October 24, 2018 glacierinvest

As you’ve undoubtedly heard, the U.S. housing market has softened a bit in recent months due to a variety of factors. Rising mortgage rates are the most recent culprit, adding to a list which has included low inventories of homes available for sale, a preference to rent vs. own, high prices/crazy bidding wars, etc… The Wall Street Journal had a write-up this past weekend discussing some of these culprits.

The housing bust from 10 years ago is likely still fresh in people’s minds but in spite of all the talk about people not wanting to own a home ever, the majority of people still want to own a home. At least that’s what the National Association of Homebuilders (NAHB) and the National Association of Realtors (NAR) would have us believe. I have no evidence to dispute those claims. The reality is there is a strong emotional element to owning a home that has been embedded in most Americans. It’s cultural in many ways and the cynic in me believes it has been perpetuated, if not created, by self-interested parties like the NAHB and the NAR. It’s similar to the diamond engagement ring phenomenon. Diamond rings haven’t always been a requirement for engagements. As a matter of fact, it wasn’t until DeBeers started promoting the diamond engagement ring culture several decades ago that the trend went mainstream. I digress.

There is a perceived financial benefit to owning a home and there is clearly an emotional benefit as well.  Many prospective homebuyers and homeowners will tout the tax benefits of owning a home along with the building of equity. Both are valid arguments in favor of homeownership. On the emotional side, there is peace of mind, validation and perceived security among other arguments in favor of homeownership. However, as with any use of money, relying on emotion can lead to disastrous results. I’m not discounting any of the reasons to own a home. After all, I’m a homeowner and find great satisfaction in owning a home. That said, perceived benefits to owning a home are debatable.

On the financial side, unless you can buy a home for cash, which most of us are unable to do, you end up paying quite a bit more for the home in interest than you may realize, not to mention property taxes, insurance and maintenance/upkeep. For example, if you were to purchase a $300,000 home (median housing price in the U.S.is around $260,000) with a 20% down payment you would end up with a $240,000 mortgage. Using today’s rates and assuming a 30-year fixed term, you would end up paying roughly $223,000 in interest over the whole life of the mortgage while recouping about $56,000 through the mortgage deduction (assuming a 25% tax rate). Additionally, you would pay upwards of $80,000 in taxes and insurance over the life of the mortgage depending upon where you live. So for your $300,000 home you’re all in net cash outflow over 30 years would be about $545,000 and that doesn’t even include maintenance/upkeep. If you assume an average annual increase of 2% in your home’s value over the 30 years you would end up with an ending value of $543,400, which is less than your total net cash outlay. So you end up cash flow negative albeit you have the equity in the home. Of course your home may appreciate more than 2% per year which could lead to a higher ending value for your home than your total cash outlay but there’s no way to predict what your home’s value will do. Note: at an average annual increase of 3% your $300,000 home would be worth roughly $728,000 after 30 years.

While the tax deduction is beneficial, you only get to deduct a percentage of the interest and taxes paid (total x your marginal tax rate). Imagine if you weren’t paying interest and could invest that money in a portfolio that generated an average compounded nominal return of 4% per year, which isn’t an unreasonable assumption. The figure below displays the compounded growth of the total saved interest invested  in a portfolio with a compounded annual return of 4% (if you were to pay cash for your home) versus the compounded growth of the tax deductible interest invested in a portfolio with a compounded annual return of 4% (if you were to use a mortgage to purchase your home like most of us do). It’s pretty astonishing to see the opportunity cost of owning a home via mortgage.

On the emotional side, the peace of mind, the sense of accomplishment, the perceived security are all valid and are feelings I have as a homeowner. However, if the circumstances that led you to buy a home change (i.e., lose a job, become ill or disabled, etc…) the positive emotions that led you to buy a home in the first place could be superseded or replaced with negative emotions including stress, anxiety and others that can make life very challenging and unenjoyable.

Homeownership has been an integral part of the “American Dream” for many decades now. The housing bust last decade caused many to reevaluate the importance and attractiveness of owning a home. It still appears that homeownership is desirable among a large portion of the U.S. population. However, there are many who aren’t interested in homeownership for various reasons. While there are several potential reasons for the housing market to be softening right now, including cyclical reasons, perhaps overall demand is waning more than we believe as more people discover and believe the opportunity costs of owning a home are too high.

NOTE: I own a home and will continue to own a home. The point of this post is simply to debate the supposed merits of owning a home. I didn’t include every perspective in my analysis, including building equity through homeownership versus “throwing money away” by renting, the time and energy required to maintain a home or the fact that most homeowners don’t stay in their home for 30 years. .