Cheerleading for Home Ownership

I’ve been a happy homeowner for many years now. I prefer owning my home to renting. But I have no illusions that this is the better choice financially. Price to rent ratios today mean I’d very likely come out far ahead if I sold my house and started renting a comparable house. But I’m not going to sell because I choose to pay the price of ownership. Unfortunately, many homeowners need to believe they will win financially, and they come up with poor analyses to justify this belief.

One such example comes from Sean Cooper’s book, Burn Your Mortgage:

“Let’s say you bought a home a decade ago for $250,000, with only 10% down ($25,000). You later sold it for $400,000, making $125,000 in profit (for simplicity’s sake, we’ll ignore associated costs such as mortgage interest, mortgage insurance, property taxes and closing costs). Even though your home only went up in value by 60%, that’s a 500% return on your initial investment (down payment) of $25,000. Try finding that kind of return in the stock market!”

For accuracy’s sake, let’s sacrifice some of the simplicity of this analysis. Let’s assume your mortgage rate was 3% for the past 10 years, and you had to add CMHC insurance of $5000 to your mortgage. This gives mortgage payments of $13,060 each year on a starting mortgage balance of $230,000. After 10 years, your mortgage balance dropped to about $157,800 so that your equity was $242,200.

Let’s say your annual property taxes were $4000, total maintenance costs averaged $6000 per year, and insurance was $1000 annually. When you bought the house, the closing costs were $10,000, and when you sold it, the real estate fees and other costs totaled $20,000.

It wouldn’t be fair to stop here because you are getting the benefit of living in the house. So, we have to factor in rent. In my area, a place that would have sold for $250,000 a decade ago and is worth $400,000 today would have rented for an average of about $1500 per month over the 10 years. Let’s say the extra utilities an owner has to pay that are usually included in rent come to $2000 per year.

Grinding these numbers through a spreadsheet, we find that the internal rate or return on this investment was 8.7% per year. Somehow we went from an eye-popping 500% return to a pleasing, but down-to-earth return, despite a 60% increase in house price and 10:1 initial leverage.

What would have happened if your home’s value had only risen to $300,000? The internal rate of return would have been -1.2% per year. That’s right—even if your house appreciates by 20%, you can lose money on the investment.

Never trust simple analyses of the investment value of owning a home. The reality is almost always much worse than it appears. Having said all that, I own my home and don’t plan to sell. But I don’t own with the expectation of making a profit.