Homeownership:  Values, Math and Financial Literacy

By Bob Peters || April 13, 2022

Values, Math and Financial Literacy

These past several years the price of residential real estate in the US has risen faster than wages earned.  The amount of new housing units available in the US has not kept pace with the number of folks looking for housing.  There has been a lot written as to the causes of this imbalance, but I am going to avoid that particular area of exploration.  Instead, let’s talk a bit about values, math and financial literacy.

Values, Math and Financial Literacy are all important considerations when thinking about whether to buy or rent a home.

Values before Goals

One of the objectives of writing this blog is to help young folks achieve financial security by being financially literate.  Being financially literate allows you to better prioritize decisions that have financial consequences in order to support your goals.  Your goals reflect your values.

If your values include pursuing a passion at the age of 60 that does not afford you with income you will need to establish a goal to accumulate enough wealth to live the lifestyle you have chosen.  Being financially literate gives you some basic tools to make better financial decisions thereby improving your chances of reaching the goal.  Values before goals.

If owning a home is a goal, then financial literacy will help you understand that you will need to save for a down payment.  The financially literate person will understand that property taxes, insurance, maintenance and furnishing a home should be included the cost of ownership.  This person will understand that there is a cost of capital that should be considered for your down payment and what alternative returns could be achieved by wisely investing in stocks.  The financially literate “you” will have a sense of the general amount of your earned income that should be attributed to your housing expense.

Being financially literate allows you to have a context in which you can contemplate the non-financial, emotional “benefit” based on your personal values.

The Problem

The problem occurs when your financial decisioning making is in conflict with your values.  This happens when you are not intellectually honest with yourself.  For example, it would be intellectually dishonest to say that you “value” living within your means and then go out and rack up credit card debt because you spent more than you earn.

Unless you win the lottery, you will need to reconcile your values with your financial reality. Life is filled with an infinite amount of tradeoffs.  

The Mathmatics of Homeownership

Putting aside the importance of prioritizing your values, it’s good to look at the mathematics of homeownership in order to understand the potential impact that homeownership could have on your net worth.  We know that growing your Net Worth is necessary to achieve financial security.

A recent article in Barrons dated April 1, 2022 titled, The Case for Building Wealth with Stocks, Not Homes.  In this article the author, Randall W. Forsyth, refers to data compiled by NYU Stern School of Business professor Aswath Damodaran who compared the 1972-2021 annual return of the S&P 500 of 12.47% vs 5.41% for residential housing (per the Case-Shiller Index).  The same analysis between 2012 and 2021 showed stocks an annual 16.98% return vs housing of 7.38%.

These numbers, although highlighting the compelling case that your net worth would have grown larger with an investment in the S&P 500 vs homeownership do not tell the whole story behind the cost of homeownership.  The cost of maintenance and furnishings add to the ongoing “cost of home ownership.”

If we assume that future returns of stocks are likely to maintain an edge over real estate then the superior returns of owning stocks would lead to renting vs. buying.  This analysis holds up IF the renter invested what they would have otherwise spent on home ownership including the down payment.

Emotional Considerations are Real

Emotions are real and they are not inherently good or bad.  We need emotions to live a life filled with joy and to connect with people.  A few emotions to think about when it comes to homeownership:

It can be heartwarming to “own” your home

It can be heartwarming to “own” your home.  I’ve heard some folks refer to owning a home as part of the “nesting” process.  Many young adults come from families that owned a home.  As they establish themselves into a career, find a partner in life and contemplate having children the idea of home ownership seems like a natural “step.” There are many who were raised living in rental property and they have a strong desire to own a home.

There is a flipside as well.  If you don’t get personal satisfaction maintaing your home, then that heartwarming feeling may turn into a less desirable emotion.

Renting feels like you are “throwing away money” and not building equity

Renting feels like you are throwing money away and not building any equity.  That may or may not be true.  If you paid your rent and regularly invested the capital you would have used for your down payment and maintenance costs then you could end up with more financial wealth as noted by Mr. Forsyth.

