In 2010 I bought a condo in Chicago. Last week, almost exactly seven years later, I sold it. In the warm afterglow of the transaction, I found myself wondering whether this was a good financial decision. Do houses really provide a good vehicle for generating wealth, or would I have been better off investing in the stock market? To answer this question, I turned to math.
At a superficial level, the decision to buy a place, assuming one is able, seems fairly obvious. If renting and buying both result in equivalent monthly expenditures, at least some of your mortgage payment becomes equity while renting is simply "throwing money away". This is a relatively simplistic analysis, however; while rent is a very simple fee-for-shelter arrangement, the ebb and flow of debits and credits associated with real estate makes the finances (and returns) of home ownership far more complicated.
Regardless of whether or not you consider the home an investment, the sheer cost associated with housing makes a thorough analysis of the pluses and minuses important. In addition to being the largest investment you'll probably ever make, acquiring and selling a home is expensive, meaning that you'll likely be stuck with the results of your decision - good or bad - for some time. This quality of life consideration makes the financial aspects of buying a home AT LEAST as important as whether or not you actually want to live there. This leads us back to the initial question - was it a good idea for an average guy like me to buy an average place in an average city for an average length of time?
As a saucy young lad of 29 I landed my first job as a neurobiologist with a large pharma company. With a regular paycheck came the persistent urge (drummed into me by society, perhaps) to put down roots and buy a place. After narrowing things down in the Winter of 2009/2010, Susan and I honed in on a two bed, two bath condo on the 40th floor of a condo in Lincoln Park. There were significant upsides to the property - it was big (by city standards, anyway) and had nice views of the Lake Michigan and Wrigley Field. The location was also good - it was as close to the lake as you could get, had about a hundred restaurants within a mile (this is not an exaggeration), and was in a financially sound building that was professionally managed by a well-respected agency. On the downside, it was vintage 1969, the year the building was built.
The price was originally $315K, definitely overpriced considering how long it had languished on the market. We bid $280K and eventually settled on $291K. After some negotiation, I borrowed the closing costs, bringing my total price up to $300K. We borrowed closing costs to save money for the inevitable renovations, which we would perform while we lived there.
Let's analyze what follows as an investment, starting with the real estate play. The opportunity cost to buy a house is pretty steep. I had to come up with a 20% down payment. That's $60K, and while there were other options for getting financing, this was the easiest path and the one I ultimately chose.
I suppose this would be the beginning point for comparing investments. Down one path lay the house. Down the other was a simpler option - we could simply rent (a similar unit cost about what renting would cost) and I could stash my down payment cash in the stock market using a no-brainer Index Funds investment strategy that mirrors the market average.
Well, we all know what I did, so let's add up the numbers and see if I was a gullible fool or the next real estate mogul (two years ago, I might have said Donald Trump here. How times have changed). Doing so is a pretty simple calculation - I add up all the money owning a house generated and/or saved me during the period I owned it and subtract the costs associated with holding it. I've ignored inflation, as well as any difference in price between renting and buying (there isn't much in my situation, but this is not always the case).
My house generated gains for us in a total of five ways:
(1) Principal appreciation. (Gain of $24,600) This is the part of my monthly payment that goes directly into reducing the amount of money I owe the bank. We started with a loan balance of $240K and owed $215,400 when we paid off the loan.
(2) Tax deductions. ($22,400 in refunds over a seven-year period) Mortgage interest and property tax are both deductible expenses for the vast majority of people. At a 25% marginal tax rate, I would get $250 back from the government for every $1,000 of mortgage interest I paid during a calendar year. I paid a lot of interest, so I got back a good chunk at tax time.
(3) A first-time homebuyer credit (one-time $10,000 tax credit) designed to incentivize people to buy a home*. This was a transient incentive that no longer exists. Thanks Obama.
(4) Home appreciation. ($2,000) This is any increase in the price over the period you own the home. We bought at $300K and sold at $302K.
(5) Rental income. ($8,500 over the past 16 months) For us, this was our 1.5-years as AirBnB hosts, but could also mean renting out a room in their home. This year we'll have made enough for us to make some additional tax deductions as a business expense. Since not everyone has (or wants to rent out) a spare bedroom, I'm not factoring AirBnB money into my equation, because it doesn't reflect a typical homeowner and might technically work.
Total gains: (excluding AirBnB income): $59,000
Now for the liabilities associated with owning a home. The first four are regular costs which, had I chosen to rent, would have been passed on to me by default. For that reason I don't include them as unique liabilities for home ownership. Items five through seven, however, are things I would never have faced as a renter, and are grouped together as the financial downside of home ownership.
(1) Mortgage. Includes principal and interest. Ranged from $1,067 to $940 a month (we refi'd a couple of times as rates fell). This isn't a cost, per se, and I've included it only for the sake of completeness.
(2) Association fees. We live in a high rise. Our association fees increased steadily from $623 to $823 a month. This is not tax deductible, just an ordinary hit to the wallet. We did get our water, gas, cable/internet and most of our electricity through this fee.
(3) Insurance. About $750 a year. Not tax deductible. We bought a high-deductible insurance policy, which paid off since we never filed a claim.
(4) Property Taxes. These inched up steadily from $4,200 to $4,800 a year as we supported Chicago's bloated city worker- and teacher's unions.
