Should I Buy a Home? Part 2: Opportunity Cost

Howdy! Last week on Should I Buy a Home (Part 1), we established that home ownership isn’t really a good “investment.” Make sure you go back and take a gander at that post first. But, when compared to the cost of renting all along, is home ownership still a better long-term financial decision, especially for early retirement? Or did we pay the biggest expense of all…opportunity cost?

Stick with me here. This sort of stuff was never my forte years ago, but I’ve grown to love this like Mrs. CC grew to love sushi. We can all learn to love raw fish, seaweed, rice, and investment return analysis.

A Quick Recap

Last week we established the following from our six years of home ownership:

• Our home appreciated from $374,000 to at least $580,000, a 7.6% yearly appreciation rate, generating $206,000 in equity.
• Our expenses of home ownership, past and expected when selling, total nearly $158,000.
• Once expenses are considered, the net return on investment is only 2% per year, basically break-even when adjusted for inflation.
• Had we foregone home ownership, we would have spent $141,450 in rent instead.
• So is it still better to own a home, even if it’s not a good investment? It’s still not throwing away money on rent, right?

The Opportunity Cost of Home Ownership

Here’s the rub. Let’s suppose that in 2013 we invested our 20% down payment ($74,800) towards our favorite broad-based stock index fund (VTSAX) instead of buying a house. Also, those surplus mortgage payments we were making, around $1,487/month on average? Yeah, let’s invest that too my man.

Renting & Investing Makes More Money

Over the time we’ve owned our house, VTSAX has produced an average return of 9.9% per year. Had we invested our free cash into the market back then, we’d now have something in the range of $270,000, as summarized in the figures below.

Compounding growth is incredibly amazing. It just happens. Just like when I put a leash on my dog…she walks. She just does it. She also poops…a lot.

In the last post we also suggested that we would have spent approximately $141,450 renting had we foregone home ownership, as summarized in the table below.

Modeled Investment Returns (opportunity cost) = $269,121*

(minus)

Cost of Rent = $141,450

(equals)

Renting/Investing Net Return: ~$128,000

Home ownership Net Return: ~$48,000

Sooooo….we didn’t exactly lose money by buying a house, but we could have more than doubled our return by renting and investing the surplus instead.

*This simple model ignores dividend reinvestment and other things that give me a headache to model and won’t materially change the result.

So, What’s a CC to Do?

We own our house, and there’s no changing that. Even though in our case we might have made more money by renting and investing, we probably wouldn’t have done that in reality.

You see, in 2013 I wasn’t a die-hard saver or investor. I was investing a very small percentage of my income, but I certainly wouldn’t have thrown $74,800 into the stock market at once. I would now, but I wouldn’t have then.

Also, what if my realtor’s email from last week is correct and the house is worth substantially more than I’ve currently modeled? A much higher home value could certainly tip the scales in favor of home ownership.

The point here is that there are many unique factors, both in time and space. Both the housing market and stock market have performed very well over most of the period between early 2013 and mid 2019.

It’s honestly not fair to compare an investment’s potential over only six years. Also, the housing market in your town might look completely different. Anyone promising you any sort of expected return in the future is truly full of shit. Truly.

Sequence of Returns Risk Hedge vs Opportunity Cost

No matter if you are 67 or 35 years old, transitioning from a sizable income and a decent savings rate to withdrawal is a psychologically demanding proposition. We want to make sure that any of our “Big Three” recurring expenses — housing, food, and transportation — are within reason. Withdrawing too much too soon, especially in times of depressed market conditions, can result in irreversible asset depletion, known as sequence of returns risk.

Despite everything mentioned above about home investment potential and opportunity cost of not investing elsewhere, having a paid-off home in early retirement is decidedly pretty cool. Maybe this aspect of home ownership is still making me feel really good about the math going forward.

If we continue living in our home after the mortgage is paid off in early 2020, I estimate our total living expenses to be in the range of $5,000 – $6,000 per year. Expenses include yearly insurance, property tax, and a portly estimate of maintenance and repair costs.

A yearly living expense of $5,000 is practically impossible to find where we live. We are also storing the value of the home in our back pocket. If the market takes a dive, our living expenses are already low and we are double backed by the unliquidated value of the home, should we need it.

How can we add even more value to a property? Let’s take a look. My palms are sweating. You too? Good.

House Hacking and Real Estate Investment

The best way to increase the investment potential — and therefore the value of a property — is to have someone else paying you to live. If you can turn an unused portion of your home or a separate property into a rental space, you can begin to dramatically lower or even eliminate your living expenses.

Here are several of many options:

• List a room or portion of your home on Airbnb
• Bring on a roommate
• Purchase a duplex, triplex, or even quadplex. Live in one unit and bring in tenants to pay the rest of it for you.
• If you are considering moving and don’t want to sell your current home, consider renting it. You can rent a second property and the proceeds of your rental will pay your living expenses.
• Invest in real estate as a primary wealth-building strategy, with no intention of residing in your properties.

Many of the items listed above are explained in much greater detail by experts who have become financially independent through a variety of house hacking and real estate investment strategies. And no, they are not slum lords. For more, check out Paula Pant’s Afford Anything, Bigger Pockets, and Coach Carson. Fancy!

Buying a Home is a Personal Decision

There will be no hard line drawn in the sand today over whether it’s better to rent or buy. With so many knobs to turn, both tangible and intangible, you can see why there is no single correct answer.

Real estate can be a great investment strategy, but your primary residence probably isn’t. I’ve shown above and in last week’s post that the unforeseen costs and relatively low historical appreciation generate low returns (at best). Plus, it’s important to remember that an expectation of home price appreciation is speculation.

If you want to own a home for any of the hundreds of personal intangible reasons, there is nothing wrong with that decision. We will very likely continue to be home owners. Just forget the idea that a home is a significantly better financial decision than rent, especially when considering the opportunity cost of not investing somewhere more fruitful (VTSAX in our case).

Also, don’t get tangled up in a FOMO mindset (fear of missing out). Just because everyone is doing it, doesn’t make it the best path for you. Know Thyself.

Regardless of your choice, real estate investment can be a very powerful investment tool when treated as a business. I’m not experienced here, so I will shut my digital mouth. Now, go outside and have fun somewhere. CC approved!

Take me to Part 3 for the Final Analysis!

---

Remember, the best laid plans mean nothing if you can’t take action today. Have questions? Need some feedback? Hit us up on the Contact page.

Thanks, see you guys next week.

---

A special request: Guys, I’m terrible at self-promotion. This is me getting way out of my comfort zone, asking for help. So, I have a favor to ask: can you send a favorite post to a friend or family member? Even better, can you share on your social media feeds? I’m willing to continue putting hard work to deliver free content for all, but it would mean so much to me if you can help me spread the good word. Here are a few popular posts to help:

But I Don’t Want to Be Frugal

Reader Case Study: Maximize Adventure or Career?

Personal Finance: Not Very Sexy, Huh?

Five “Essentials” That Are Destroying Your Savings