The Ignorant Investor

In his June 12 column, "How Houses Eat Money", Wall Street Journal writer Jonathan Clements examines whether his home has provided the kind of investment returns we've all come to expect from the red hot real estate market.

Clements bought his New Jersey home back in 1992 for $165,000, and since then he's seen its value rise up to somewhere in the $500,000 range, giving him a paper profit of about 200%.

But, he notes, in calculating the value of his investment he couldn't stop there. He'd also have to include expenses. In his case, about $130,000 over the years in rather mundane and ordinary improvements to the house like a new roof, new boiler, screened in porch, new kitchen (keep in mind, the purchase price of his house was probably discounted because it needed work). These improvements improve the value of the house, he says, but not to the tune of $130,000 because nobody pays full price for what is now a 'used' kitchen or a 10-year old roof.

Then comes interest and real estate taxes: $171,000. Although these are tax deductible, he notes that he would have taken a standard deduction even without owning the house, leading to about $24,000 in federal-tax benefits from these two items. Subtracted from $171,000 means total cost was about $147,000.

The money quote is here, as he counts up the damage:

Combine that with my $165,000 purchase price and the $130,000 in home improvements, and I am up to $442,000 -- not much below my home's $500,000 current value. The picture would be even uglier if I counted my initial closing costs, routine maintenance expenses and annual homeowner's insurance, to say nothing of the innumerable hours of my own time that I have sunk into the place. And while I have no intention of selling, that day will come. Imagine I sold today, paying a 5% real-estate commission. After enriching the brokers involved, I would net $475,000, perilously close to my total cost.

What did he get in exchange for spending all this money?

For a start, freedom from rent, the cost of which he didn't mention and which is impossible to gauge without knowing the value of local house rentals between 1992 and 2005. In constant 2005 dollars, assuming the equivalent of $1,500 to $2,000 per month to rent a house each month would mean he would have spent between $18,000 to $24,000 per year over the same time period (or $234,000-$312,000 in total if I'm figuring it right). This imprecisely determined figure may be far higher, and as it is the sum isn't too far from what he actually paid for housing.

He could count his equity, of course, as an asset. However, the same amount he paid towards equity each month could have been put into an investment account that probably would have grown to equal or better his current equity.

Still, as anyone who has ever been in a rental knows, he never had to worry about the landlord raising the rent, and that's no small reward.