Costs Unique to Home Ownership
(5) Renovation and maintenance. ($15,800) As planned, I spent quite a bit out-of-pocket on renovations to the interior of our condo. Much of this was done by me, so I got a lot of mileage for my money. Regular maintenance costs would be a bigger thing for a single-family home (e.g., replacing the roof), but we lived in a concrete box, so I ignored the very minor costs we did incur.
(6) Closing costs. ($8,941) Taxes, title insurance, legal fees, doc fees, et al. This includes only our selling closing costs; we borrowed our closing costs when buying, which were also about $9,000. This is reflected in the relatively modest appreciation of the house.
(7) Realtor fees. $0. We sold our house ourselves, which saved us a hefty commission. I'm going to write a post on how we did this.
How did it work out?
(Total Gains) - (Total Costs) = Total Profit/Loss
$59,000 - $24,741 = $34,259
So on a $60,000 investment, I walked away with $94,259, a gain of $34,259. That's a 57 percent return which, over seven years, works out to annual return of 6.7%. Not bad.
Would I have been better off investing my money in the stock market? Oh heck yeah. In the same period (2010 to 2017), the stock market returned 13.2% (calculated here), outperforming my housing investment by nearly double. However, this was a fairly good period for the market; historically the S&P 500 returns 9-10% over the long term**. Had I opted for a smoother ride by investing in more conservative investments, my returns would have been even closer to what I got through buying. Had the market turned against me, I would have craved the mid-single digit returns my residence generated. Of course, that doesn't mean real estate is safe - had I bought in 2006, I might still be underwater, owing more on the mortgage that the property was worth.
You cannot (and should not) count on appreciation of home values. My home basically stayed flat, maybe even lost a little value, and I was in one of the nicest parts of Chicago in a building where people live their entire lives. While there are 'guaranteed' ways to make money on housing, appreciation is luck.
Renovation is a terrible idea, financially. I spent nearly $16K to fix up our place and only sold it for $12K more. Even accounting for zero appreciation/inflation in property values, I only got back 75 cents for every dollar I spent. Also (and I cannot overemphasize this enough), the same professional renovations would have cost $30-40K, resulting in an even poorer return on investment. Return on time investment was even poorer, abysmal actually; if I calculated my per-hour rate on all the work I did, I think I'd cry. We also lived in the unit while I worked on it, which was stressful to say the least. I can honestly say that this renovation was the closest Susan and I have ever come to breaking up. I know that sounds incredibly yuppie, but it's true nonetheless.
Much of my return (55% in my case) came from tax incentives. This is something I really wish I would have known going in. For one thing, it's possible to predict the returns (more or less) and get some idea of how long until you'll recoup your investment. Also, structuring your purchase to include a higher proportion of tax-deductible payments is beneficial. For example, I spent nearly half of my regular payment on a non-deductible assessments. Purchasing a home might have no homeowner fees but a higher price that includes more tax deductible interest. Same price, bigger tax break. This opens you up to larger single expenses, so caveat emptor.
Closing costs are a bitch, especially when selling. Seriously, buying and selling this place cost me nineteen thousand dollars off the bat, a six percent loss that occurs the moment I signed the paperwork. This actually understates how bad it is: through a little planning, I avoided two big closing costs. First, I have a legal plan that paid for a real estate attorney (that's a $1,500 fee). Second, I avoided a realtor, which saved another $12,000-$18,000. Adding those in and I would be in for up to almost $38K, a guaranteed 12.5% investment loss. And to think this is the route most people take!
When selling, never use a realtor. See above.
The longer you stay in a place, the better. Our main expenses in owning were one-time costs that can be amortized over the course of owning. For example, we were unlikely to renovate the place for many more years. Similarly, closing costs are fairly static (and when they do increase, it's because of a higher sales price that reflects the even bigger gains in appreciation. Adding to this, loans are structured so that the big principal paydowns occur later in the loan. Like most investments, holding long term is the key to success. For what it's worth, this was our plan, but my job moved to San Diego and it was just too sweet to pass up.
If you can, make your property generate revenue for you. AirBnB might have totally changed the way we look at our homes. If I would have generated $7,500 (four months of activity) for only five of the seven years we lived there, our returns would have nearly doubled (to 11.6%). This might be a little too unique to us, but it's a nice option if the stars align.
Two last questions I find myself asking myself:
First, would I consider renting my home instead of selling it? Answer: we looked at it. Our unit would be low maintenance. However, the flat appreciation in Chicago and the nominal gains of holding the property weren't attractive when weighed against the possibility of bad tenants or unexpected damage. Plus, the building is getting old, to be honest. Special assessments would have made the place harder to sell later. If we had planned to come back to Chicago for sure someday, I would have rented it in a heartbeat, but in the end we decided to cleanly divest ourselves from the property.
Would I buy a home again? Answer: yes, but with some qualifications. (1) We would have to decide that San Diego (or wherever) would have to be our permanent home. Long term only. (2) The buy vs rent numbers have to be close enough together to make buying worth it. (3) I think we're in another real estate bubble, so I need to see some price correction before I get in. (4) I would want an AirBnB friendly place. I don't plan on working forever, and I'd like the revenue stream the service provides.
For the moment, though, we return to the blissful, worry-free life of renters.
*I had owned a home before, but I was eligible for the credit anyway. 2010 was chaos time(TM).
**These returns are 6-7% when inflation is taken into account; considering the possibility of housing prices matching inflation my result seems a little rosier.
Noah's Inner Monologue
Scribblings of a man who can barely operate an idiotproof website.