I’m including a link to a YouTube video prepared by Ben Felix, Common Sense Investing who does a nice job of walking through the math of comparing renting and owning.  Ben uses a 5% rule that is a bit of a different way to evaluate the comparison, but I agree with his approach.  Check out the notes in his video which will provide other helpful links.

For folks living in the US, don’t get distracted by Ben’s reference to Canadian property markets or Canadian retirement options such as RRSP’s and TFSA’s.  The RRSP and TFSA programs are somewhat similar to IRA’s in the US.

I feel warm and fuzzy with my home, but I don’t feel the same with my investment portfolio

I feel warm and fuzzy with my home, but I don’t feel the same with my investment portfolio.  There is a human element here.  It is far easier to feel an emotional attachment to a home, building relationships with neighbors, making improvements, raising a family in your home than there is viewing your investment portfolio.  It’s personal and there is no way to put a dollar value on this emotion.  People differ in the ways that they value these emotional attributes.

Ownership and Renting will both have some degree of stress that you will want to manage

Ownership and Renting can both have some degree of stress you will want to manage.  Having a mortgage payment, paying property taxes, insurance and maintaining your home is a fixed expense.  I included maintenance expense because if you don’t maintain your home it declines in value.  While the actual monthly cash expenses you spend on home maintenance may vary month-to-month it’s probably reasonable to include in your budget 1% of the value of your home as maintenance including covering items like roofs, furnaces, appliances, repainting, etc.  The point here is that the cost of owning a home goes beyond your mortgage payment.

 If your sources of income are stable and your future earnings are likely to increase the percentage of your take home income going towards your housing cost will decline over time.  If, on the other hand, your income is less certain, or you choose to reduce your employment income to raise a family the fixed costs associated with homeownership can seem daunting.

What are the stresses of renting?  Having your landlord raise your rent at the end of the lease? The emotional loss of not participating in “home ownership?”  Your temperament and personal situation will dictate your level of stress?

The cost of mobility rises for homeowners

The cost of mobility rises for homeowners.  It’s reasonable to plan for the selling cost of a home will be approximately 10% of the value of the home.  These costs are lost.  If you bought a $500,000 home and sold it shortly thereafter you should plan on losing about $50,000.  Now, if you owned the home for 10 years and the price of the home in 10 years was $1,000,000 you would net about $900,000 (10% of $1,000,000) before deducting for the balance of the mortgage. 

You might also owe federal capital gains taxes which may further reduce your net proceeds. Unless you want to become a landlord and rent it out, I would suggest that a owning a home for a minimum of 5 years, preferably closer to 10 years.  Where your home is located and the net in/out migration into your community will impact your ultimate return.

If your career is likely to create opportunities or requirements to move every few years you may be better off going the route of renting and increasing your allocation of income to investing wisely vs. purchasing a home.

House rich, Cash poor is stressful

House rich, Cash poor is stressful.  The term “house rich, cash poor” often describes another phenomenon where buyers use all of their liquid assets to make the down payment and pay for closing costs but are left with no cash (liquidity).  It’s no fun to be scraping by every month for ongoing basic needs plus the mortgage payment.  New buyers will want to furnish the home. It’s also important to rebuild your emergency reserves if a portion of this was used to fund the purchase.

If, after you purchase your home, your income drops because of starting a family, health or job insecurity, you will want to make sure that this “downside” cash flow scenario is still sufficient to build back emergency reserves and dedicate cash flow towards other goals you might have.

Summary

Buying a home is very exciting and may very likely be one of your biggest single financial decisions should you decide to do so.  Understanding the financial consequences of homeownership will help you make the best decision to support your personal values.

By learning, you have increased your financial literacy and improved your chance of achieving financial security. You can have financial security either owning or renting.

Good luck!