In the vast landscape of personal finance influencers, a growing chorus seems to sing the same tune: real estate is a bad investment. I'm a big fan of questioning traditional financial advice and exploring different perspectives, so I took some time to read through the articles and book chapters that many of these influencers use to highlight their qualms with real estate investing.
Rather than making the statement that "Real Estate is a Bad Investment", PF gurus would be more accurate in saying "homeownership is a bad investment".
The common argument is that real estate is a bad investment because home values don't appreciate as well as stocks do. But that argument relies on the misguided use of a national historic average of home appreciation as a return benchmark for real estate investing. This tells us that those making the argument that "real estate investing is a bad investment because homeownership returns are so much less than stock market returns" are lumping primary homeownership together with real estate investing. Primary homeownership and real estate investing are not the same; these are two different objectives, and mixing their outcomes leads to skewed conclusions that can misinform aspiring investors.
Primary Homeownership vs. Real Estate Investing
To unravel this misconception, it's essential to distinguish between primary homeownership and real estate investing. The primary home is a unique asset that, by nature, does not generate income. Unlike traditional investments, the primary residence is a place to live, not a source of financial returns. Therefore, comparing the returns of primary homeownership to other investment strategies is akin to comparing apples to oranges.
The primary residence's return is predominantly rooted in natural appreciation, which is the increase in the property's value over time. While this can contribute to a homeowner's overall wealth, it does not reflect the full spectrum of investment opportunities available. In contrast, real estate investing involves purchasing properties with the intention of generating income through rent, and equity through capital appreciation. Real estate investing offers significant tax benefits to the investor, whereas homeownership offers far less significant tax benefits (and only to those who can itemize). All of these wealth-generating tools wind up producing far greater returns for the investor, which is why real estate investing yields 11.1% on average (compared to 5.5% in home value appreciation and 9.9% in stock returns).
Critics argue that the returns on a primary home are subpar compared to other investments, but this misses the point. The primary home serves a different purpose, providing shelter and a place to live rather than serving as a revenue-generating asset. It's like complaining that your car doesn't appreciate in value the same way a rare collector's item does—it's simply not designed for the same purpose.
Tacking on cost of homeownership is something that plays into this rampant argument of "real estate < stock investing", making real estate investing indeed sound less appealing. Homeowners are likely to pour money and time into improvements that align with their personal preferences, and not with a direct profit incentive. There's nothing wrong with this, but it's a factor that plays into the cost of homeownership that plays far less into real estate investing. On top of these costs, there are the reliable costs of taxes, insurance, maintenance, and homeowners' association fees. Since these costs are not associated with traditional (stock) investments, they certainly appear to tip the scale. However, while these are costs that must be eaten by a homeowner (or in some cases, deducted from taxable income), they are costs that are paid for by residents in a real estate investing model. Not by the investor.
Homeownership, while becoming less and less attainable, is still very much a part of the American dream. There are benefits beyond wealth that are achieved with homeownership, but it is true that factoring in the costs and the low returns associated with homeownership should always be done by someone considering purchasing a primary home.
Is owning a home a bad investment?
Answering this question is not as easy as comparing the financial returns of the stock market with that of the housing market. Investing in the stock market can provide for many needs, but homeownership provides the most expensive need of people in the US: housing. It can also provide stability, security, and community, which are intangibles that stocks may or may not match. Using money that would otherwise be spent on a downpayment, to invest in the stock market might be a huge win for many people. But, there is a risk that the rental market continues to rise, and all of the costs of homeownership are still absorbed by renters because landlords will pass those costs down to renters. My opinion about this comparison is that there is no one right answer because the financial outcomes are too dependent on individual circumstances. However, investing in real estate does not require someone to be a homeowner first.
Clearing Real Estate's Name
Real estate investing, as compared with homeownership, allows for diverse strategies that can yield consistent income and significant appreciation. Rental properties, for instance, generate cash flow through monthly rent payments, providing a tangible return on investment. Over time, property values can appreciate, offering additional financial benefits.
The argument against real estate as an investment often stems from a misinterpretation of data, comparing the apples of primary homeownership to the oranges of traditional investments. It's crucial to recognize the distinct purposes of these assets and understand that real estate can be a lucrative and viable investment option when approached with the right strategy. So, before dismissing real estate based on flawed comparisons, consider the unique merits it brings to the table and make informed decisions that align with your financial goals.
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