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How Counting Chickens Before They Hatch Can Kill You

I recently found out that a house that I had bought in a small town for my mother to run a small business in has since tripled in value since I bought it 12 years ago. (It’s not in America.)

Does that mean I’ve made three times my money? Not even close.

There seems to be a prevailing myth out there that a home is a terrific investment. While it can be ok, it’s certainly not a no brainer. In fact, it is not unusual to only break even on a house EV-wise (expected value… in this case, inflation adjusted profit) even when you haven’t lived through a massive housing correction like America just has.

There are all sorts of expenses that go into the care and maintenence of a house that eat into your “profits”.

For example’s sake, let’s say I purchased the house at 33k, and is now “valued” at 100k. “Gross profit”: 67k.

First, before you even walk in the door, there’s taxes. Depending on what state or province you live in, you are probably going to have to pay 5-15% sales tax to get ahold of a piece of property. Selling with a real estate agent? Tack on an extra 4-7% in commission. Then there’s property taxes and homeowner’s insurance. Typically around 1-2% of the home’s value combined. Paid every year. 12 years. Ouch. Home maintenence. Say another 1% per year to keep everything in shape and keep up curb appeal. Most years will be less, but some will be a lot more.

Finally, you didn’t buy that house cash, did you? Uh oh. Then you’re paying interest, and a lot of it. With a 20 year loan at 4% interest, expect to pay more than 40% than the value of your loan over the period of the loan. Want 30 years? Better bump that up to 75%. And if you need 30 years to pay off a mortgage, believe me, you can’t afford whatever home you’re looking at. You’ll be paying so much interest that even a small increase in interest rate is going to have your mortgage underwater. That’s how the American housing crisis got started in the first place.

Now the wild card in all of this is inflation. It works on several variables of the equation. Let us assume that we will see an average of 3% inflation per year, which over 12 years means that the value of a dollar declines by one third. Your yearly expenses keep up with inflation, which means that every 12 years, you’re going to be paying 50% more for them. So does the value of the house. In fact, it’s a major driver of the appreciation of real estate. If a $33k house is worth $50k 12 years later, it may have “made money”, but it hasn’t appreciated a single iota in real value. So in EV terms, my gross profit is only twice what I paid for the house (before expenses), not triple.

So take a 100% gross profit, and take off say 10% for commission and taxes. Then 3% (proerty taxes, insurance, maintenence) times 12 years, reduced to 1/2 to account for appreciation/inflation (because 3% when it was worth 33k is not as much as now that it’s worth 100k). No, that’s not the exact math. It’s just ballparking, but it’s close enough. That’s another 18%.

Then there’s the interest on your loan. Your payment does not go up over time unless interest rates do. But inflation marches on regardless. A $200 payment per $30k of loan may suck now, (it will really suck), but 12 years from now, it’s going to feel like a $100 payment. Of course, you’re paying an inflated price for your home because of the interest you pay. But when your interest rate and inflation are equal, (which is pretty close to the case these days) they effectively cancel each other out.

But when the interest rate you pay is higher than inflation (most of the time), then you’re losing value by paying more interest than inflation shrinks the value of your payments. Which means you’re losing EV via interest.

So I haven’t really tripled my money. I’ve made anywhere from 20-70% in EV based on how big my loan was.
Wow, what a letdown. I could have made more money just buying 25k worth of gold and hiding it under my bed.
And I GOT LUCKY. If the house was in America, I would have lost a boatload of EV.

So what’s the good news? Well, it’s twofold.

How many assets do you know that would have even kept up with inflation over the last 12 years (50%)? Stocks? Nope. Bonds? Sorry. And did you have 25k just laying around 12 years ago to buy gold with?

Here’s the beauty of home-ownership. It doesn’t have to keep up with inflation. It has function above and beyond that of an investment, unlike gold.

We all need a roof over our heads. Our physical bodies, at least in a financial sense, are liabilities. We have to pay money each month to keep them going. If you didn’t own a house, you’d have to pay rent. That money is going out the door regardless. And let’s say you bought a house 12 years ago, saw it appreciate 3% a year (which works out to a 50% increase… a 50k house would be worth 75k twelve years later), but then lost it all in the housing correction in 2008. Sure, you lost value, because your house is worth the same money as 12 years ago, and a dollar is worth only 2/3 as much as 12 years ago, but you would have had to pay that much EV in rent anyways. It was actually a breakeven situation, not a loss!

But if you were counting on a gain to balance out bad spending habits…. you are effectively floating up Shit Creek.  Paddle sold seperately.  Basically, buying a house is not really an investment. It is ideally a way to turn a liability (needing a place to live) into less of a liability, or hopefully breakeven or even make a little bit of EV over time if you’re lucky.  But if you’re buying a house assuming it’s going to make you money down the road, make no mistake… you are not investing, you are gambling.

Not only that, but if you’re counting on making money on your house, you are almost certainly going to buy more house than you need, (or can afford) and thus unwittingly be taking risk on par with that of derivative traders.

And you ain’t getting no bailout.

6 Comments

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