Friday, July 2, 2010

A House is a Home, Not an Investment

At some point in the past, people got it into their heads that housing was an investment. Like many fallacies, this started from a basis of truth. Families who had gotten into the housing market after World War II found themselves in a position to finance college for their children and grand children, finance businesses, &c due to the equity that they had in their homes. Furthermore, some properties rise dramatically in value, due to factors such as location and other market forces.

Then well intentioned people decided that more people should get to own homes because owning a home gave them equity with which they could improve their lives, especially since housing prices kept rising, increasing the value of the homes. Unfortunately, the equity is only of value to a family if they have the financial education to understand it.

Now, let us look at why this makes as much sense a planting money in the ground and expecting it to sprout a money tree.

Let's imagine that you have a tree fort in the woods (and let us assume that you own the tree under it), and you want to sell this tree fort to your friend for $100. There are many reasons that your friend may want to buy this tree fort, but if you were to suggest that this fort would appreciate in value and that this was an investment, you would likely lose a friend because he would think you were trying to take him for a ride.

Now, let us make this tree fort bigger. Perhaps 2000 square feet with two bedrooms and one and a half baths. Now, you are selling it for $300,000, and you suggest to the buyer that it will increase in value, and he finds that to be completely reasonable. After all, the amount of land is finite, people will always need housing, etc.

In some neighborhoods, land is an issue pushing up prices, but in most areas, they always manage to find some spot to turn into a new subdivision. So, in most places, the increasing scarcity of land will not significantly increase the price.

If you take this house and keep it ten years, it will be a 2000 square foot house with two bedrooms and one and a half baths. The intrinsic value of this house will not have changed. It will still have the same value. It will however be worth $390,000.

Ahha! You say. There it is. Price appreciation. But you have been fooled. The house did not appreciate. The dollar with which we measure the value depreciated. He house is worth exactly what it used to be in 2010 dollars. It is only because we are now considering 2020 dollars that it seems to be worth more. Now, when you think about the mortgage interest, new roof, new water heater, new vinyl siding, property taxes and all the rest, you probably put over $90,000 into this "investment" to keep up with inflation.

Don't get me wrong. I am a great fan of home ownership. You get to take money that would have been going to rent and instead build equity with it, but don't get carried away. Investment growth only occurs when the thing in which you are investing increases in value.

If you have stock in Raytheon and they build another missile factory so we can bomb Oilrichistan, the company has increased in value. If you have stock in Apple and they put out the new iWidget that will do everything but blow your nose ("There's and app for that...eww"), the company now has more value. In that case, you own a piece of that company, and you own a piece of the growth. Your house, however, is the same house it was ten years ago... just older.

You want a place to call your own: buy a house. You want investment growth: buy mutual funds.

Thank you for reading. Here are some resources you may find valuable in the real world:


  1. Hi Michael,

    I just wanted to say that I really enjoy reading your blog. It is different and refreshing. There are some things that I learn that I did not know before.

    When we spoke the other day you had mentioned talking to your mother and teaching her how to network and how what you say makes people listen vs how others would handle it.

    I was wondering if you could touch upon this in your blog. What are your tips for networking? What is the best way to approach people? What are common (and not so common) mistakes people make when networking? Finally, how should one handle objections such as, "I've never heard of you, why should I listen to you?" or just plain being ignored.


  2. A couple comments:

    1. Now, at least where i live, housing prices are really low so if you buy a house now there is a good chance that when the economy gets better you will be able to sell it for a good deal more than you bought it.

    2. If you own a house, you also have the opportunity to rent it to tenants, earning you additional income that you don't have the opportunity for if you rent.

    I agree that a house won't magically make you richer but its usually a better option than throwing away your money to rent, as long as you can afford it. Not to mention the $8000 tax credit :)