Some financial advisors maintain that putting money in the stock market rather than buying a home is a better investment, particularly when housing prices and interest rates are high. For example, a contributor to Forbes notes: “Put simply, an investment in real estate earns just three to four percent per year historically; on the contrary, investments in the stock market post about 10 percent annual returns.” But it’s not that simple, in my humble opinion.
I am not a financial advisor, but I don’t see why it would be an either-or proposition. Holding real estate in addition to holding stocks gives me a more diverse investment portfolio, which seems like a good way to manage risk. If the stock or bond market is down at retirement, at least my husband and I will have equity in our home (which might even be paid off by then) and some income from rental property as well.
Moreover, real estate and stocks are fundamentally different types of investments, which is why simply comparing home appreciation rates to stock market returns doesn’t make sense. After all, real estate often involves leveraging other people’s money through mortgages, while the average person rarely, if ever, gets a loan to buy stock.
Because of leverage, buyers can secure an asset that is far more valuable than the money they put down. Consider a theoretical example comparing a $110,000 investment in real estate or the stock market. One could use that money to purchase a $400,000 home with a $100,000 down payment and estimated $10,000 closing costs. Or the individual could put that $110,000 in the stock market and hope to get a 10 or 12 percent return—more or less. Who stands to benefit financially the most in this scenario?
Economist Scholastica Coroaton points out in a National Association of Realtors blog post that real estate appreciated by as much as 8.5 percent annually between 2017-2022. But over a 30-year period, home appreciation has only been 4.5 percent—far less than the 10 percent that our theoretical investment *might* get in the stock market. But leveraging with a loan can put the home buyer ahead of the game.
The homeowner’s appreciation is not limited to the $110,000 initial investment; it’s on the total value of the home. So, the homeowner in our example would get 4.5 percent on $400,000 over 30 years or however long he holds the home, which is on average $18,000 a year. If those funds earned 10 percent in the stock market, that would average out to $11,000 a year. Of course, these are just theoretical averages, but you get the picture.
Advocates of the stock-only approach will point out that you do have to pay the loan back with interest and manage home maintenance costs. True, but those who don’t own their homes still have monthly living expenses associated with renting, so why not have some of those costs go toward equity? And rents are set so that landlords can cover their taxes and maintenance expenses, so renters are not completely insulated from such costs. And rents tend to increase yearly, while if you get a fixed rate loan, a large chunk of your payment—the principal and interest—remains the same for the life of your loan, which could be 30 years.
And when a homeowner decides to sell, special tax advantages apply. The federal government provides a capital gains tax exemption up to $250,000 (for singles) or $500,000 (for couples) as long as they lived in the home three out of the last five years before they sell. Finally, if you decide you don’t want to live in the home, you can also rent it out and have someone else pay down your loan, while you buy or rent another home.
Of course, retirement accounts also provide tax advantages, enabling individuals to avoid taxes in the short term with pre-tax retirement accounts and tax-free appreciation in a Roth IRA. But you can only put so much into those accounts each year. In any case, it makes sense for people to do both: Buy a home and invest funds for retirement, if possible.
Of note, homeowners tend to have a higher net worth than renters. Personal finance reporter for CNBC Select Brett Holzhauer noted earlier this year:
In 2019, homeowners in the U.S. had a median net worth of $255,000, while renters had a net worth of just $6,300. That’s a difference of 40x between the two groups.
There are many reasons why homeowners have a higher net worth. You could argue that owning a home is much like [having] a forced savings account, where each month part of your mortgage payment goes into the equity of the home. Whereas, renting is a sunk cost with no return on investment.
Surely, there are probably additional reasons, such as the fact that people who buy homes might also have higher incomes and save more money, but it certainly helps to have home equity.
There are other, less financially focused reasons to own real estate as well, such as personal enjoyment associated with home ownership, and one’s ability to make improvements that meet personal needs.
Of course, every person’s situation, wants, and needs, are different, so do your own research, speak to qualified financial advisors, and craft your plan! But when you do your analysis, consider all the benefits of each investment, including leverage associated with real estate investments, and most important, your personal happiness.
