NOTE: Originally published February 2, 2023.
Buying a House: The American Dream
When people ask if it is a good time to buy a house, they are really asking if allocating funds to real estate is the best use of their money right now. They fear making a poor investment as much as they fear missing a lucrative opportunity. But real estate is a great hedge against inflation, and in this article we will explain why.
Home Values, Economic Uncertainty, and Other Factors
While homeownership undoubtedly remains a financial milestone, one major question frequently accompanies the endeavor – is right now a good time to buy a house?
In recent months there have been many (predictable) headlines about the intensity of the real estate market: prices are too high, interest rates are too high. But does that necessarily mean it is a bad time to buy?
As the old adage goes, “time in the market is better than timing the market.” Meaning, you are better off just entering the market (buying property) when you can and letting your asset appreciate over a longer period than you are attempting to wait for the perfect moment to buy. Let’s take a closer look.
Say you plan to buy right now and sell within the next 24-36 months. Your transactional costs will likely wipe out any gains you make in appreciation, tax benefits, and principal paydown. Even if you are considering flipping your home, the improvements to the overall value of your property could be offset by the additional budget and effort required to execute a successful renovation.
I would like to share my belief you absolutely do not NEED to own where you live. Why? Sometimes renting is a fantastic option because you can rent for less than the monthly mortgage of a comparable home. You could allocate the down payment to other investments where your money might produce a higher return. The S&P 500 is the baseline hurdle rate (~8% per year) that I personally use to decide if I should buy. Everyone ought to survey their own investment options and determine their personal hurdle rate before considering buying property.
The next step is considering housing prices, interest rates, and inflation to get a general idea if an investment in property makes sense.
House price index is currently at a high of $617,890 per home.
According to Corelogic, home prices have appreciated 11.4% on average the past 12 months. A short term correction to the market may occur, but prices have historically appreciated at an annual average of 3.2%. So it is clear that property is an extremely high-value asset, but one that should certainly, steadily appreciate.
Interest rates have indeed gone up in the last couple years, which is always considered less favorable for buyers. But interest rates are based on the 10-Year Treasury Note which, once you zoom out, has declined significantly since 1985. Looking specifically at the last decade, the rates remain relatively attractive, although admittedly not by the comparison of 12-24 months ago. (In November 2022, it is possible to find a 5.5% rate). Even if the recent rise in interest rates tempers your enthusiasm, it is worth noting that a 30-year-fixed conventional mortgage remains one of the best debt instruments available, according to Warren Buffet’s personal investment manager.
Another factor for home buyers to consider is the consumer price index, which we use a proxy for the inflation rate. If you borrow money at a rate less than inflation and invest that money in a productive asset, that will usually result in a positive outcome. Many successful corporations use leverage to multiply their buying power, why shouldn’t you?
The US Bureau of Labor Statistics cites CPI as 7.7% for the last 12 months; meaning, your cash has decreased in value 7.7% over the last year. So it is worth highlighting that you can still find a 30-year mortgage with a rate below inflation.
One should also consider the strategic advantage of buying property. Over long periods of time, there is a strong correlation between inflation and home prices, with the two variables generally moving together. Therefore, it is an excellent hedging technique to invest in property in order to protect your wealth from inflation.
When you combine all that data, from a general perspective it is still a fairly good time to buy a house. You can borrow money cheaper than the inflation rate (just be mindful of your monthly mortgage payment), acquire a valuable asset that will appreciate over time, and protect yourself against inflation.
However, the right answer for each person depends on their circumstances: an individual’s financial situation and the specific property in question.
Example Scenario: Conventional Loan in the Current Housing Market
Let’s walk through how a $1,000,000 single family home might not end up being such a great purchase. Given historical appreciation averages (3.2%), after 30 years the value of that home would be $2,572,710. That number feels impressive at first but it may not hold up under the microscope.
With a standard 20% down payment of $200k, and a $800k loan at 5.5%, your monthly payment will be $5,800 including property tax and insurance. The total of all the mortgage payments is $2,088,000. So you’ll spend nearly $2.1M to service the property, the initial $200k down payment, and then you’ll have to factor in additional transaction expenses. (*This is our estimate – you should always double check your own credit report and consult with mortgage lenders to better understand your monthly payments… a larger down payment would obviously impact your mortgage loan).
The closing costs you must cover usually add up to about 2% to 5% of the home’s purchase price. (As the buyer, you’ll typically cover things like the cost of any inspections, appraisals, title search and insurance, and a loan origination fee).
Even more frequently overlooked is the cost to sell your house down the road. Closing fees as a seller usually add up to about 5% to 7% of the final sale price, with the commission to the agents usually being the biggest culprit. In our example you’ll spend about $170,000 on closing costs.
All said and done, this property investment only generated about $100k in profit, giving you a miniscule return on your investment. Alternatively, had you put the $200k down payment plus the $50k closing fees to buy the house into the S&P 500 and let it sit for 30 years averaging 8%, you would have gained $2.265M. In this scenario it actually seems clear that spending $5k/mo to rent a $2M house while your money works harder in the stock market is far more advantageous than buying that house.
If you want to run the calculations in detail, check out this spreadsheet HERE. Feel free to use the calculator to see if your individual deal will generate the outcome you’re seeking and work with your monthly expenses.
CONCLUSION
Overall it’s still a reasonable time to buy a house, since debt is relatively cheap, the value of the dollars in your checking account continues to decrease faster than we’ve experienced in the past, and real estate will hold value in tandem with inflation. But it’s worth it for home buyers to run the numbers to see if an investment in property clears your own personal hurdle rate.
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