Executive Coaching & Consulting
I like James Altucher’s “aww, shucks” podcast, but his post on Home Ownership is Financial Suicide is fuzzy-headed thinking. Here’s why:
Buying a home is both an emotional and a business decision. When you are comparing investments rationally, you must do math… period. I’ve seen many business leaders succumb to emotion and “received wisdom” instead of rationally thinking through the alternatives. Buying vs. renting is too important a decision to take any advice (even mine) at face value.
James says that homes don’t historically appreciate, they chain you to a location, and saddle you with mortgage and capital expenses that you’ll never recover. His first point is debatable, but his other points are baloney.
You’ll have to make calculations about the *particular house* you are buying in the *particular market* you’re in. You’ll have to compare it to the *particular alternatives* available to you, including local rental prices, availability, suitability for your family (do you have 3 school-age kids, 2 cats, and a pit bull? You may have a harder time finding a rental that feeds good schools and will accommodate your needs and budget). I actually built an elaborate spreadsheet model to do just this. But this guy built a better one. For us, the benefits of buying over renting were realized in Year 2.
Making sweeping generalizations as James does about historical house price appreciation rates, dubious assumptions about alternate investment options, and rah-rah speeches about how investing in yourself is much safer than owning a home may be an emotionally compelling argument, but it’s not a logical one. If you make major decisions about your net worth without ever invoking a spreadsheet or calculator, well… good luck.
James’ advice here is TRUE for some people, some of the time. But it’s not true across the board.
If you are a military family, or travel a lot for your work, then renting may be a great option for you to “sample” different countries, cities, and neighborhoods before deciding where to put down roots. There is still an argument to be made for investing in homes (indeed, you could likely buy homes on more favorable terms and later turn them into rentals), but it’s reasonable to rent if you are sure to move within 2-3 years.
Anyone can buy a home stupidly. Many do. Developers bet millions that you’ll overpay for finish-out and poor locations. But good homes are generally in good locations. What does a good location buy you? Safety; good schools; convenience to retail shops and restaurants, amenities, recreational facilities, and (probably) employers; access to public transportation; and better quality neighbors. Good dirt is relatively expensive, but it will always repay the owner with the above non-financial returns, plus the financial returns mentioned below. Bad dirt may not. So, when you buy, purchase good dirt. If you can’t afford good dirt, then you may want to save money until you can, at which point, James’ arguments will hold much less appeal. Can you reap the benefits of good location by renting? Of course. But if you value that location, why would you not invest in it (buy a home), rather than rent? Do you value being able to move frequently within that neighborhood? If so, then you obviously should rent. But not many people value that much flexibility.
When thinking clearly about your home investment, here are some points to consider:
By logical extension, Altucher seems to be saying that no long-term investment is worthwhile. Should readers cash in their IRAs and 401Ks (and take the hit of associated penalties and tax liability), and instead keep their money under their mattress? Altucher says, “Cash is good.” Indeed, it is. I recommend having a sizable amount of cash-on-hand. But not my entire net worth. When the inflation rate is 0.2% as it is at the time of this writing, then cash looks very smart. But when inflation is 2% (as it was just 15 months ago), or 4% (in 2012), then keeping huge amounts of cash is like keeping all your sand in a leaky hour glass: your cash is guaranteed to lose value every month. Keeping your asset portfolio (and yes, you’ve got one, no matter your income) is work; knowledge work rather than physical, but work nonetheless.
Altucher (and many commenters) offer anecdotal support for why buying a home is silly: “I bought a home, and then had a heart attack from the stress of a mortgage,” or “I bought a home, and 2 days later it was underwater in value,”etc., etc. These arguments conflate the cause and effect. If Altucher bought a home that caused him to stress out over his mortgage, then he probably purchased a mortgage he simply couldn’t afford. There was a lot of that going around in the early and mid-2000’s. But wouldn’t he have had the same trouble paying equivalent rent? This is likely a cash flow problem, not an asset purchase problem. The business equivalent is to say, “We cannot afford to invest in innovation, because cash flow is (a) so tight right now, or (b) so healthy that we can’t afford to stop!”
Similarly, if a commenter purchased a home that was underwater after a market correction, then likely one of two things happened: (1) they were the victim of a black swan event which few saw coming, and for which the borrower did not adequately prepare, or (2) they bought a Stupid Home (see below). Neither of these scenarios is specific to home ownership, or even real estate investments, for that matter. I have purchased Stupid Stocks. I have invested in Stupid Startups (including my own), and even a Stupid Home!
We buy cars rather than lease because we earn equity on our purchase; because lease restrictions are onerous; because we can take some pre-tax savings in the form of deductions; and because when we sell the vehicle, even at a depreciated price, we recapture some of that equity.
There are many types of returns to consider when making an investment. ROE helps you know how hard your money is working for you. Your primary residence is one of the few investments where you can put down just 3-5% and control a giant financial asset without downside exposure to the total value of that asset. Owning a home raises your credit score (assuming you pay your bills on time). It allows you access to capital (HELOCs), and lets you reduce your costs in the future through refinancing. It provides pre-tax savings through deductions. And even if your home only appreciate near the rate of inflation, that is at least as good as buying Treasury Inflation-Protected Securities bonds (TIPS), which will lock you in for the life of the bond. All in all, that’s a lot of return on your down-payment!
