. And it shouldn’t be viewed as anything but that. Because in the end, your primary residence is just that. It doesn’t NEED to be an investment. There are other ways to make money. Heck, there are other real estate opportunities through which you can make money.
It costs money to live. That’s a given. What a home should provide is a meaningful place to live in. That should be the biggest factor in the decision-making process.
Stay Positive!
CoFi
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.
