If you are like me, home ownership is probably a long ways away. However, I recently read a white paper called “The Rate of Return on Everything, 1870-2015” published by the Federal Reserve Bank of San Francisco. Theres a lot of good facts and data in there and I strongly encourage you to read it (or skim it like a certain Modern Piggy Bank Founder did… looking at you Will). But if reading 123 pages of economic data and commentary isn’t your cup of tea I’ll spare you the burden and tell you what I found most interesting.
The paper looks at major asset classes over the time period 1870-2015 most notably bills, bonds, equities, and housing and analyzes their return statistics. Believe it or not housing was on par with equities with average return of 7% a year. In the post World War II era, equities have taken a marginal lead, but the investor has also needed to take on more volatility and is subject to the ups and downs of the business cycle. Where as the housing market has been much steadier over time. Additionally, housing does not correlate heavily to the global markets i.e. a bear market is less likely to have a significant adverse affect on housing prices.
Now home ownership has been seen as a rite of passage in America and a sign that someone is financially well off. Unfortunately, situations like the 2008 financial crisis show how a house can sometimes not be a wise investment especially your primary residence. I’m currently looking to apply for my first credit card which I will talk about in a later post, but I find it concerning how the Federal Government insured home loans leading up to 2008 and will loan teenagers with no grasp of the concept of credit hundreds of thousands of dollars to achieve higher education because it’s a “good investment” while private credit institutions want new credit card owners to have $200 spending limits. Anyways, I digress.
Back on track. You will always need a dwelling, it will always be an expense. I will even go on to make a controversial claim that a mortgage on your primary residence is nothing more than an expense. If you weren’t paying it down every month you would be living in an apartment paying rent. When you go to upgrade homes you will now have a higher monthly expense with the total offset by the profits on your past home sale. Furthermore, theres property taxes, utilities, home improvement/maintenance, etc. Your primary residence will probably not produce a dollar of cash flow.
Enter the rental home market. Instead of adding to your expense column you can invest your money into a home for tenants. Sites like airbnb have made this incredibly easy for vacation spots. Some people even rent guest rooms in their own homes to offset their housing costs. For me, it makes sense to invest in an asset that tends to increase in value over time, although this is not always the case, while I can put it to work and pay off its expenses and maybe even a little extra. To take it a step further the white paper previously mentioned suggests that the lower volatility will protect my downside in case things go wrong as opposed to the equity markets which are heavily correlated across the globe.
If you can fit it into your budget and are willing to do the due diligence consider investing in a rental property. I mean not to discourage you from home ownership because it is something incredibly rewarding that I look forward to one day. I mean to challenge your thinking so you can minimize your expenses and optimize your savings.
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