This may hold true, in certain areas, if you keep the same house for 30 years. I...

dmv · on May 12, 2008

Three obvious ROI friction factors you missed:

1. Closing costs.

The mortgage is not a free transaction, for the buyer. There are a lot of services (inspection, title insurance) and misc charges. That's a couple thousand dollars. I don't know what the rule of thumb is; I know that it ended up being about $11k for a mortgage less than $300k, and that's without points or any other mortgage instrument issues.

2. Equity.

Almost all of your payments in year 1 go to interest with 10% as the downpayment, you'd probably owe about $266.7k -- play with an amortization calculator. If you sold the house for $312k, the difference would be about $45k. That's $45k back for your $55k... except

3. Selling fees.

The seller in a transaction is typically responsible for paying the real estate agent fees for some combination of seller and buyer. That's 3% each (if you both used something like redfin.com, it would still be 4% total). That's up to 6% of the $312k -- $18.7k.

So, with #1 you increase your investment requirements (call it $10k, so $65k for the year). With #2 you decrease your net ($45 on the $65k). With #3 you decrease your net even more ($26 on the $65k). On the plus side, you typically only make 11 payments in the first year, so you're only out $37k instead of $39k!

Summary:

Real Estate transactions are not efficient, low-friction or highly liquid investments. Duh. This has a positive and negative aspect - you have the potential for outsized appreciation because of the illiquidity, and because transaction costs keep the potential market (somewhat) more constrained. But you also have greater penalties on shorter ownership cycles.

Conclusion:

One year is an awful timespan for a house purchase unless you're completely confident in an extreme appreciation or you are investing additional sums or sweat equity which may guarantee the extreme appreciation (ie, a flip). It has to be extreme.

ssharp · on May 12, 2008

You need 20% down to avoid PMI, don't you? PMI is mortgage insurance if you don't have enough equity in your house. I'd guess that could run an extra 2-3 hundred per month.

You're also missing homeowners insurance which would probably end up being close to $200/month for a 300k house.

You ROI doesn't really make sense to me.

You're paying a little over $1340 / month in interest, $200 for homeowners insurance, $312 in tax, and $200 for PMI. That's $2052 / month in housing costs where none of that money goes towards principle. Now depending on how you're doing your taxes, most of that is tax deductible, so lets say that's going to save you about 20% of that - $19,700 is the cost of your housing per year ($1,641 / month).

Furthermore, 4% growth isn't guaranteed - especially with the current housing slump. The growth in housing experienced from the late 90's - early 2007 will likely not happen again anytime soon. I thought traditional growth was more like 2-3%. Plus, appreciation has to be considered in the long term. You need to pay capital gains if you sell the house within 2 years and any sunk costs on the house sitting vacant or realtor fees will lower your actual returns on the sale.

So if the house is worth spending $1,641 / month vs. what you could rent for $1,641 OR you plan on living in that house for a significant period of time where the fixed cost of ownership becomes valuable, then buy. If not, renting is still the better option.

For young people who aren't stable and might be moving around, I just don't see the benefit of home ownership, especially in today's uncertain housing market. Once you're ready to settle down, home ownership is a better idea.

menloparkbum · on May 12, 2008

vanguard emerging market stock index fund was doing that well for a while...