House Expense Ratios

 

While U.S. stocks during those years enjoyed an average real rate of return of about 6% a year, the annual inflation-adjusted return on houses was a meager 0.18%. Factor in real estate’s heavy transaction costs and that number turns negative. – Michael Milken’s WSJ OpEd

The scariest part is that the above return for houses would be even worse if things like maintenance, property taxes, interest, insurance and other expenses were included. I estimate the all-in expense ratio of a fully paid off house to be at least 2% per year and one recently purchased with a mortgage to be initially over 5% per year (with current low interest rates).  On a $300,000 house with a new mortgage combined costs would be ~$15,000 per year.  Over 10 years (assuming no increase in value/expenses) the average expense ratio may fall to ~4% as the interest portion is reduced but would still be ~$120,000 in costs that have to be overcome before any net appreciation can occur.  When the house is sold at the end of the ten years it will likely incur another 6%+ transaction fee, bringing the total 10 year costs to $138,000 or an incredible 46% of the original purchase price.

This isn’t to say that people shouldn’t buy houses as there are many good reasons for owning them – stability, access to schools, etc. and of course you do need a place to live.  Where things go wrong is when the “investment” argument is pushed to justify excess home spending in lieu of other savings and investments.

Any extra dollars allocated to housing are nearly guaranteed to lose money on an inflation adjusted basis.  These extra dollars are also locked up in an extremely illiquid asset which you may be forced to sell if you no longer want to live/work in the same city.  All the while you have missed the opportunity to diversify your investments and generate additional wealth by investing in low cost ETFs and mutual funds.

You wouldn’t borrow money to invest in a mutual fund with a 3%+ expense ratio, a 6% back-end load and a long term track record of negative real post fee returns.  Don’t make the same mistake when buying a house.

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