A House is a Terrible Investment
And why people think it's a good one.
You’ve probably heard it before. “Buy a house. It’s an investment.” Homeownership is part of the American Dream. It’s a universally celebrated virtue, while on the other hand, renting is “throwing money away.”
To be clear, when I say house, I’m referring to one’s primary residence. I’m not talking about buying a property that you rent out. Real estate can be a great investment if you know what you’re getting into.
But your house is not an investment, and to the extent you consider it an investment, it’s a pretty bad one.
Why a House Isn’t a Good Investment
A House is Illiquid
A house is illiquid, unlike assets like cash, stocks and bonds. You can’t just decide to sell it one day and buy it back another. Buying and selling involves a lot of time, negotiations and closing costs that make this unfeasible. Furthermore, if you never plan on selling your home, you’ll never realize your gains anyway.
It Doesn’t Produce Income
Unlike a rental property, a primary residence doesn’t produce income. You may be able to rent out a part of your property and earn some extra money, but not everyone wants to do this or has the space. A house is an unproductive asset, unlike stock in a company that creates products, earns profits, innovates and solves problems in the market. A house just sits there as you hope that the price goes up.
It Costs Money to Own
Not only does a house not produce income, but it costs money to own. You have repair costs, taxes, insurance, utilities, etc. There are no corresponding expenses involved in owning stocks or index funds, other than taxes. This reduces your return on investment if you do see appreciation.
It’s Undiversified
People like to claim that buying a home is a form of “forced savings.” But what good is this if you’re putting all your money into a single asset? People’s homes tend to be the biggest asset they own. It would be one thing if you owned several homes across different real estate markets. But keeping the majority of your net worth in your personal residence is the real estate equivalent of putting all your money into a single stock.
Poor Returns Compared to Stocks
Compared to stocks, real estate barely beats inflation over the long run. Some housing markets have experienced incredible growth over the last several years. But they aren’t representative of housing as a whole, and if you go into a home purchase expecting the property value to increase, you’re engaging in pure speculation as opposed to investing in a productive asset you have good reason to think will increase in value. Housing appreciation isn’t guaranteed, and for every Los Angeles or San Francisco, there are smaller areas in Ohio and Pennsylvania that still haven’t fully recovered from the housing crash of 2007/2008. There’s no such thing as a national housing market, only thousands of individual housing markets.
If a house isn’t an investment, then what is it? I’d say it’s primarily an expense, a lifestyle choice. And it can be a great one if it fits with your goals and overall financial picture. Not everyone wants to rent forever. When you’re young, it makes sense to rent, as you’re more likely to move around and you don’t have the credit or the savings to secure a mortgage loan. But one day you may decide to settle in one place, you may start a family, and at that point, it might make sense to buy a place you can permanently call your own.
But too many people rush into buying a home because they think it’s a great investment. They often do this before they’ve even begun thinking about investing for retirement. And when you say something like “a house is not an investment,” people get angry. Let’s unpack this.
Why People Think Houses Are Good Investments
So why do people think of their house as an investment? There are several reasons:
It’s What They’ve Been Told
The simplest reason is that it’s what they’ve been told. There’s huge social pressure to be a homeowner in the U.S. It’s a milestone for success in life.
Emotional Attachment
People have deep emotional attachments to their homes. Sometimes this causes them to make a post facto justification of the purchase.
Financial Attachment
Similarly, people have financial attachments to their homes. It’s the biggest purchase they’ll ever make. They spend thousands of dollars a month on mortgage payments, property taxes, insurance, repairs, etc. No one wants to think that they’re pouring so much money into something and not getting a good return.
People Overestimate the Risks of the Stock Market
People generally overestimate the risks of investing — long term — in the stock market. We’ve all probably heard at one point or another: “The stock market is like gambling.” Like I mentioned above, pouring all your wealth into a personal residence is the equivalent of investing all your money in a single stock. That sounds much more like gambling to me than investing in a diversified index fund.
Houses Are Tangible Assets
When you buy stock in a company (or shares in an index fund that owns stock in companies), you’re purchasing a tangible asset. But it doesn’t feel the same as owning a piece of property that you see every day. For many people, investment account balances might just seem like numbers on a screen. People simply understand houses more than they do stocks. Stocks are complex financial instruments that seem incomprehensible to most people.
Renting Can Be Better Than Buying
Another frequently repeated assertion is that renting is throwing money away. This isn’t true. Renting can even be more affordable in some situations.
People underestimate the costs and complexities of homeownership. The financials of renting are simple. The costs are rent + utilities + renters’ insurance. A home is more complicated. You have the mortgage payment (principal + interest) + utilities + repair costs + taxes + homeowners’ insurance + PMI (if you don’t put down 20%).
People also overestimate how much happier they will be when they buy a home. People tend to adapt. Hedonic adaptation refers to the tendency for people to return to a baseline level of happiness after a positive or negative event. There may be a short happiness boost after buying a home, but this soon wears off as people get used to their living situation.
Renting gives you more flexibility to pick up and move to a new place. You aren’t throwing money away when you rent.
Should You Still Buy a Home?
If buying a home fits the lifestyle you want and you plan to stay in that home for at least five years, you should definitely buy a home. But you shouldn’t view it as an investment, because chances are it’s probably not going to be a very good one compared to the alternatives.
There are many great reasons to buy a home. Buying a house does free you from rent increases, and during an inflationary environment, a mortgage can put you in a better position. But there are too many risks and unknowns to count on this working in your favor.
The only time a house makes a good long-term investment is when you plan to sell it at a later date for a capital gain and move into a cheaper home. But this assumes you get lucky in choosing your location and it forces you to sell an asset that at that point you may have an emotional attachment to. No one is going to have a similar emotional attachment to their index funds.
If you buy a home, it’s important to go into it with the right mindset. While it’s not an investment in the financial sense, you may see other payoffs. If you want to make a true investment for your future, you’re better off opening an investment account.