Saving in 401k vs Saving for Home Downpayment

[Data10]

@FallGirl

House #4 - Bought 1998, sold 2022. Made a lot of money (sold 3X what we paid). Even given the improvements we made (H built a deck, finished the basement adding another family room, bedroom and full bath) and making updates along the way we still did really well. We got lucky and timed it just right.

Tripling in 24 years is an annualized 4.7%… less when you subtract the cost of the “significant improvements” you made including adding extra rooms and more usable sqft. I wouldn’t call this type of outcome “getting lucky.” 4.7% is similar to the historical average annual increase for home equity, which is less than half the historical annualized gain for the S&P 500.

That said I agree with you that a house can sometimes be a good financial investment, and one should consider more than just the financial numbers when deciding whether to buy or rent, including personal quality of life benefits .

I live in a VHCOL area where the least expensive condo starts at ~$1M, and homes with a small amount of property typically exceed $2M. My first home was essentially the least expensive condo that was very close to where I worked. It was an upgrade from the apartment that I previously rented, but it did not have most of the key features I wanted to have in a home, so I was never particularly satisfied. I made a larger net gain than I would have made in the stock market during this period, which primarily relates to the stock market tanking, with an average annualized S&P 500 gain of under 1% per year during the reference period.

I was more thoughtful with my 2nd home and took a more active role in the process. I waited to buy until I thought the market conditions were right – shortly after the subprime mortgage crisis, when prices were more favorable compared to historic trends, and my regional market was flooded with short sales and foreclosures. My realtor and I spent months looking for the perfect home. He gave me access to the private realtor database, which I’d use to find a list of homes that we’d visit each weekend.

I bid on several homes. One got as far as inspections. However, I walked away after the inspection revealed some issues with improperly mitigated past water damage and potential mold. Eventually I came across a unique, one of-a-kind home that was an especially good fit for me, with many features I have never seen before. We closed on the day before switching from short sale to foreclosure, which was helpful towards price negotiation. I was satisfied with the price in an absolute sense, and over $100k worth of A/V equipment was included within that price.

Financially the home has done well since then, with an average annualized gain in value of ~8% per year (prior to what will be a substantial capital gains tax + selling costs). However, even with the higher annualized gain, I would have likely had a better net with market investments. Beyond finances, the quality of life benefits have been worth the relative loss to me, even more so when working from home since COVID. With the home, I now have the space to have things like a nice theater and exercise area. I also enjoy have a fenced in yard for my dog, as well as trails + that lead to a large athletic field where my dog sees and plays with other neighborhood dogs most days. My dog adoption last year wouldn’t have been approved if I did not have a fenced in yard. I also like the neighborhood – low crime rate, friendly + helpful neighbors, wide sidewalks, rated one of the best areas in US for pedestrian safety, etc. All of these metrics are better than any other location I have lived.

[ucscuuw]

Housing is generally not great financial investment but there are points in time where the market gets severely disrupted and buying/financing at those points can generate considerable value. In our case:

House 1 - bought at the bottom of the market in 2011 with minimum down (3%). That house became 2x quickly and picked up steam again during Covid. Its now holding that elevated value. Even without selling, this is a good investment for us because we refinanced at 2.x% and our monthly costs (inclusive of taxes and insurance) is well under market rental value. This is our primary residence so we save $$ on rent every month

House 2 - bought late 2019 the coastal bay area market (10% down). At the time we bought it, rent and mortgage in that market was even. Then we refinanced during Covid at 2.x%, and values shot up 50%. Now, we rent it out and we net 1k every month so this is a cash flowing investment

In both scenarios, we had no way of forecasting a 2.x% mortgage for either house, and we benefitted from the bottom of the market for the 1st and the Covid induced boom for the 2nd.

I would buy neither house at current market value.

[Colorado_mom]

How should one factor in the interest paid on a mortgage? Sure, you can say that a house has increased in value by 1.5x, 2x, whatever. But much of the monthly payment goes to interest, especially in the early years. Maybe consider the interest to be a rent-swap?

[FallGirl]

@Data10

Tripling in 24 years is an annualized 4.7%… less when you subtract the cost of the “significant improvements” you made including adding extra rooms and more usable sqft. I wouldn’t call this type of outcome “getting lucky.” 4.7% is similar to the historical average annual increase for home equity, which is less than half the historical annualized gain for the S&P 500.

I was actually referring to the timing of our sale. Two couples we are close to put their houses up for sale in Summer 2021 and did really well. (they both lived very close to us). They urged us to consider selling then, be we weren’t ready. We took the risk of waiting until February 2022 to list the house. At that time the prices in that area were going even higher, so we were indeed lucky in that regard.

[Data10]

@Colorado_mom

How should one factor in the interest paid on a mortgage? Sure, you can say that a house has increased in value by 1.5x, 2x, whatever. But much of the monthly payment goes to interest, especially in the early years. Maybe consider the interest to be a rent-swap?

Yes, one needs to consider more than just the difference between buying and selling price. In the original post methodology, I am doing a year-by-year total. Each year compares the rent saved vs extra expenses on mortgage interest + home expenses/tax. Principle payments are also relevant, as they reduce the amount of cash available for 401k or other investments, effectively reducing leverage.

[ucbalumnus]

@Colorado_mom

How should one factor in the interest paid on a mortgage?

Mortgage interest is payment for renting the money, so it can be considered a substitute for rent payment on rental housing. Property owners also have to pay property tax, which is somewhat embedded in the rent payment on rental housing (of course, in California, Proposition 13 is like the property owner’s analogue to rent control).

Homeowner insurance replaces renter insurance, but also includes insuring the building (that cost is somewhat embedded in the rent payment for rental housing). Maintenance on an owned house is out of pocket for the homeowner, but embedded in the rent payment for rental housing.

The non-analogous financial aspects are that buying a house means making a highly leveraged investment in real estate, which may result in big gains or big losses, and that the transaction costs relating to buying and selling a house are much greater than moving to different rental housing.