Buying a home is probably the most significant financial decision most people will ever make. Indeed, for many people, buying property is their primary financial goal in life -- it's why they save in the first place. Retirement comes in a close second, although using property equity to fund retirement at a later date is a common strategy.
It is common to believe that buying property is always "a better use of capital" than renting because renting is basically throwing money into the bottomless pit of landowners' pockets with no permanent gain for the renter. Paying someone else's expenses does not seem financially responsible when one could acquire property themselves and build up their own equity.
Of course, as most renters know, it's not that simple. The up-front cost of buying property can be high due to down payments, and even those with enough money to buy often do not have sufficient credit history to buy without a wealthier co-signer. Additionally, if you have enough savings for a home down payment, there could be better opportunities for that cash if one has the investing sense to take advantage of them.
When to buy a house
Buying property is such a significant financial decision for many people because not only is this likely to be the largest transaction they will never complete, but it will also likely be their most significant asset.
Having all of your wealth in one asset could be interpreted as being a risky strategy. It may also limit one's options. This is the very reason why Warren Buffett (Trades, Portfolio) did not buy property until he was relatively well-off and could afford to continue investing while purchasing a home.
However, Buffett told shareholders the following at the 1998 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting:
"I'll just relay one story, which was when I got married we did have about $10,000 starting off, and I told Susie, I said, "Now, you know, there's two choices, it's up to you. We can either buy a house, which will use up all my capital and clean me out, and it'll be like a carpenter who's had his tools taken away for him. "Or you can let me work on this and someday, who knows, maybe I'll even buy a little bit larger house than would otherwise be the case." So she was very understanding on that point. And we waited until 1956. We got married in 1952. And I decided to buy a house when it was about — when the down payment was about 10% or so of my net worth, because I really felt I wanted to use the capital for other purposes."
Buffett believed that the opportunity cost of acquiring property was significantly higher in the long term. The money he put down on the property could be worth several times its initial amount after several years of being invested.
Here's an extract from "The Snowball: Warren Buffett and the Business of Life," a book by Alice Schroeder, which explains why Buffett was against spending $31,500 on a house:
"In his mind $31,500 was a million dollars after compounding for a dozen years or so, because he could invest it at such an impressive rate of return. Thus, he felt as though he were spending an outrageous million dollars on the house."
If we take this through to today, the opportunity cost of this $31,500 expenditure would likely be worth several billion dollars. Would this have been a mistake? Should other investors follow the same path and avoid buying property for them to live in until their net worth is much higher?
In my opinion, the answer to this question will vary from person to person. It really depends on one's own personal preference. Renting has some advantages, but so does owning.
The most important thing to consider when looking at this case study is that most investors are not Buffett. The Oracle of Omaha is one of the greatest investors of all time and has been able to compound his capital at 20% per annum over the long term.
However, we know the average investor achieves returns nowhere near this level. Some studies have placed the average investor's return at less than the inflation rate over the long run. That implies most investors would be better off buying property because the value of property has typically increased faster than inflation in the long run.
Disclosure: The author owns no share mentioned.
Read more here:
- Li Lu on Charlie Munger and the Ability to Remain Rational
- A Look Back at Warren Buffett's Investment in Mondelez International
- The Challenge of Identifying a Durable Competitive Advantage
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