Leverage only works to your advantage when the average annual return on your investment (ROI) exceeds the APR on the capital you borrowed. For example, if your $100k house appreciated in value by 5% in a single year it would be worth $105k. If the loan on that house cost you $6k in interest that year, then the loss to your net worth is $1k.

Now that’s assuming that the house continued to appreciate, and you still lost money on your investment. If the house depreciates, then the financial situation is very painful because not only have you lost value in the home (you still owe what you borrowed), you’ve also still lost the interest you’ve paid on your loan. Whereas, if you were renting you would be able to negotiate for lower rent or you’d be able to move into another similar location where the cost of renting has mirrored the drop in the market.

I realize that the tax break would help, but I doubt it would overcome the costs of maintenance, insurance, and property taxes.

Renting definitely has huge benefits. As a member of the military, I’ve rented rooms for significantly less than the cost of a mortgage, and I have the benefit of flexibility when it comes time to move or deploy. I can’t imagine the hassle of maintaining a house from overseas, dealing with troublesome tenants, or being forced to live with 2 mortgages at once.

Keep up the good work.

Still, I like the bottom line of the story: that there is more to real estate investment returns than plain vanilla value appreciation, and that the actual ROI is usually substantially better than the rate of appreciation due to leverage and the elimination of rent.

But I think we are getting a little too complicated… While the post was, indeed, about performance, in the larger picture he is more focused on net worth.

Calculating one’s net worth appreciation over time would be interesting as well…

Aand as I’ve made clear more than once, I didn’t “ignore” the interest cost. I simply traded it out against what we would’ve otherwise paid in rent. If this was an investment property then I would agree with you that we would explicitly need to account for this, although we would then have been collecting rent to offset at least part of the interest costs. Likewise, if the mortgage payments were less more than rent, then we’d have to correct for that as well. But using the crude assumption that these amounts are equal – in reality, the mortgage payment is more or less the same as what we would’ve paid in rent, although this ignores that fact that a small portion of every mortgage payment actually went toward principal. Thus, I’m actually being conservative by ignoring it.

Brad has it right. Because this was our principal residence, and because we would’ve otherwise incurred rent in an amount equal to our mortage payment, it’s perfectly fair to view this as a free and clear profit (admittedly, after ignoring a small amount of upkeep/maintenance costs that we incurred).

Look at it this way. We paid X dollars per month to put a roof over our heads (whether than was rent or mortgage, it doesn’t matter) and we then invested $30,000 for four years and profited $45,600. Whatever we chose to invest in, the numbers work out the same.

I do realize that I’m making some simplifying assumptions for the sake of convenience. This was also made simpler by that fact that our rent and mortgage costs were a push. But the general approach is valid.

J: You’re going to have to re-state your criticism more clearly before I can respond to it.

*That’s* the problem with this post. I just couldn’t figure it out initially.

Yes, property taxes and insurance can be a large part of the equation. Here, property taxes are 2.5% but are only assessed on 25% of the tax appraisal value of the home (and this appraisal is notoriously below market value). So our property taxes are quite low. Additionally, homeowner’s insurance is cheap as I live in a relatively “safe” (from natural disaster) area. In Florida, due to all the hurricane damage, insurance is many times what it is here. Both of those factors lead to the conclusion that it “makes sense” as an investment to buy a home here; much moreso than it would in other places.

It’s the property taxes which really kill real estate in many places. For instance, if this had a 3% property tax rate (as we have here), you can knock $25 grand off the “returns” (tax affected down to ~$17k).

You are trying to make the issue more complicated than it is, IMO. By spending an extra $30k, nickel has gained an extra $45k. That is the bottom line. The return on nickel’s spending is 152%, no matter how you choose to label it. I fail to see how this is different than any other investment return.

And reading your post again (maybe I missed this and/or it was added), if you think you could rent it out at the same rate as your mortgage monthly payment, the return on equity is likely in the range you’re looking at.

Teach me to read quickly first thing in the morning!

As you point out, you have to spend money to live regardless of whether or not you buy a house and it is because of that regardlessability (new word!) that you should factor interest expense into your return on equity.

“We would’ve written that check either way, so it’s perfectly fair to exclude that amount when figuring our effective return.” If you’re comfortable that your “effective return” is not comparable to investment returns as normally calculated, that’s fine.

It’s a fundamental theory of finance that you must compare leveraged returns numbers to leveraged capital numbers and unleveraged returns to unleveraged capital numbers. That is why mkt cap / net income and enterprise value / EBITDA are valid valuation metrics but mkt cap / EBITDA and EV / net income are not.

I know many people don’t like to consider their primary home an investment, and that’s okay. But I will make the most of it financially, no matter what people wish to call it.

Looking at it another way, let’s say we broke even after subtracting mortgage-associated costs (interest, from our gain. In that case, we would’ve lived for free for 4 years, but it wouldn’t be fair to say that we didn’t earn anything, as we would’ve effectively earned enough to completely offset four years worth of rent payments.

ntguru does, however, have a valid point when it comes to maintenance and upkeep. Fortunately, this was a brand new house, and we didn’t actually put too much money into it. But to be perfectly fair, I should’ve reduced our gain by the amount of money we put into maintaining/improving the property (at least to the extent that it would exceed our upkeep costs had we rented instead).

And hieronymus has a good point with regard to tax deductibility. I called the mortgage vs. rent issue a wash, but the mortgage interest was actually tax deductible, which would make the mortgage payment *smaller* than the rent payment, thereby making my calculation somewhat conservative.

I would offset the interest cost against rent because that money would be spent in either case unless there was no mortgage.

It serves the same purpose as rent; it gives you a place to live. Without that interest payment, there would be no house unless he had spent a lot of time saving ahead of time…

Yes, he should look at overall expenses, but he also has to live SOMEWHERE, so interest expense is what he paid in lieu of rent, so the math is not quite straightforward.

Also, don’t discount the tax benefit of interest deductibility (again, it can get quite compicated if the deduction moves you down a marginal bracket–OR causes you to be hit with AMT!).

For my purposes, excluding the interest-expense effects if likely a conservative approach, given that my overall mortgage payments (*excluding* the beneficial tax treatment) are far less than I would have to pay for an equivalent rental.

Certainly if this was a purely rental property you would have to include the interest. However, in that scenario one would presumably have rental income, which would hopefully at least offset the interest portion of the mortgage payment. One could argue that in the first example the “rent payment” is made to yourself (ie you are the renter and the landlord).

Also, to be fair, you would need to include other upkeep and maintenance expenses.

That is the wrong way to look at it. If you are going to allow yourself the benefit of leverage, you have to factor in the cost (interest expense). I think you probably paid ~$40k of interest, so your total return on the house was probably less than the 26% you show above.

Heck, with a return on capital of 6%, you probably would have lost money had you levered it 100% (though rates were quite possibly much lower when you took out the loan).

You must compare apples to apples, my friend.