People love to exaggerate their experiences when it comes to the topics of money and love. It is a rule of thumb for me that whenever someone starts boastfully revealing how much money they make or how many times they have been approached by the opposite sex, I immediately chop it in half. I call it the 50% rule. I assume that everyone has a percentage figure that they implement as well. Surely, you don’t believe your neighbor always wins when they go to Vegas.
One claim that people intuitively overstate is how much money they made selling their house. I do not attribute this exclusively to exaggeration however. Much of this hallucination is a result of the indoctrination of the real estate and mortgage industries that have made a fortune convincing people that home ownership is the fast track to wealth. I have owned eight homes during my lifetime, sometimes proudly, many times reluctantly. I can crow about the fact that I made money on one of them, quite a bit money actually. The same thing happens in Vegas too. Sometimes the dice, the slots or the cards go your way and you score a good payout. That payout gives the justification to keep playing, which is what Vegas wants. The casino does not mind you getting a good win here and there, because over time, they get all of your money. Of the other seven houses I have owned, I either broke even or lost a sizable amount of money.
To prove my point, I will take the example of someone I know who years ago purchased a mountain cabin. For the sake of this story, I will call her Nancy. After paying $160,000 for the cabin, Nancy decided that the mountains wasn’t her cup of tea and sold it a year later for $170,000, for which she boasted she made $10k after only owning it for one year.
Making $10K certainly seems like a nice return, but for a $160K investment, it is really just a yield of 7%. This is about the same return one can get by investing in the broad stock market, an investment that can be sold at a moment’s notice should you need the money. When it comes to real estate, you just can’t cash in your investment with a phone call or click of the mouse. You have to put it up for sale and hope a buyer comes by one day and agrees with you on the value of the house. .
The truth is that Nancy certainly did not walk away with an extra $10,000 in her pocket. In fact, she lost money. That is because under the surface of the initial sale, is a long list of expenses that undermine the perceived imaginary profit. Let’s break down the numbers and take a look underneath the mirage.
First off, Nancy had to list the property with a real estate agent. Let’s assume the agent charged a 6% commission, which is pretty standard. This 6% was split between the buyer and seller’s agents that came to $10,200. Yes, that is correct, that $10,000 profit was a fleeting mirage that vanished once the real estate agents took their share.
The real estate commission is only the tip of the iceberg however. When Nancy purchased the cabin, she had to pay closing costs, which typically range between 2 and 5 percent in her state. Let’s give her the benefit of the doubt that she shopped around and found a deal for 2%. That would put her closing costs at $3,200. So far, Nancy is $3,400 in the hole.
Nancy also had to pay property taxes on that cabin. For the sake of argument, we will assign her taxes at $2,000, as it is a second house so she cannot declare homestead exemption on it. This cabin was located in a gated community that boasted a number of great amenities. Those amenities and privacy have a price tag of $2,000 a year of $2,000 in HOA fees. Nancy is now $7,400 in the hole.
Nancy paid a year of interest on that home. Of course, the real estate industry comforts us by the perpetual mantra that we get a mortgage deduction. True, but it is not a tax credit, just a deduction. In other words, if you are in the 28% tax bracket, you get to write off 28 cents on each dollar you spent on your mortgage. Big deal. I would rather have the entire dollar in my pocket. We’ll put her mortgage payment at $600 a month plus $50 a month for homeowners insurance. In order to take full advantage of her tax deduction, we will put her in the 30% tax bracket. This puts her out of pocket costs after her mortgage deduction is $5,460. Now she is $12,860 in the hole.
Now none of this includes any updates or repairs she may have made to the house moving in. It does not include the furniture, rugs and window treatments. It doesn’t include a termite contract and pest control service.
The list just keeps on growing and growing. Did Nancy say that she made money? This is the lie that so many homeowners tell themselves; the lie that the real estate and mortgage industries have convinced them is the truth. If you own a home, it is because you want the security of owning something, not because you plan to make any substantive return on investment.
