Wisebread publishes an article by Antar Salim (an MBA who teaches business at the Rasmussen College School of Business, MN) that mounts the classic argument against investing in residential real-estate:
Depending on your sources, the average home price in the U.S. at the beginning of the millennium was approximately $160,000. Today, that same home will sell for approximately $200,000. If we explore the change in home prices, the average home increased by $40,000, or 25% over the decade. If you do the math — considering present value, future value, and time — this equates to a 2.2% compound increase year over year. Congratulations, we’re now in the positive rates of return.
Just one moment. We haven’t considered the rate of inflation, which we know historically is greater than 2.2%. Not only that, we haven’t taken into account that it cost us approximately 5% to 6% a year to borrow the money to purchase the home.
Granted, we all have to have a roof over our head, and I’m not suggesting that real estate is a bad investment, but it is my personal opinion that if your home is your best and biggest investment, then you may be in trouble.
Now, I agree with Antar’s last point: if your home is your best and biggest investment, then you are in trouble.
Regardless, here are the basic errors in Antar’s thinking:
1. Let’s say that the 2.2% compound growth rate will hold true for the next decade; this is an across the entire country average. Can you think of some areas that will grow faster than others? Look at your own town: can you name some suburbs that you can be pretty sure will grow faster than average, and others that will do worse? Of course you can.
2. Are you going to invest the entire $200k required for the house or are you going to borrow 80% from the bank? You are going to invest just $40k and make more than 25% profit on the entire property; that’s $50k+ back (less closing costs) on your $40k investment! Over 10 years, that smells more like a 7++% compounded return to me.
3. You are going to pay 5% to 6% (less 20% for the portion of the house NOT financed i.e. your deposit) of that return to the bank in mortgage interest.
4. You are going to claim tax deductions on the mortgage interest.
5. Here’s an investment that makes money by saving you money … because you don’t have to spend on rent elsewhere!
Not only is this such a good deal for you, even taking into account that 2.2% is a really crappy ‘look ahead’ estimate for housing over the next 10 years, that you should not just do it once …
… you should do it (at least) twice, making the second one a true rental (and, if it’s new, you may even be able to claim some additional depreciation allowances on your purchase).
Time to go back to (business) school 😉