Last week I examined an article
by investment expert Ken Fisher published in USA Today in which he argued that buying a house is not a sound
investment decision. I pointed out what
I considered flaws in his reasoning. After
publishing the article he had to go back to re-work his numbers and found that
the theoretical house in his example returned a 10.8% annualized rate rather
than the 3.1% he originally calculated.
That fact alone should have sunk his argument because that rate of
return is very close to the historical returns of the U.S.
For all the technical errors I
pointed out last week, they are minor compared to what I think is Fisher’s
wrong starting point for his argument.
First, he writes that renting is
cheaper than buying. That is not
completely accurate. Money magazine, citing statistics from
the real estate data company, Trulia, states that buying is cheaper than
renting in the majority of states in the U.S.
But even more fundamentally wrong
is Fisher’s treatment of the money that would be used for purchasing a house. He views it as a single pot of cash that can
either be used to buy the house or to be invested, and since he thinks that a
house is a lousy investment, then you should invest it in stocks. Okay, but you still need housing.
Let’s consider a hypothetical
situation. Suppose after all your other
expenses you have $2000 each month left for housing and investing. Some of that money has to be spent on either
renting or buying shelter. Let’s further
suppose that rent is $1000 per month and that the alternative is to spend $1700
on a monthly mortgage payment (principal, interest, and escrow for taxes and
insurance) and $300 in related housing expenses. And finally, let’s take Fisher’s original
estimate of only 3.1% annualized return on housing and then round the average
annual stock market return to10%. It
would look something like this:
Renter Buyer
$1000
spent on rent $1700
spent on mortgage payment
$1000
invested in stocks @ 10% $
300 spent on housing expenses
This doesn’t look too bad for the
renter. He has invested $1000 and gotten
a 10% return on it. The buyer is spending
all his money on housing and has nothing left to invest. In the early years of the mortgage, only a
small portion of the $1700 can even be considered “invested in the house” because
much of that payment is interest and is not even going toward paying off the
principal.
But what is missed in this line
of reasoning is that while the buyer has relatively little equity, the 3.1%
rate of return is applied to the value of the house, not the amount of equity. So let’s say that the house was worth, and
was bought for, $200,000 and was 100% financed at a fixed interest rate of 4.5%
, i.e. no money down. So after one year
the investment situation looks something like this:
Renter Buyer
$13,200
= total investment value $3230
= equity ($ paid on principal)
(calculated
as if the entire $12,000 $6200
= investment growth of house
was invested the entire year) ($200,000 @ 3.1%), $9430 total value
The renter is still ahead, and by
quite a bit. But in the second year, and
in every subsequent year, the amount of principal paid (and equity accumulated)
will increase for the buyer. The renter,
however, will likely face a rent increase annually, cutting into the amount of
money he can invest from that $2000. So
the buyer’s investment will accelerate, the renter’s diminish. And remember, we’re using the very
conservative estimate of return for the buyer.
Does purchasing start to look
like a more attractive investment option?
More next week.
Until then,
Roger
“Invest in truth and wisdom, discipline and good sense, and don’t part
with them.” Proverbs 23:23 CEV
No comments:
Post a Comment