You can also control leveraged assets with stock options, but you are subject to calls at any time; the risk is much higher, and potentially disastrous for you, financially. By contrast, with a conventional mortgage, you know exactly what your risk profile is for the life of the loan. If you are confident of your cash flow, then it’s a pretty low risk (assuming you don’t lie on your app). If you’re not confident of your cash flow, well, then, you can’t afford to buy a house. But neither can you afford to rent (except perhaps month-to-month).
There is a reason that large corporations and rich people lobby so hard for tax reductions: it’s because taxes are a major wealth-destroyer, particularly for the middle class and small businesses. Government does some good things, to be sure, and it requires taxpayer money to do so, but if you are a W2 employee making $100,000/year, and renting, you can expect to write a $10,000-12,000 check to the IRS each year (or perhaps it’s just taken out of your paycheck, where it feels less depressing). What else could you do with (even part of) that money? Make a down payment on a home, perhaps? Too many people in the U.S.A. ignore the effect of taxes on their financial health.
This is the nub of James’ argument: by investing in yourself (or being an angel/VC investor), you earn a greater return on equity than buying a home, even with all the returns I mention above. This may be true for some. If you have $200,000 in the bank that you can put down on a home or invest in yourself, chances are you’ll be fine either way. Most folks save for years to pull together a $20k down payment on a $150k house. They are risk averse. They don’t have the knowledge to invest confidently in individual companies. Even people who do often lose their entire investment; that’s why Wall Street invented mutual funds. Joe & Jane Everyman can’t gamble with their life savings. Now, if they could be assured of a return twice the rate of inflation, should they take it? Of course! But where can they get a no-risk investment like that?
“Invest in yourself,” James says. Yes, I absolutely agree. But James also advocates not putting all your net worth eggs in one basket; I also agree with him there, even if that basket is yourself. Why? Because what James is saying is “be an entrepreneur.” I like that approach, but it’s not for everyone. It takes time and luck to grow your skills, find something you’re both good and passionate about, and to build a business out of it. Some people simply are not cut out for it. I’ve met them, done business with them, and watched helplessly when they flame out. Conversely, even those who ARE cut from entrepreneurial cloth sometimes crash and burn. I did. My father did. With a wife, child, and large SBA loan, his business suffered growth pains that he couldn’t cure, and he filed Chapter 13 bankruptcy. For some people, buying a good home in a good location at a good price on good terms, with a good-sized down payment is simply a better investment than any other alternative. And, head-fake- buying a home IS an investment in yourself! You are building assets on your balance sheet, rather than merely your income statement or monthly cash flow. The more you think about your home as a financial asset, the less likely you are to buy a Stupid Home.
James cites some specious examples of how much better it is to hire tradespeople than to do repair work yourself. NEWS FLASH: Homeowners can hire tradespeople, too! And the homeowner, I can call any person I choose, not simply the one the landlord insists on. I can schedule immediately, not just when the home warranty company or apartment maintenance guy gets around to it. True, I bear the cost. But the convenience alone is worth it to me. In the long run, even capital expenses are dwarfed by the returns on equity that I’m getting from owning my home.
Home ownership has taken a knock for restricting flexibility. Flexibility has three (3) components: mobility, liquidity, and work opportunities.
Work opportunities are determined by your job skills, not your house. They have NOTHING to do with your home ownership status. If you have transferable skills, like computer programmer, or medical nurse, then the world is your oyster. If you are a school teacher, or a CFO for a large company, you may be chained to your location. But then again, you may not; you can take personal service skills anywhere you like, as long as you’re willing to move.
Altucher claims that buying a home “chains” you to a location is wrong. You can sell anytime you like! Will your home sell in 1 or 2 days? I don’t know; maybe. Two of mine did. Another took 4 months, and another took almost a year to close. How does that compare to renting? Most residential leases are 6-12 months. You can break the lease anytime you want, but you’re probably liable for the entire amount of the lease; you cannot simply move any week you like without incurring penalty. Selling homes involves closing costs; changing rentals involves putting down new deposits, new utility connections, etc. Both have some costs and time delays associated with them.
If you are willing to sell a home at 90% of market value, it will be VERY liquid. Just like buying TIPS, if you need to sell quickly, you can; you simply sacrifice some (or all) of the appreciation. Saying that homeowners are “chained” to a house for 30 years is disingenuous. When you sell at market price, you certainly will get back some or all of the down payment you made (see ‘Equity’ above), plus appreciation. If you sell shortly after moving in, you may take a hickey on the transaction costs. If there is a major market disruption, like the housing meltdown, you may find the value of your asset (house) has dropped, but you’ll also probably see similar drops in the stock/bond markets, unpredictable inflation, etc. In short, in a black swan event, all bets are off.
For context, I’ve been a “free spirited” (broke) artist, then a successful professional actor and musician, lived and worked in 5 countries and 3 continents as an independent consultant, and been both an employee and serial entrepreneur. I lost half our net worth in the Great Recession of 2006-2009 (most of it in equities, not RE). But we recovered. I’m the sole provider for my wife and 3 kids. We own a home and a some RE investments. And I’ve never felt trapped. We’ve also never been wealthier or happier than when we started investing in ourselves… by buying a home.