It’s popular for money influencers to make the claim that your house isn’t an investment. Sounds good on the surface, but is it true? The reality is that investor psychology plays a huge part in the equation.
Sounds Good In Theory: Rent and Invest the Difference
This is the most common argument I hear. “Rent and invest the difference between your rent and what a mortgage would be.” This sounds good in theory and actually makes sense. If my rent for a two bedroom apartment is $2,300 and the monthly cost of ownership for that same two bedroom is $3,200 then it makes more sense to rent and invest the difference.
The difference in the spread for the first year is $900 per month. The plan would be to take that $900 per month and invest it. Over the year that’s $10,800. Invest that over 30 years at a ten percent rate of return and you’ll have $1,954,189.
Huge win, right?
Yes, in theory that’s a massive win. Just rent and end up with almost two million dollars while the equity in the property you would have bought doesn’t come close.
There are two big problems with this comparison though. The first is fairly obvious in that rents don’t stay stagnant. That first year rent of $2,300 might be close to $2,400 the second year and around $2,450 in year three.
The historical average of rent increases is between three and five percent. Assuming the lower amount of three percent, that $2,300 first year rent balloons to $3,042 by year 15 and $3,887 in year 30!
At a five percent rent increase, the numbers are even less favorable for a renter. $4,782 in year 15 and $9,940 in year 30. Meanwhile, the principal and interest in the place you bought stays the same over all those years. While acknowledging property tax, insurance, and other expenses will go up.
There comes a point in time when rent becomes more expensive than the mortgage and you no longer will be able to invest the difference, but end up paying more. There also comes a point where you are not only paying more, but paying significantly more in rent year over year.
Investor Psychology
The second problem isn’t as obvious, but equally important, if not more so. It has to do with investor psychology and what people tend do with the extra money from saving on rent.
The psychology is that the majority of people won’t invest the difference. Some people will, but most just don’t. I was one of those people and can speak about it firsthand.
The majority of people will take the savings and absorb it into their daily lives. They’ll buy more expensive cars, get nicer clothes, spend more going out, etc. Lifestyle creep will rear its ugly head.
It won’t be invested and millionaires won’t be created from saving on rent. Saving on rent and investing the difference works in theory, but rarely in practice.
Wrong Comparisons
Another error I frequently see in these rent versus buy comparisons is comparing two different products. For example, a one or two bedroom apartment in a middle class area is compared to a three or four bedroom house in a more desirable area of town.
There will be a gap of thousands of dollars between renting and buying and this will be cited as evidence. Well, of course there’s a big gap because you’re comparing two totally different properties. It would be impossible not to have a gap.
I guess it’s good data to have for those deciding whether to leave the one or two bedroom apartment for a house, but it’s an apples to oranges comparison and holds little value.
Conclusion: Your House Is An Investment
It’s popular to say your house isn’t an investment or shouldn’t be listed in the asset column. It gets headlines and clicks, and makes sense on the surface, but it’s just not true for most people.
The truth is that a house is an asset and the equity buildup, appreciation, and debt paydown can make someone much more financially secure than someone without the asset.
A house is a forced savings account–make the payments or risk losing the property. Most people make the payments and systematically pay down the debt on the property.
Then that money is yours to keep upon the sale of the house, or you can live without a mortgage. Or go a different direction and rent it without any debt on the asset.
The forced savings account is something that has to be factored in and plays directly into the investor psychology. And that psychology is that most people will pay their monthly mortgage, but few people will invest the difference between renting and owning.
