Believe it or not, for many local residents, it is true. But, as many financial planners will tell you, as with any investment, it could depend on the length of time you stay in the home.
Unfortunately, many publications just don’t “get it”, when it comes down to analyzing the rate of return on a home. They generally write articles or cite statistics that state housing’s average appreciation rate roughly equal to the rate of inflation over the past 50 years – about 3.7% annual housing appreciation rate. In some areas (like our Northern VA homes), they calculate housing as a bit better than inflation rates, but maybe only 4.5% average appreciation rate per year. On the surface, that does not sound like a very exciting rate of return. Especially when comparing to historical mutual funds averages in the 8%-10% annual range.
But this is where the novice analyst/reporter drops the ball and unknowingly misguides the general public. When comparing housing to inflation, these unwitting article authors compare the total cost or total current value of a home ($400,000 in our area) and its average annual appreciation rate, to the annual Inflation rate. This understanding is lacking in a true comparison of apples to apples. Very few Northern Virginia home buyers ever buy a home with ‘all cash’. Most finance their home purchase with a mortgage. The actual cash invested averages between 10%-20% down payment, plus closing costs.
In order to properly break down the numbers on an average home price of $400,000, you would use the 50 year average annual compounded housing appreciation rate of 4.5%, and you would see a 10 year return of $226,797 in value growth on that home. Then, since the average home buyer is financing their purchase, we really need to be fair in our comparison, and see what the rate of return has been on the actual cash invested.
On a $400,000 home purchase, we will use an average down payment amount of $60,000 (15% down payment) plus closing costs of $10,000 for a total investment of $70,000. Now we find that an investment of $70,000 that grows to $226,797 in 10 years is an 11.8% annual compounded rate of return. I challenge you to find any large market that has shown an average compounded rate of return of approximately 12% annually over the past 50 years. You won’t, because you don’t get the kind of leverage in other market vehicles that you get with Real Estate, due to low cost mortgage financing.
Even more exciting is if you use a 10% down payment of $40,000 plus $10,000 in closing costs, which totals $50,000 invested. Then you get a whopping 15.22% annual compounded rate of return. On the other end of the spectrum a 20% down payment of $80,000 plus $10,000 in closing costs, results in $90,000 invested, which generate a 9.28% return- not too shabby. Plus, don’t forget, since you put up a larger down payment of 20%, you will also have lower monthly mortgage payments, so there is more money you get to keep. Don’t forget to evaluate that in the total return, which will take it up over 10% compounded annually.
Of course dissenters to these obvious facts will stand up and yell, “You didn’t calculate the cost of the monthly payments. That will bring the yield down to a lower number”. But, if they would stop and think before jumping to conclusions, they would realize it is irrelevant – simply because if you don’t own a house, then you have to rent. Therefore, you have to make monthly payments wherever you live, whether you make mortgage payments, or rent payments, so it is not a factor.
With homeownership, you also get the mortgage interest deduction on mortgage payments. This tax benefit brings the average house payment down to a net monthly figure below the monthly market rent payment for that same house. However, when you own a home, you do have maintenance costs you need to spend money on, and that will generally even out the tax savings difference from that mortgage interest deduction.
According to the National Association of Realtors and the Mortgage Bankers Association, there analysis shows that there has not been a better market for buying a house in the past 50 years due to the convergence of low interest rates, and lowered prices. Just imagine what the yields could be over the next 10 years if you buy a home now.
Thierry Roche is host of the DC areas longest running Real Estate Radio Show, ‘Inside Real Estate”, and a 22 veteran Realtor with Re/Max in Northern VA. His proven strategies for saving home buyers money can be accessed for free at www.allfairfaxvahomesforsale.com or at his blog, http://thierryroche.inside-real-estate.com/blog/
I agree that one can’t simply compare the difference in total house value (or selling price) over time, but don’t you have to also consider in the above calcs average estimated monthly payments and average estimated annual tax deductions. I’m guessing the actual ROI is more than inflation but less than 12%.