Jeremy Biberdorf recommends investing in a home. I recommend not listening to Jeremy Biberdorf.
One of the most persistent personal finance myths around is that buying a home "is your best investment." You'd think this notion would have been wiped out during our recent financial unpleasantness — along with hundreds of thousands of luckless home "investors" — but the idea persists.
Just to be clear: Owning a home can be a good move for the right people in the right circumstances. But the same can be said for owning a chainsaw or a pet turtle. That doesn't make either of them an investment.
"Investment is a complex subject that most people feel totally insufficient to understand," Biberdorf writes. Then he proceeds to very effectively demonstrate the utter truth of that statement.
25% gain? That's 100% wrong
Biberdorf is a website marketer who runs the personal finance blog Modest Money. He recently wrote an unfortunate and blaringly wrong-headed post for Quizzle.com, a personal finance and credit scoring site run by the Quicken Loans folks. Before this bad info gets too far around the Intertoobz, let's correct Biberdorf's biggest mistakes.
After asserting that "the purchase of your own home is still one of the best ways to invest your money," Biberdorf goes on to give an example of someone who puts $40,000 down on a $200,000 house. Because "houses appreciate at about 4 percent to 5 percent annually," the first-year bump in the home's value gives you a $10,000 gain for, "a shocking 25 percent increase on your initial investment of $40,000."
Shocking, well, yes; that sentence is so shockingly wrong that it makes my brain hurt, so give me a moment here.
OK, I'm back, and let's take first things first.
No, houses don't appreciate at 4 percent to 5 percent a year. They appreciate at that rate in some years and neither you nor I nor Jeremy Biberdorf knows what those years are going to be. They also lose value in some years, and they don't give you advance warning about that turn of events, either. Also, absent our own personal crystal balls, most of us are not ready to pick up and move out so we can lock in our awesome one-year gains when our homes do show gains.
On average, most folks move every 10 years. In the best 10-year period, according to the Case-Shiller Home Price Indices, the value of a home increased by a whopping 74 percent. But that stretch ran from 1996 to 2005, which includes the insanity of the pre-collapse housing bubble — you know, the one that so wildly inflated home values that it triggered the worldwide recession still being felt today, so maybe you don't want to bet on it happening again too soon. To show how extreme that was, from 1950 to 2005, home values increased 91 percent. But extend the range from 1950 to today, and values increased 46 percent. (These are all adjusted for inflation.)
During the worst years of the mortgage mania, home prices grew at an annually compounded rate of 5.68 percent, so getting an average of 4 percent or 5 percent in most years is a ridiculous assumption. In the 56 years from 1950 to the height of home values in 2005, the compounded annual growth rate of home values was 1.17 percent. And from 1950 until today, it's 0.58 percent. So, if you're going by a long-run historical average, your rockin'-sockin' home investment is going to do about as well as a savings bond.
A further reality check: In all the 10-year periods beginning in 1950, home values gained 33 times but lost value 23 times, including 11 percent drops in the 1990s and, worst of all, a 24 percent loss for the last 10 years.
Of course, you could conceivably sit on your "investment" and wait for it to hatch into a golden opportunity as soon as a price hike comes along. Which means that if you got a great job offer or had a baby or wanted to retire to a sunny condo in 1995, you only had to wait to move for several more years — and hope that life didn't get in the way while also praying for one of the worst asset bubbles in history to inflate. Then you could cash in your big winnings. But stay too long, and you'd be back in the red.
Show your work, Jeremy
Our man Jeremy also skips doing the math when it comes to a few other aspects of your home "investment" that will dim the luster of his projected sky-high returns. He writes that "your property tax and interest are both tax deductible, making these costs essentially government subsidized, locking in your 25 percent equity return."
Wrong again, Biberdorf.
On the $160,000 mortgage you'd need in his example, first-year interest amounts to $6,300. Yes, it's tax deductible, and Uncle Sam lets most of us write off about one-quarter of that. Who pays the other 75 percent? You do, and it knocks your $10,000 gain down by nearly half.
Then there's property tax of, let's say, $1,500. There's also the approximately $2,500 in closing costs and fees that you paid, which Biberdorf forgets, along with moving costs and homeowners' insurance, which means that celebrating your savvy "investment" strategy is going to be limited to bringing your own bottle of domestic champagne to the local Chuck E. Cheese's.
But wait: Even if your home value did increase 5 percent, you don't actually have any more money than you started with unless you sell the house (and you'd better sell now, bucko, since that 5 percent boost indicates your home value is headed for a fall in the next few years).
To lock in your genius gains, you'll pay a 6 percent Realtor's commission on your $210,000 sale of $12,600, plus other closing costs such as title insurance, advertising and document fees. Remember to add moving costs to what will have to be a cheaper house, because your $10,000 gain is as flushed as the Tide-e-bowl tablets you left behind.
All told, you put $40,000 down, sold the house for $210,000 and netted about $188,000. But you still have a mortgage balance of $157,000, which leaves you with $31,000. What happened to your "shocking" 25-percent gain? Aren't you supposed to have $50,000 now?
Some evil mysterious source has erased your $10,000 paper profit and produced a $9,000 real-world loss — and that's before you subtract what you paid for property insurance and two sets of moving costs. The name of that evil, mysterious source?
So, be just like Jeremy and invest in a home to grab that 25 percent annual gain on your down payment. And believe me, when you see the return on your investment, you'll definitely be shocked.
Brian O'Connor is author of the award-winning book, "The $1,000 Challenge: How One Family Slashed Its Budget Without Moving Under a Bridge or Living on Government Cheese."