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How Your Home Stacks Up as an Investment

Jeff Brown

With spring comes the peak season for real estate, when homes look their best and buyers are impatient to enjoy the summer in the new place and be settled for school. The home, as we've all heard over and over, is often the household's biggest investment -- not a choice to be taken lightly.

But is it really an investment comparable to, say, stocks, bonds or mutual funds? If so, it might make sense to buy the most expensive home you could afford. If not, perhaps a modest home would be better, with the savings invested elsewhere.

"From an investment standpoint, consider a home in most communities to be a place to invest that will shield against modest future inflation, but not produce the financial gains possible in other strategies such as stocks," says Glenn S. Phillips, CEO of Lake Homes Realty, an Alabama-based firm that specializes in lakefront properties in 10 states.

[See: 7 Agricultural Stocks and ETFs to Buy and Hold.]

"The real estate bust showed it was a myth that homes are always a safe investment," he says.

Everyone needs a home, so some of the ownership cost is like paying rent. The question, then, is whether the home produces a return on top of its value as shelter.

As investments, homes certainly have some benefits. For most homeowners, gains on a primary residence are tax-free, and the homeowner with a mortgage can benefit from leverage. Put $30,000 down on a $300,000 home and you'd double your initial investment if the value rose by 10 percent, which could happen in just a few years if you were lucky. At least, that's the pitch from those who see homes as good investments.

A home can also be a stable holding.

"Home prices are much less volatile than stock prices, especially on the downside," says Andrew Armata, co-owner of LAER Realty Partners, a real estate firm in Massachusetts. "The housing market has historically been much less prone to bubbles and crashes."

In part, that's because a home can't be sold on a moment's notice. And homeowners stick with their homes, shoring up prices, even in shaky markets, because they need a place to live.

Ask your grandparents what they paid for the home they've owned for 50 years and it may look like a gold mine. And, of course, plenty of people make quick killings in red-hot markets. But those who buy at the peak can get hammered when the bubble bursts. Just ask the tens of millions of homeowners who were underwater for years after the housing bubble of the past decade collapsed, leaving them owing more than their homes were worth.

Though there are always some hot local markets, on a national basis the home doesn't look like an especially good bet, with price gains averaging 3 to 4 percent a year over long periods, according to various studies. Stock market gains averaged around 10 percent a year for the 20th century, or 6 to 7 percent after inflation.

[Read: 5 Reasons to Avoid Penny Stocks at All Costs. ]

"Houses historically have appreciated at the overall inflation rate," says P. Jeffrey Christakos, lead advisor with Westfield Wealth Management in Westfield, New Jersey. "In certain parts of the country, this appreciation is more than offset by real estate taxes."

Also, comparing home price gains to stock returns is apples to oranges. You can buy a stock or stock mutual fund and sit on it for decades with virtually no expenses, while owning a home typically entails paying mortgage interest, insurance, taxes and upkeep.

'I believe you should buy a home that you can comfortably afford while investing other funds elsewhere," says Charlie Crawford, CEO and chairman of Private Bank of Buckhead, an Atlanta firm which operates a national mortgage service PrivatePlus Mortgage.

"And when I say afford, I'm referring not just to a monthly mortgage payment, but all the costs associated with home ownership."

Generally, it doesn't make sense to buy the biggest and grandest home in the neighborhood, Armata says. "Although there are always outliers, typically the highest financial return is from homes that you can increase in value by doing some repairs and that do not have exorbitant monthly carrying costs."

Obviously, a home is also an illiquid investment. You could get stuck with it for years, while you could dump a stock or mutual fund with a few clicks of a mouse.

Finally, as the value of your home rises, so will the values of other homes you might buy in the future. So what you earn on today's home may be required to buy tomorrow's, leaving nothing for college or retirement expenses. A home puts money in your pocket only if you sell and buy something cheaper, or take cash out with a home equity loan, cash out refinance or reverse mortgage.

So before using the investment rational to justify buying the most expensive home you can afford, ask some questions:

Is the location promising? Most buyers narrow their neighborhood choices by proximity to work. But a hard-headed investor might steer clear because of a pattern of low appreciation, a lack of neighborhood amenities or an oversupply of homes due to new construction. From an investing perspective, it's a red flag anytime you shrug off such factors and choose a home for personal reasons instead.

How will I get my money out? If the home's value soars, will you be willing to sell when you think the market has hit a peak, as you would with a stock, bond or mutual fund? If you need cash, will you qualify for a home equity loan? Since that would require an income, a home is not a good cash reserve for a stretch of unemployment.

Equity can be taken from a home through a reverse mortgage, but you must be at least 62, willing to give up some of your equity to fairly steep fees and interest charges, and comfortable knowing you might not have much equity left for your heirs.

[Read: How Taking a TV News Fast Makes for Better Investing.]

How long will you stay in the home? It may take a number of years worth of appreciation to cover various costs of buying and selling a home, such as title insurance, loan fees and realtor's commission. Earning nothing, in effect, for four or five years would reduce your average annual return over the time you had the home even if it did well over the next four or five years.

What are the prospects for the alternatives? Even if the home makes money, another investment might make more. No one knows how different assets will behave, but a home, if seen purely as an investment, would make sense only if it made more than the alternatives. Ideally, it should earn a premium to compensate for your risk of being stuck with it in a falling market.

"Real estate has always been about location," says Peter Loewy, chairman and CEO of Teles Properties, a firm that brokers luxury properties in California. "Buying the least expensive home in the best location is the best advice. The purchase of a home is always about value, not necessarily about whether it is the most expensive home. Naturally, if one can buy a home and diversify the rest of their assets, it is better than stretching to the most expensive home and having no hedge."

For insight into the investment potential of a specific property, play with a buy-versus-rent calculator and use online tools to find home price trends in your neighborhood.

Making money on a home is no slam dunk. The most prudent course is to buy the cheapest home that will serve your needs, investing the savings in assets that are more liquid and have a better track record. To buy an expensive home is to opt for luxury, with the value coming through pleasure, not necessarily profit.

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