Being realistic about homeownership as an investment

When asked why homeownership is important to them, many clients are likely to answer that it’s a good investment or that they no longer wish to “throw money away” on rent, especially with monthly rents in many areas having soared recently.

The purpose of this article is not to discourage the goal of homebuying but to provide a realistic assessment of the true costs and benefits. Clients looking to purchase a home ought to understand the potential financial pitfalls that come along with building equity and having the liberty to live as they wish when they are their own landlord.

This article aims to provide a perspective to clients who feel societal pressure to own, in the absence of the other reasons, which the author sees often in practice.

Assessing the motivation behind homeownership

Reasons clients cite for wanting to be a homeowner include living in a desired neighborhood, putting down roots, needing more space, escalating rents, etc. However, when clients push themselves into a purchase solely out of a desire to stop “throwing money away” on rent or because they are concerned about market timing, interest rates, etc., it’s a sign to proceed with caution. When the primary reason for buying is simply because the client thinks it’s a better financial decision, especially when they are stretching themselves financially to make the purchase, the outcome is more likely to find the client buying before they are financially ready and ending up regretting the purchase.

Psychologically, wanting to buy a home simply because it seems like a “good investment” often has clients forcing their finances to fit a property that is outside their ability to afford or feeling pressure to buy due to market conditions. This often has clients ending up in a home they don’t love while also feeling financially stressed.

Understanding the total costs

Regardless of their reason for buying, future homeowners need to be clear on the total cost of homeownership outside the down payment and monthly commitment. In addition, it’s wise to be fully aware of the opportunity cost of homeownership. Consider the following:

Property taxes and mortgage interest: While there is technically a tax deduction available for property taxes and mortgage interest, under the current tax law, fewer than 10% of taxpayers overall realize a benefit by claiming itemized deductions, according to a recent Congressional Research Service report (for tax year 2021; see Table 1).

Also, property taxes can rise significantly with little recourse, as Chicago homeowners have experienced, with property taxes doubling in the past 10 years.

Homeowners’ association (HOA) fees: These fees, which vary drastically based on geography and property type, are a growing consideration. Once a rarity reserved for wealthy gated communities, HOA membership is rising quickly, with roughly one-third of housing units in the United States currently within a community association and over $100 billion collected in assessments for these communities in 2023.

Closing costs and commissions: Typically glossed over by real estate brokers and title companies, the cost of actually acquiring and selling a home can take a large bite out of any gains in market value, despite recent changes to how agent commissions are paid in the United States.

The opportunity cost of funds invested in a home

Perhaps the biggest eye-opener of an examination into the true return on investment of homeownership is this: Look at the opportunity cost of what funds used for a down payment could have grown into had they been invested in the stock market instead of into real estate, even when factoring in paying rent.

Using an example based on real-life circumstances, Connie and Kellen bought a home in 2014 near downtown Chicago, selling it for $91,000 more than they paid in summer 2021 near the peak of the market that year. During those seven years of home ownership, they spent approximately $40,000 on repairs and maintenance, including new appliances; a new HVAC system; repairing roof damage from a snowstorm; condo association special assessments; and general upkeep for a two-bedroom, two-bath condominium. That comes to an average of about $5,700 per year, which is about 1% of the $439,000 purchase price and in line with the rule of thumb that homeowners should plan to spend between 1% and 5% in repairs and maintenance per year.

In addition to the repairs and maintenance, they also kept track of the total property taxes, homeowners’ insurance (which is far more expensive than renters’ insurance), HOA quarterly fees, and mortgage interest they paid. These costs added up to $161,000 over the seven years they owned their home.

Finally, the couple paid approximately $52,500 in closing costs, real estate commissions, and other expenses associated with buying and selling a mortgaged home. Factoring in the $91,000 gain in market value, Connie and Kellen ended up having just over $162,000 in housing expenses during their seven years in that home. This comes out to about $1,935 per month, which is equivalent to the amount of rent they would have paid if they’d opted out of homeownership and instead rented in the same neighborhood.

However, this was not a break-even transaction because the couple started out with a down payment of $90,000. If, instead, that $90,000 had been invested in the stock market, based on the actual performance of the market, they would have had close to $265,000 in their brokerage account, while still spending $1,900 per month on housing.

Although investing in real estate and investing in the stock market involve different levels of risk, the above example does provide food for thought for clients approaching the decision from a purely numbers-based perspective.

Remaining clear on the true financial benefit of home ownership

The conclusion certainly isn’t that CPA financial planners should discourage clients from pursuing homeownership. Rather, it’s to help clients who are feeling pressured to buy simply because they think it would be a far wiser financial decision than renting to carefully consider the numbers.

At the end of the day, housing is an expense, and buying a primary residence should not be viewed as an investment in the same vein as investing in marketable securities. Clients should be purchasing a home because they desire all the other benefits of putting down roots and are financially and mentally prepared for the responsibility, not because they think they are getting “a good deal.”

The greater message is that buying a home comes with a lot of emotion. As CPA financial planners, we can help clients avoid financial distress by making sure they are fully prepared for all the costs and that they understand that while homeownership is often considered a marker of financial success in our culture, it’s not always an actual financial success when weighed against all the other factors.

Buying a home is a serious commitment and likely to be the largest financial transaction many of our clients will engage in. Help them to make that decision from a place of rational numbers instead of due to societal pressure and incorrect assumptions. This advice can save clients who perhaps for now are better suited to renting and investing more diligently from the consequences of making a big financial and life mistake.

To further assist clients interested in purchasing a home, download the AICPA Personal Financial Planning Section’s checklist for buying a home and offer clients copies.

— Kelley C. Long, CPA/PFS, CFP, is a personal financial coach and consultant in Arizona. To comment on this article or to suggest an idea for another article, contact Dave Strausfeld at David.Strausfeld@aicpa-cima.com.