The Power of Leverage

Question:  Allison, we have been long-time renters in Summit County and now are considering purchasing our own home here. We’re concerned about the overall economic outlook in the country and here in Summit County and wonder if we wouldn’t fare better to just keep renting and put our money in the stock market. What are your thoughts?
Answer:  Good question! Newspapers and business magazines are fond of horse races. Who's the richest? Which company's stock has risen the most? Which company posted the biggest profit or loss? And so on. Recently, the Washington Post ran a story asking if stocks are a better financial investment than owning a home. 
While tempting, simply comparing the average return over a period of time is a misleading way of looking at the financial benefits of owning real estate versus stocks.
According toPaul Bishop, Managing Director of Survey and Marketing Research, consider the following scenario. How would a buyer who purchased a home in 1977 fare compared with the investor who instead invested the same amount in a portfolio of stocks tracking the S&P 500? While home prices increased at an average rate of 5.6% per year between 1977 and 2007, the S&P 500 increased at an average annual rate of 9.2% during the same period. Therefore, stocks are a better investment than a home.
Or so the story goes.
Although this appears to be a straightforward analysis, there's one very important factor that's missing. While there are buyers who purchase a home without using mortgage financing, the percentage that do so is very small. According to the 2007 NAR Profile of Home Buyers and Sellers, 93 percent of buyers used a mortgage. With a mortgage, the power of leverage operates in full force.
So, back to our scenario. A household in 1977 has two ways to invest $10,000. As before, the household can forego home ownership and make a one-time investment in an index fund that tracks the S&P 500. This investor will end up with a nest egg of $141,300 in 2007 for a net gain of $131,300.
The median existing single-family home price in 1977 was $42,900. For the purpose of this scenario, assume our home buyer purchased a home for $50,000 with a $10,000 down payment using a 30-year fixed rate mortgage. The home buyer not only captures the non-financial benefits of home ownership and the value of a home as a shelter, but also the financial gain that leverage provides. Assuming that the home increases in value at the long-term rate of 5.6% per year, the buyer would be able to sell their free and clear home in 2007 for $256,400, leaving a net gain of $246,400. So, clearly, the power of leverage makes home ownership a powerful source of wealth accumulation over the long-term.
The Power of Leverage
Stock Investor
Beginning investment
$10,000 down payment on a $50,000 home
Annual appreciation
Ending value
$256,400 home value
$141,300 stock value
Net gain
While the homeowner will own their home after 30 years, the investor will end up with a smaller nest egg, while also paying rent for the 30 years during which the home owner was able to enjoy the benefits of home and hearth. For many home owners there also are substantial tax benefits from home ownership, including the deductibility of mortgage interest and in most cases a tax-free gain upon the sale of the home. Neither of these benefits is available to investors in stocks.
Of course, most households do not face a choice of only investing in a home or in financial assets. Many households invest in stocks and bonds and also purchase a home while others will choose to rent a home and invest. However, it should be clear that over a period of several years the returns from owning a home will usually keep pace with, and in most cases exceed, the returns from stocks while also providing the intangible benefits of ownership. (Copyright National Association of REALTORS®, Reprinted with permission.)
For answers to your real estate questions, call Allison at 970-468-6800. Email - [email protected]. Allison is a long time local in Summit County. Summit Real Estate – The Simson/Nenninger Team is located at the Dillon Ridge Marketplace. Allison’s long-time residency and years of real estate experience can help you make the most of any buying or selling situation. Her philosophy is simple, whether buying or selling, she understands that the most important real estate transaction is yours.  Want to know the value of your Summit County property? Visit   

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