When is 1.1 greater than 12?
Every so often, we come across an opinion piece from a self-appointed financial expert arguing that homeownership is a bad investment for most Americans. So it was no surprise to see the latest version of this argument in an article on Bloomberg.com with the catchy title “Millennials Should be Happy They Are Stuck Renting.”
The crux of the author’s argument is that home prices haven’t increased that much, when corrected for both inflation and the overall increase in home quality over the years. He cites an inflation-adjusted compound annual growth rate of just 1.1% since 1972.
That rate of 1.1% does seem low, especially when we see headlines of stock prices hitting new highs. But percents don’t live on their own. You always have to ask “percent of what?” And that’s where a trick of homeownership comes into play to turn 1.1% into a much higher return. The trick is the magic of leverage. The appreciation rate on a home applies to the entire value of the house, not just the portion put up as a cash down payment. In other vehicles, appreciation is only earned on the available cash. Say a person has $10,000 saved up and uses it to purchase a home priced at $200,000 (Homewise offers an even lower down payment option of just 2%). In ten years at a compound annual growth rate of 1.1%, that house will have grown in value by more than $23,000. Compared to the original cash investment of $10,000, that’s an equivalent return rate of 12.7%. The magic of leverage!
Another way to say that is, if that person had invested the $10,000 savings in another vehicle like stocks, he would have needed a return rate of 12.7% every year for those ten years to yield the same end result. Homeownership not only serves as an investment but also meets the basic human need of housing. Everyone will pay for housing costs. Why not have that monthly cost also contribute to asset building?
And there are other benefits to buying a home instead of renting. By taking advantage of a fixed rate mortgage, a buyer locks in his housing costs in perpetuity, largely protecting them from the ongoing inflation that causes rents to increase. And boy do rents increase. The article author himself points this out, citing a figure that rents have increased 20% faster than inflation since 1980. Housing is the biggest monthly expense for most families but owners lock those expenses in, giving them more and more room each year to add to their savings compared to renters.
It’s not a coincidence that the median wealth of homeowners is $231,400 compared to just $5,200 for renters. Homeownership is a critical way that American families build wealth, so critical in fact that researchers at Brandeis University found it was the single most important factor explaining the racial wealth gap. The author ends his article by sharing his enthusiasm for investments in rental apartments (apparently missing the irony of recommending that people own someone else’s housing but not their own). We think the smartest place to start an investment strategy is by becoming your own landlord through homeownership.
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