Investing in a home has long been considered a cornerstone of the American dream. With home prices generally rising over time and the ability to build home equity, owning a home is often viewed as a true investment that can appreciate in value. However, the 2008 housing crisis revealed that real estate investing still carries risks. When approached prudently over the long run, homeownership offers financial security. This article will analyze the merits and considerations around investing in a home.
A home as a forced savings vehicle builds equity over time
Owning a home functions as a forced savings account in the form of built-up home equity. By making monthly mortgage payments comprised of both principal and interest, homeowners steadily pay down their loan balance and increase their stake in the property. This equity acts as a nest egg that can be borrowed against in the future via home equity loans or lines of credit. Ultimately, home equity can provide funds for other investments or expenses like college tuition. With median existing home prices up over 50% in the last decade, appreciation has also let many homeowners realize substantial returns.
Homeownership stability encourages community involvement
The stability inherent to homeownership alsostrengthens communities. Compared to renters who may move morefrequently, homeowners tend to stay planted and invest themselves locally. Their kids remain in the same school district, families put down roots at neighborhood parks and community events, and adults engage civically through local government, nonprofits and neighborhood associations. This continuity and sense of permanence make homeowners more devoted citizens invested in bettering their towns.
High transaction costs and illiquid nature discourage flipping
Despite potential for appreciation, theilliquid nature of real estate and high transaction costs involved in buying andselling discourage speculative investing or flipping homes. Between agentcommissions, closing costs, property taxes and insurance, transaction fees cantotal 10% or more of a home’s value. These sunk costs make homes more suitedto long-term holds rather than short-term trades. The overall illiquidstate of the market also limits one’s ability to exit a position quickly.Together, these dynamics promote more patient, buy-and-hold mentalities alignedwith home values gradually increasing over a decade or more.
Leverage cuts both ways, magnifying gains and losses
The use ofleverage is another defining aspect of real estate investing thatdistinguishes it from securities or bond investing. By putting down 20% or lessas a down payment and financing the remainder of the purchase price, investorscan control a much more valuable asset. If the property appreciatessubstantially, an investor captures that full upside return despite onlycontributing a fraction of the capital. However, leverage also exacerbatesdownside risk. With most wealth tied up in the home itself, investors have muchless of a margin of safety compared to investing in diversified securities usingcash. This compressed margin for error visits maximum pain during housing downturns like in2008. While painful at the time, markets eventually recover and return to formgiven a long enough time horizon.
When approached as a long-term investment, homeownership builds savings through equity and encourages community stability. Despite risks surrounding leverage, illiquidity, and housing volatility, history has shown that buying a home can pay dividends over a lifetime. Proper expectations around timeframe, costs, and risks associated with real estate will lead to informed investment decisions.