Suppose I purchase a home for $1 million, with a 20% down payment and a 30-year mortgage term.
Interest rate = 5%
+
Property tax = 1%
+
Maintenance = 1%
-------------------------------------------------
= Total annual ownership costs of 7%
Average annual home appreciation in America is 5%
-
Annual inflation rate is 3%
----------------------------------------------------------
= Net annual gain of 2%
Problem #1: Tax & Maintenance
Over 30 years, one would end up be paying over $1 million just in interest and taxes, not including other expenses like maintenance & insurance.
Even if the house is fully paid off, the 1% property tax plus 1% maintenance offset the 2% annual gain, resulting in a nearly break-even scenario. Given the current inflation rate (roughly 7%), owning real estate may not be profitable.
Problem #2: Capital Gain Tax & Costs to Sell
Also, remember there are capital gains taxes for profits over $500,000 upon selling the house, and closing costs typically amount to 5%-6%.
Problem #3: Inflation
After 30 years, the property value would appreciate to about $4.3 million. Looking good? Not so fast! By taking inflation into account, that $4.3 million is roughly just $1.9 million of 30 years ago, so the net profit is -$100,000.
Conclusion
Adding the costs of maintenance approximately 1-2% annually over 30 years, the total expenses would likely reach around $400,000. This brings the overall profit to -$500,000 after three decades of homeownership. Not a favorable outcome.
In my opinion, tax benefits are minimal (with a maximum annual deductible of $10,000), and the capital gains tax on $2.8 million would be roughly $850,000 (including federal and state taxes), resulting in a total profit of -$1,350,000.
Nonetheless, why would anyone choose to invest in something that could potentially incur losses of up to $1.3 million over 30 years?
a) You want to have two (or more, potentially) scenarios to choose from. Maybe Option 1: rent for X years (with assumptions) vs Option 2: purchase a house for X years and then sell it (with assumptions). In both situations you start with no housing, and end with no housing, and you can compare the financial state after X years. Or maybe you don't care about your housing, so you could do Option 1: purchase a house and rent it to someone for X years, then sell the house vs Option 2: do nothing for X years vs Option 3: invest the starting funds from Option 1 in a S&P500 fund for X years and then sell it. Again, you'll be in the same situation after X years, except with more or less cash.
b) If you're going to compare dollars, you need to cast them all to the same time frame. Today's dollars and next year's dollars are not comparable units, because of time value of money. This requires assumptions about appropriate rates. Look into net present value.
If you own a home, yes be ready to spend shit ton of money on shit ton of expenses and then sometimes, more things will break which you didn't plan for. So plan for those.
Now re-do your math for 15 years after that, and the final number will look better for the same 30 year time frame.
I'm not saying real estate is always the right answer - it isn't. There is no guarantee that values will rise like they have over the last decades, and there are costs along the way. But even so, you probably end up in a better place when you start out at a reasonable scale.
The biggest reason is the source of funds you're using is your rent money. You can't invest your rent money in stocks, bonds, or real estate. But you can 'invest' it in an owner occupied property. You just don't have the flexibility that a normal investor has and as a result the return will be lower.
Also the best dodge I ever saw was a friend did a 100% refi of his house at 2.5% to buy a rental property outright.
The question that matters is whether buying a house makes better financial sense than renting a place to live.
Now, there are a few hacks here. You could rent a room in a house with 7 housemates, which will invariably be cheaper than buying your own place. You could also choose to live in a tent, or van, ro something very cheap. If that works for you and makes you happy, then sure.
But if you're serious about maybe buying a house, then I think of it like this:
If interest + property taxes + maintenance are less each month than you would have been paying in rent, then you are betting off buying your own place, and anything you pay down onto the capital is just a form of forced savings.
- In California Prop 13 limits your taxes to a value much below inflation if you stay in a house for the 30 years
- In California rent prices rise rapidly. A mortgage payment stays fixed; up until a year or two ago the rate was significantly below inflation.
And you need to live somewhere.
The same is true of cars.
why would anyone choose to invest in something
that could potentially incur losses
Second, personal finance is not a mathematical optimization problem. You need to consider the effects that certain financial moves have on (fallible) human decision making.
You are more likely to pay their mortgage _every_ month than you are to contribute to a different investment. A home is also more illiquid than an investment account so it is harder to cash out for toys/vacations. Sure, foreclosures and home equity loans happen, but, for a lot of people, financing a home has a great chance at improving their net worth over their lifetime.
Living in a present-day million-dollar home for a net cost of $500k over 30 years is a great deal. That’s a little over $1000/month on average. Where can you even rent an apartment at that price these days?
Also there are a ton of tax deductions that were left out of your calculation. PMI, mortgage interest, even certain types of maintenance are tax deductible. Not to mention green energy upgrades, depending on where you live.
Those sound small but would probably be enough to flip your -500k calculation into a significant positive over 30 years.
https://www.nytimes.com/interactive/2014/upshot/buy-rent-cal...
Inflation works for you as the amount you borrowed is worthless as time goes on.
You can reverse mortgage it later not sell but live in it the rest of your life and have a % of the value.
Your calculation mixes present day value and past value and tries to compare it
In todays environment homes are so expensive that it can be a questionable investment. At other times in the market that wasn't always the case.
1. All real estate is local. The US is FAR from a homogeneous market. Most real estate investors buying single-family homes are NOT buying $1 mil houses in coastal states. They are buying 5- and low 6-figure houses in suburbs of growing or stable inland cities.
2. Analyzing real estate investments is not at all like analyzing a purely financial instrument like a bond. Practically none of the numbers are set in stone and every single deal is different from the next in every way you can imagine. It takes a lot of education, practice, and some experience to get good enough at this to not lose your shirt.
3. All successful real estate investors are also good at networking. They go to meetups, they have mentors, they hang out with each other and share information. They form amicable business relationships with real estate agents, contractors, and property managers.
4. There are many kinds of real estate investors, each with their own set of goals, skills, and strategies. It is virtually impossible to just copy whatever someone else is doing and do it well because you are not them. Some investors are at it full-time and end up being multi-millionaires. Some investors want extra income to supplement their full-time job or pay for their kids' college tuition. Some are retired and want a way to grow their nest egg. Some just want the park their cash in an appreciating asset for a few years. Some are good at finding properties well below market rates, some are good at negotiating, some are good at renovating homes at low cost, some are good at being landlords. ALL are good at analyzing deals. You have to figure out what you are good at and whether those things can help make you successful.
If this is something that truly interests you, I would suggest reading a few introductory real estate investment books from well-regarded authors and hanging out on the Bigger Pockets forums. There is a staggering amount to learn and it's not for everyone.
You missed two things though: - If you buy more than one property as investment you can rent it out, covering your expenses.
- You didn't mention risks, those are non negligible over 30 years. City plans change, surrounding population change, areas grow and fall in value etc.