After the Great Recession, American homeownership has been on the decline from nearly 70% in 2005 to 64% in 2019. The 2008 recession led many homeowners to lose their homes, but it also changed people’s enthusiasm for owning properties. More people prefer renting to owning their own homes. Buying a home is no longer a necessary part of the American dream.

Because of the changing attitude toward homeownership, fewer millennials buy their homes than the previous generations. However, avoiding buying a home might not be the best strategy for your financial future. Homeownership is an investment and a decision that requires careful analysis of the potential returns and costs.  

Whether or not to buy a home is a big decision. While there is no absolute answer to this question, we can share the best and most practical tips to prepare you to take the important step.

Recommendations from others don’t always work

When you are deciding to buy a home, recommendations from others are not always useful for a few important reasons.

First, people’s views on the real estate market are heavily influenced by its past performance instead of its future potentials. Prior to the Great Recession, the housing market boomed. Witnessing the growth of the housing market, many advocated for buying homes. But that recommendation led some people to buy at the worst time possible, just before the crash of the housing market. After the Great Recession, many people believed that renting is a safer choice. However, during the same period, the housing market experienced an impressive recovery and home appreciation that the renters unfortunately missed out on.

Recommendations from others can mislead you because they don’t always apply to your local market. The real estate market varies greatly from region to region. Each city has a different level of risk and potential for appreciation. For example, in 2008 the property market in California tanked, but the properties in Texas only experienced minor setbacks.

Should I buy a home – cost analysis?

Purchasing a property costs more than the price tag of the home. There are many costs that come with homeownership. Overlooking these costs, some homeowners ended up becoming “house poor”, with little cash left after paying for the property and its monthly maintenance.  

Being house poor is a sticky situation that can leave you with no financial freedom. The best way to avoid buying a house beyond your means is to understand all the costs associated with becoming a homeowner.

Closing costs

After your offer is accepted by the seller, you will start the closing process on the property. The closing process is costly. To close on a home, you need to work with a lawyer, a property appraiser, a real estate agent, a title company, insurance companies and more. Everyone wants their cut. You, the buyer, will need to cover all these expenses, which can quickly add up to thousands of dollars. In fact, the more expensive your home is the higher the closing costs would be.

If you are buying a home in Canada, you can learn more about Canada-specific closing costs in this article.

Taxes, HOA fees, and insurance

Homeowners are also responsible for paying taxes on their properties. Local governments charge property owners city and school taxes every year, based on the assessment value of your property. The tax rate also varies by region. The average property tax rate is 1% of your property value. The school tax can go as high as 4% of your property value. Thus, it’s critical to check the tax rates when buying a home.

If your home is managed by a Homeowner Association (HOA), you then need to pay a monthly HOA fee. Lastly, it is always a good idea to buy insurance on your home against damages and liabilities. Fortunately, home insurance is relatively affordable.

Mortgages

If you buy a home with a mortgage, you need to make a monthly mortgage payment. Each mortgage payment contains two parts: the interest payment and the principal repayment. The interest payment is used to cover the cost of borrowing money from your mortgage provider. This is the true cost of using a mortgage. On the other hand, the principal repayment goes toward reducing your debt and gives you more home equity.

Maintenance

Renters and homeowners have very different levels of responsibilities. As a renter, you can expect the landlord to take care of the house. But as a homeowner, you are responsible for all the maintenance. The costs of hiring a plumber or buying a new dishwasher come directly out of your pocket. Maintenance can be a heavy burden especially when big-ticket items break. Even small repairs such as changing a door handle or a smoke detector can add up over time.

Opportunity cost

Lastly, homeownership has a cost that is often overlooked, the opportunity cost of owning a home. Whether you pay for the house in cash or with a mortgage, buying a home locks a large sum of money into your property. This money, if not used to buy properties, can generate income in the stock and bond market. The opportunity cost is the loss of potential gains from an alternative investment such as a stock or bond. The size of the opportunity cost depends on the market and how you normally invest your money.

Home appreciation

Although buying a home comes with opportunity costs, your home is also an investment with the potentials to appreciate. In fact, home appreciation is one of the main reasons people buy a home. Historically, home prices can at least keep up with inflation. In growing cities, the return of the real estate market outpaces the stock market. In these cases, your earning from buying a home outweighs the opportunity cost. Additionally, a house can provide rental incomes when it is vacant.

Homeownership is an investment

Although renting and buying a home are two options often compared side by side, this comparison is inherently flawed. If we list out the costs for each option, we can see that renting a home is, in essence, paying for a service.

Renting is not different from paying for a monthly transportation card or Netflix. On the other hand, buying a home is an investment.

Renting Costs	Buying Costs
Security deposit	Maintenance cost
Monthly rent	Mortgage payment
	Return on a home

Homeowners are investors. As with any investment, owning a home comes with risks and returns. The real return of your home is the difference between home appreciation and the opportunity cost. If the opportunity cost is higher than home appreciation, you will have a negative return. On the other hand, if your home appreciates more than the opportunity cost, you will have a positive return.

Understanding the return on your home

The return on your home can be calculated using the formula below.

Home appreciation brings you more real investment return but opportunity cost reduces it. The opportunity cost is calculated based on the amount of money you invest in your home and the alternative return.

This calculation also reveals an interesting property of mortgages. With a mortgage, investors can buy homes with only the down payment. This means less investment in the property. With less home equity, there is less opportunity cost. However, the investor still profits from the full appreciation of their homes. This is the leverage effect of mortgages; it allows you to increase the investing power of your capital.

Factors that affect your return

While other costs of homeownership are predictable, both home appreciation and the opportunity cost are forward-looking factors. These two are difficult to predict, making buying a home a hard decision. Generally, the market condition affects your alternative returns and the local real estate market affects your home appreciation.

Market condition

The market condition directly impacts the alternative returns of your home equity. Business cycles and monetary policies affect the market as a whole. During a bull market, your opportunity cost is high, because the money used to buy your home could generate higher returns if invested in the market.

Additionally, the actual return also depends on how you normally invest your money. If you generally invest in bonds, the alternative return is low and more stable. If you invest mostly in equities, you might have a higher investment return but also higher risks.

Real estate market prospect

In contrast, your home appreciation is affected by more local factors. Property appreciation varies greatly from town to town. Companies that create jobs, good public schools, and increasing demands can all improve property values.

Personal circumstances

Finances aside, there are personal circumstances that can affect your decision. If you need flexibility in the short-term, renting provides you with the freedom to move. This is especially useful if you expect a new job assignment or changes in your family.

However, this flexibility is often overrated.

As a homeowner, you still have the freedom to move. When the home is vacant, you can rent it out and hire a local property manager to take care of your tenants. The rental property can generate a nice income you can use to cover your mortgage and maintenance costs.

Making the call

Buying a home is one of the most important decisions in your life. Part of the challenge lies in the fact that buying a home is an investment with many unknown variables such as market conditions and real estate market performance.

Treating homeownership as an investment can help cut through the noises and make more informed decisions. Through thorough research and careful analysis, you will have more confidence and make better decisions for your future!