April through June is prime home buying season. During this period, most houses are listed for sale, and buying activity is highest.
Purchasing a home is a milestone for any family. It enables folks to plant roots in a community and serves as a base for a lifetime of memories and smachot. A home is also the largest asset for many families. Since it is such a personal asset, people tend to get emotionally charged when discussing its investment merits. They state tax benefits, unsubstantiated return assumptions, and conveniently forget to factor in the massive upkeep costs associated with homeownership.
In a video clip I recently saw online, a realtor was interviewing a man who purchased a home 50 years ago in Palo Alto, perhaps the hottest real estate market in the country, for $40,000. She told him he can sell his modest home for nearly $3 million today. The owner is amazed, the comments on the video are in disbelief, and the realtor uses this interview to support how homeownership is a great investment. The truth is, Palo Alto is an outlier, with most parts of the country not experiencing the same explosive growth in their housing market. More importantly, if you calculate the return for this homeowner, it would be approximately 9% a year. This is a great return, though it slightly trails the performance of the broad stock market. Additionally, once you factor in the annual costs of owning a home, like property taxes and upkeep expenses, his effective return is actually a few percentage points lower. This seems like a lot of excitement for a net return in the mid-single digits.
All in all, folks tend to think of their house as a better investment than it actually is. My personal view on homeownership has evolved over time. Instead of focusing on the subpar returns that most homes will generate, I have come to appreciate why a house may be an excellent financial decision for many families. My thoughts below may offer a helpful perspective for those who are in the market to purchase a home today.
Why A Home Is A Bad Investment
Shvach long-term returns: Historically, housing returns vary by region and even more by specific cities within a region. However, according to the Case-Shiller Home Price Index, a widely recognized measure of U.S. residential real estate prices that tracks changes in home values, home prices have appreciated at an average annualized rate of 3-5% over the long term. As I already mentioned, these percentage returns don’t factor in the costs of homeownership. By way of comparison, the U.S. stock market has annualized approximately 10% a year over the past 30 years, while more conservative bonds have annualized around 5%.
Illiquidity risk: This refers to the potential difficulty of selling an asset when you need the funds without significantly impacting its price. Unlike stocks and many investment grade bonds, which can be bought and sold throughout the trading day with ease and minimal costs, real estate can take months to sell and typically at significant expense. If you purchase a home, you better plan to stay there for a while or you may not recoup your transaction costs.
Concentration risk: Concentration risk refers to having too much of your assets in a single investment. Unlike stocks and bonds, which can easily be diversified across hundreds of different positions, a house is one asset, in one asset class (real estate), and in one market (your community). That is a lot of your eggs in one very specific basket. If your community experiences unfavorable changes, including demographic shifts, oversupply, or more attractive nearby communities, or, more broadly, if there are economic downturns or prolonged elevated interest rates, the value of your house can drop or remain stagnant for years, which may derail your financial life.
Using leverage: Leverage, or borrowing money to invest, is risky because it amplifies both gains and losses. This means that while it can enhance returns, it can also lead to significant financial distress if things go wrong. For example, interest payments on one’s mortgage can erode profits if returns don’t exceed borrowing costs. Furthermore, too much leverage can have a ripple effect on the rest of your finances, making it more difficult to generate sufficient cash flow to afford your other expenses. Leverage can be a powerful tool, but it requires careful risk management to avoid financial instability.
Why A Home Is (Usually) A Sound Financial Decision
Despite the aforementioned risks, homeownership offers some advantages over traditional investments. These include:
Forced savings: Every month homeowners are required to pay their mortgage or risk losing their house to the bank. That risk is a great motivator for people to make timely monthly payments. It may take several decades, but over time, the mortgage will be paid off and the entire asset will be owned by the homeowner.
Illiquidity: Illiquidity has its negatives, which I mentioned previously. However, there are also benefits. Gyrations in housing values are not felt as acutely as the stock market. Investors can view their stock performance to the second. A scary headline or a rough month can cause panic. However, it’s impossible to accurately price your real estate every day. This offers the illusion that while your stocks are falling, your home value has remained stable. This psychological benefit minimizes the desire to make impulsive and imprudent decisions, which are common when investing in the stock market.
Long holding period: According to ConsumerAffairs.com, on average, a homeowner stays in a home for almost 12 years. In some parts of the country, like Los Angeles, folks average nearly 19 years in their home. In the frum world, this may be even longer, as families plant their roots, raise their kids, send them to the local yeshiva, and are comfortable with the Jewish amenities in the area. One of the keys to financial success is sticking with an investment for the long term.
The illiquid and forced savings aspects, along with the personal reasons for sticking with it, make a home a reliable long-term investment. Even assuming a mediocre return of 3% after expenses, there can be significant dollar appreciation in your home value after holding it for decades. Anecdotally, from working with hundreds of families, a home makes up a significant portion of many retirees’ net worth and offers them the option to comfortably live off the proceeds from sale of that home in retirement.
When Homeownership Is A Mistake
I’d be remiss if I didn’t mention some of the mistakes folks make with homeownership in the frum community that can negate the financial benefits. These include the following imprudent decisions:
Overextending oneself: When families purchase a house that they either can’t afford or decide to do extensive work using borrowed money, it may be a recipe for disaster. Don’t buy a home or do work on your house if it causes your cash flow to be strained. It will lead to financial hardship.
Using your home as an ATM: Banks are happy to lend you money against your house, working out terms that are favorable for them. However, homeowners should not use their home to afford their daily lifestyle. I know this is common in many Orthodox communities where costs are high and the pressure to keep up financially with those in your social circle is significant. Resist these urges as it will lead to higher monthly expenses and the inability to develop a sufficient nest egg.
Upsizing in retirement: Occasionally, someone will share with me that they decided to buy a larger home in retirement in order to host their entire family over Yom Tov. This is the wrong decision. Financially, increasing your costs with limited ability to increase your income is imprudent. Practically, as time goes on, your children will have their own families, move out of town, both of which make spending significant time in a parent’s house unlikely. The realistic trend is for parents to stay with their children over the chagim and family gatherings, not vice versa. Downsize in retirement and use the remaining proceeds to help finance your lifestyle.
Retirees buying a home in Israel: In a previous article I mentioned that retirees shouldn’t rush to purchase a home in Israel. The real estate market in Israel can be quite expensive, oftentimes making the rental market more attractive. Renting may be a far better decision than wiping out most of your nest egg to buy property in Israel. It’s imperative to speak with your financial advisor and determine what is financially prudent for your family.
Final Thoughts
Over the years, the biggest lesson I have learned from purchasing a home is that regular mortgage payments, compounded over a long period of time, even at modest returns, can build a substantial nest egg for many frum families. Even though a home is objectively not a good investment, the discipline it gives us and the wealth it generates can offer optionality later in life. Hopefully, new home-buyers will use these thoughts and approach their home buying decision with eyes wide open.
