I’m always a little annoyed when a fellow millennial tells me how much their home value has gone up in the last few years. Unless you’re downsizing, a rising housing market is not good for you; and usually when a millennial sells their home it’s not because they’re downsizing, rather the opposite. Consider this data from the national association of realtors:
This makes logical sense, as we age and our families and incomes grow we tend to buy bigger, better located, and more expensive homes. So what exactly will happen to Mr. and Mrs. Median Millennial when they upgrade from their starter home 10 years down the road?
Assuming they purchased the home for $205,000 and it appreciates 3%/year for 10 years, they will be able to sell it for $276,000 – that’s a tidy $71,000 gain! Except that they have to pay 6% ($17,000) in closing costs, but still, they come out $54,000 ahead right!?
Let’s look at the house they are upgrading to – that $261,000 craftsman in the ‘burbs the median Gen X’ers bought 10 years ago. This house has also appreciated 3%/year for 10 years… so now it costs $351,000, which is $90,000 more than it cost 10 years ago. So in 10 years the Median Millennials “made” $54,000 on their home only to have to pay $90,000 more for their new one. Bet they wish home prices had been falling…
Your Home as an Investment
According to a recent National Association of Realtor survey, 84% of Americans believe buying a home is a good investment. No it’s not. Don’t get me wrong here, I’m a home owner and generally think it’s better to own vs. rent, but don’t get excited when your home value goes up on Zillow. Most likely every other home is going up proportionately and you’re losing purchasing power.
So what are the action items? First let me be clear, I’m not advocating making your first home purchase bigger, quite the opposite. When making a home purchase your priority should be finding a place to live, not picking up an “investment”. My suggestion will always be to keep your housing costs low; it provides greater flexibility and will allow you to invest more money in, well, real investments. Housing should be thought of as a fixed cost, not an investment vehicle.
You’ll hear some people argue that housing can be a great investment because of leverage. What they mean is, for a paltry 10% down payment you can pick up a huge asset. Let’s look at this a little more closely:
The Medians buy a $205,000 home with a $20,000 down payment. Same as above, they sell it 10 years later and clear $54,000.
The Standard Deviations on the other hand use their $20,000 and buy a $160,000 home. If their home appreciates at the same rate as the Medians it will be worth $215,000 in 10 years, which after closing costs nets them a profit of $42,000.
So far it looks like the Medians and their leverage is winning out, but hold on, the Standard Deviations have a lower mortgage payment… At a 5% interest rate, the Standard Deviations pay $2,900 less in mortgage payments each year. Even if they stuff it under the mattress and earn 0% on it, it adds up to $29,000 after 10 years.
This brings the Standard Deviations to a total win of $71,000 compared to the Medians $54,000.
Despite the leverage available when buying a house, it’s still better to buy a less expensive home and save the difference. The above example even ignores the effects of the higher costs of owning more expensive property (utilities, property taxes, mortgage insurance, etc.). There is also another factor to consider, the value of your home could go down (gasp!), and obviously if this happens it would be better to be in the less expensive home.
One final point
If you want to ignore all of the above and still think of a home as an investment, at least consider diversification. If your home truly is an investment then it’s probably your largest holding. And if you’re a millennial with $100,000 in savings I would say you’re doing great! If you have a $200,000 home it means your house, a single asset, is 67% of your portfolio!! You will have trouble finding an investment adviser who advocates keeping 2/3 of your portfolio in a single investment…
In conclusion, buy a cheap house!