Is a Home an Investment?
A man named Benjamin Graham once said, "An investment [operation] is one in which, upon thorough analysis, promises safety of principle and an adequate return." This man is also known as the father of value investing and was mentor and teacher to Warren Buffet - a living legend in the investment world.
So, does a home satisfy Benjamin Graham's definition of an investment?
There are three criteria that need to be met in order to answer this question:
- Thorough Anaysis
- Promises Safety of Principle
- An Adequate/Satisfactory return
First, let's just assume a home is an establishment in which you live, sleep, eat, have a family, and where you have all your belongings.
Many people would say a home is priceless, but let's just stick with the dollar value and numbers side of things for the purpose of determining whether or not a home is an investment.
A thorough analysis of a home includes knowing the value of other homes in the same location, cost projections, appraisal/inspections, etc.
Below are some expenses and costs that go into owning a home:
- Down payment
- Mortgage (principle balance borrowed)
- Mortgage interest
- Property Taxes
- Maintenance and Repairs
- Optional Improvements
In terms of meeting Ben Graham's definition of an investment, quite simply, if a home is costing you money to own it does NOT satisfy the definition of an investment. The home must satisfy all three criteria in order to be defined as an investment.
The value of my home is going up, why is it not an investment?
Appreciation in the value of a home is a tough thing to predict. It is usually safe to assume you won't get rich from owning a home. Sometimes the value of a home doesn't go up at all, and sometimes it can even go down as we have all seen during the recession; its a terrible thing to happen when you're "upside down" on your mortgage (paying more for your house than what its worth). Also, if nothing is done to help protect the home's value in terms of maintenance and upkeep, the home's value goes down.
A home is not an investment as the costs of owning a home can sometimes overpower any appreciation in the value of the home. If you live in your home for 5 years and see a 15% rise in its value, it sounds great and all, but if the amount of expenses you've incurred in those 5 years cost you more than the rate of appreciation the home is not an investment.
So, until you stop making those mortgage payments with interest and the house appreciates more than the cost of taxes, maintenance, and insurance, your home is not an investment.
In my opinion, a home you live in is more of a savings account. However, it isn't something you can take money out of quickly until you take out a home loan or by selling the home.
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So why is a home called an investment?
Your home IS an investment - however, it's an investment for the bank or financial institution that you have a mortgage with. They are the ones making thousands of dollars over the 15 or 30 years you own your home. That "little" interest rate you signed up for is where their "adequate return" comes from and if you can't make your mortgage payments after some time, they can take your home (foreclose) and auction it off. To banks, your mortgage and your home satisfies all the criteria of Ben Graham's definition of an investment.. not you!
There is a chance that the value of your home will appreciate enough to make it an investment, but I believe it cannot be depended on therefore I don't take appreciation into account when making an investment decision.
Other than that, It's not so bad. Just keep up with the mortgage payments and you'll have equity in the house. Don't worry about foreclosure crawling up your alley, it's just two or three months worth of missed payments. Kidding of course, everyone should be worried about their homes being taken away.
The next question in your mind should be, how can you make it an investment?
You can rent it out for more than your costs per month or by "flipping" it - selling the house for more than you bought it for. If you can pull this off, you gain the title of "real estate investor." Unless you rent out each room in your house while you sleep in the garage and make more from the rent money than all your other costs for the home, there really isn't another way to make your home an investment. Though, It might an idea worth thinking about if you're in college and want nearby housing.
Real estate investors play around with their numbers in order to make the "adequate return" - its like a balancing act and the numbers need to fit in order to work. Real estate investors must plan far ahead before making an investment decision.
How is a home an investment if you have to take out a mortgage, a debt?
Some investors focus their efforts on the idea of making money using as much of other people's money as possible (the banks or from other investors); this would only work IF the numbers make sense. The idea of going into debt is great IF you always had tenants who were willing to accept the price of rent/lease, but that IF is risky. That risk can only be mitigated if you attain more knowledge and skills in real estate investing. There are many books out there and gaining knowledge before taking on any financial risks is absolutely necessary in order to not put yourself into a situation where you will see bankruptcy down the line.
However, there disadvantages to debt and using other people's money strategy. Sometimes, as we have seen in the latest recession of 2009, those who relied on debt to build a a real estate portfolio of investments can't make their payments. Or, some investors get sloppy and are willing to buy any house at any price without doing the thorough analysis - this does not provide a safety of principle. The result may have an initial return that's adequate, but will gradually move underwater "upside down."
Some regular homeowners who relied on
this same strategy set themselves up for disaster - so don't go too far into the water. Although there may be tax incentives for owning a home, you still need to stay within a reasonable limit of your income.
If you are considering owning a home, you should really consider it a more of a savings/equity account. If you want to make a home an investment, rent it out or sell it for a quick profit. Either way, make an informed investment decision that focuses on "thorough analysis, promises safety of principle, and provides and adequate return."
Check out these real estate books:
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