Think of a house as a home not as an investment

Buying a house is not an ideal way to build generational wealth.

Let’s do a little math. Say you are buying a house that is listed for $407,000, which as it happens is the median sale price of a home in Florida according to Florida Realtors. Putting a traditional 20% down means coming up with $81,400 in liquid assets at the time of purchase, which for many families is no small feat. The median savings for US households is a little over $5,000. While there are some people who can afford to save up the $81,400, some US families will likely dip into other investments including their retirement accounts to pay for the house. Doing so can be disastrous to creating long-term wealth. We’ll get back to that in a bit.

Current interest rates for a 30 year mortgage are around 6.5% to 7%, depending on where you are, but I’ll be generous here and assume it’s more like 5% just to prove the point.

Congrats, you’ve bought a house! But you’ll be paying for that decision for a long time. From now until January 2053, you’ll be paying more than $2,000 a month with most that money going toward interest on the loan. Over the life of the loan assuming a monthly payment of $2,081, you’ll have paid $629,662 in addition to the $81,400 you initially paid as a down payment. I’m being awfully generous there with the $2,081 as home owners insurance policies are getting increasingly expensive in Florida. So that $407,000 house you thought you were buying turns out to be more like a $711,062 house, or you know $304,062 more than the list price.

Let’s stop here to appreciate something really obvious. If you are going to be paying more than $300k on the list price of an investment, you are going to need a miracle to get a truly great return here. Even with acute housing shortages in areas, the great return isn’t there, especially when you consider other means of creating generational wealth.

Now say you took half of that down payment, $40,000, and you invested it in an S&P 500 Index Fund. And because this is an exercise in assumptions, we’ll assume that the next 30 years of the stock market will look a lot like the previous 30 years. Using returns based on a 1992-2022 time frame, that $40,000 would be $656,701.83, an incredible 1,541.75% on your return! If you want to build generational wealth, index funds sure seem to be the way to go, as they lack the wild volatility found in most individual stocks (Apple stock over 20 years has an insane return while Ford would have lost you money. Almost goes without saying that it’s difficult to predict the long term outlook of any individual company) while still generating an incredible return over a long period of time. There is a reason a lot of billionaire wealth is tied up in stocks. If you were proto-Glenn Beck and invested in gold before it became fashionable in right wing circles, you still would have something like a 480+% return on your investment over the past 30 years. Even some Furbies are returning something like 50% on an “investment” over the past 20+ years.

Here again is where I pause to say that I am only considering the wealth implications of home ownership and only because it gets used time and again as a reason why we can’t build more housing. The only way housing returns any value as an investment is when we manufacture artificial housing shortages and make it harder for people to buy a house. We need to screw a lot of people to make a few people somewhat better off. Capitalism at it’s worst. And these shortages are needed to prop up a bad financial investment, even before we account for the large amount of money spent over the 30 year life span on repairs and maintenance.

The general rule of thumb is to set aside somewhere between 2% and 4% of your home value every year to cover maintenance costs. For a $407,000, on the low end of costs, you should expect to spend $8,140 per year. Over the life of a 30 year mortgage, that comes to an additional $244,200 in expenses. So what you saw as a $407,000 purchase ends up being a $711,062 house with an extra $244,200 in additional costs. Congrats, you’ve now ended up spending nearly $1M ($955,262 to be exact) in costs on what was supposed to be a $407,000 investment.

You’re not making money on this house, regardless of what people tell you¹ about houses as a wealth building vehicle. You’ll need to own the house for decades after the mortgage has been paid off, get extremely lucky with long term maintenance issues, and have some persistent housing shortages in your area to make it worthwhile.

If you’ve pulled money from your retirement account to help pay for a house that you thought was going to build generational wealth, you have likely made a huge financial mistake. You’ve taken money out of a passive investment that typically returns a great percentage over time with very low costs attached and put it into the opposite of all that. In some cases, you’ll be taxed for taking money out of a retirement account early too. Losing money is a stupid way to build wealth.

Of course a house is more than an investment. It’s a place to live. If you are not looking at a house as a wealth building vehicle, then spending money to buy a house makes a lot of sense sometimes. You want the security of a place that is yours with the freedom (unless it’s a historic house or in a homeowners association or deed restricted neighborhood, then the freedom is somewhat curtailed) to do with it what you will. And that makes a lot of sense! We should treat houses like a place to live more often and like investments less often because they aren’t great investments. And the effects of treating houses like wealth building instruments are pretty terrible too. To get a great return on a house, you either have to rent it out and be kind of a crappy landlord charging high rents, be a house flipper and contribute to a housing bubble by artificially driving up valuations in an area or hope that housing shortages cause an investment bubble that spike your home valuation. Or in other words, you need to be kind of an asshole to make this work.

Addendum: I spoke with a few smart friends who pointed out that I missed a few things in here. One, a lot of people think a house is a great investment because we were living in what was basically a historical anomaly with low interest rates. From December 2011 to February 2022, 30 year mortgage interest rates mostly hovered in between 3.5 and 4.5%, with rates dipping to a historic low 2.6% during the pandemic. Getting a rate of 2.6% on a mortgage does change the equation a bit as a rate that low is basically free money and allows for a comfort-level with leveraging that wouldn’t exist in normal interest rate environments. Rates are back up to around 6-7%, which is still on the low end of the spectrum historically but not so low that taking on that sort of loan isn’t a bit onerous on someone’s finances. Given past trends and the reasons why interest rates were so incredibly low (basically, the Federal Reserve’s response to the worst global recession since the Great Depression + the worst global pandemic since the Spanish Flu), it seems likely that we won’t see a repeat of the free money era any time soon. It’s a safer bet to assume that the 6-7% that we’re seeing now will represent the lower end of normal rates going forward. Even with that historic anomaly, it still was a better financial move to invest in an index fund since the returns in that period were high and the costs to invest were basically nothing (if a 2% expense is free money, consider that Vanguard charges a .04% expense ratio on their S&P 500 fund).

Disclaimer: This is about buying a house and thinking of it as an investment. If you are buying a house or considering buying a house and you’re only thinking of it like a home, what I wrote largely doesn’t apply. Also this is not financial advice, and I am not a financial advisor. I’m making a lot of assumptions based on past performance, which as we all know, is no guarantee of future performance. As with all things financial, consult a professional and preferably a fiduciary for actual financial guidance.

1. Ok, so I don’t usually footnote but the link I use here features some of the worst math and logic I’ve seen. It completely ignores interest payments, closing costs, and maintenance costs. A lot of people get financially dumb when it comes to houses because the math behind whether you are making money or not can be complex.