If popular perceptions of real estate agents were accurate, nobody would use them and the whole profession would die out. A recent MSNMoney survey found

What are the most common mistakes that home buyers make?

There’s one that trumps the rest: buying a home as an investment.

The math has never really checked out. The idea that houses are a productive investment class has always been a narrative unsupported by rigorous data.

Some aspects of that:

  • People forget about inflation. US houses saw a annual average price increase of just 4.5% from the end of WWII to today. Inflation over that same period was about 3.7%. [1] [2]
  • People forget about hidden costs. “Back of the napkin” math often only includes the mortgage payment and property taxes. Actual cost of ownership averages out at about 4% of the home’s value per year.
  • People forget about interest spreads. You can’t compare the monthly costs of your mortgage to something like rent in a vacuum. If you compare total costs over 25 years, what would happen if you had invested the difference (rent always being less expensive) into a basic index fund? The US stock market returned just shy of 9% over that same period. [3]
  • People forget about fees. Between what you pay your realtor and the costs of titles-searches, inspections, etc., you’re looking at 3-4% over the actual home cost. You also incur a fresh set of fees if you sell/move.
  • People forget about opportunity costs. That 20% down-payment you put down? That’s cash you aren’t investing elsewhere for a better return. It’s also cash you can’t touch without paying even more interest.

What happens when we add up those oversights?

In a typical case of a $400k house on a 4% 25-year mortgage, you’d net $264k more by renting over that same period. [4]

(This amount varies by country. In the US, the comparable delta is more like $190k because of the mortgage interest tax credit.)

So why buy a home?

  • It’s a cultural expectation in the US. (Less so in other countries, where people are more pragmatic — see: Germany, Switzerland.) [5]
  • It’s an affordable indulgence for many. It’s about the feeling of owning a home and the flexibility ownership affords, not the money.
  • It forces you to invest. People who rent don’t tend to buy stocks with all the money they save. Paying a bill takes far less discipline than forgoing discretionary spending.

If you do decide to buy a home, a few less drastic mistakes to avoid:

  • Realtors will always favor buyers over sellers. They get paid on ratio-based commissions. As the Freakonomics guys documented, this tilts the market pretty dramatically.[6]With rare exceptions, you have more negotiating leverage as a buyer. Use it when buying; beware of it when selling.
  • Look at as many houses as possible. Never, ever, ever buy on impulse. If you hire a realtor, maximize your investment. Task them with finding out about future developments that might influence neighborhood values. Know about demographic makeups, schools, etc.
  • Never plan to renovate a house while living in it. Exactly 0% of people who have done this look back on it as being a positive decision. It will take longer than you think, and it will ruin your quality of life. If you aren’t able to afford a place that’s move-in ready, plan to live elsewhere until renos are done.
  • Inspections and title-searches are only optional if you’re a gambler who wants to directly play against the odds.
  • When doing inspections, pay less attention to cosmetics and more to the “major four”: roof, foundation, electrical, plumbing. For older houses, you also want to check for asbestos, lead paint, and wiring no longer up to code. Each of those could cost you tens of thousands if you try to renovate later and your permit gets rejected until said problems are solved.

In my consulting days, I worked with property managers, brokers, realtors, lawyers, and accountants. That’s where I learned the above.

My last piece of advice: find people in those roles and take them out for dinner — before you’re actively purchasing. What you’ll learn from them about the local market will pay out a 100x ROI.

Footnotes

[1] CPI Inflation Calculator

[2] 100-Year Housing Price Index History

[3] http://pages.stern.nyu.edu/~adam…

[4] Would you be better off financially renting or buying a home?

[5] Most Germans don’t buy their homes, they rent. Here’s why

[6] Real Estate Agents, Revisited – Freakonomics