What's A Better Investment: Primary Residence or Stocks?
Normally, a primary residence should not be considered an investment unless you house hack and rent out part of the home while you live in it or you end up selling the home. In the house hacking scenario, your primary residence acts like an investment because renting out a portion of your home could certainly reduce your housing costs. Better yet, if done right, it could even net you a profit!
If you end up selling your primary residence, the home acts like an investment because you will hopefully yield some capital gains after building equity for many years. Plus, selling your primary residence has a nice tax perk where you can exclude up to $250K (single) or $500K (married) of the capital gains from taxes! The latter scenario is what my partner and I recently did when we sold our home in California for nearly $1 million over asking. So how does our primary residence as an investment compare with, say, the stock market? Let’s dive into the numbers today and find out!
Valuing Our Primary Home
In Nov 2015, my partner and I bought a home together in a beautiful neighborhood for roughly $1.8 million. Just over 6 years later, we sold it for $3.4 million!
We didn’t pay for the home with all cash; we put $450K into the home as a down payment and took out a $1,350,000 jumbo loan to buy it. By the time we sold it, the remaining loan balance was $1,178,000, down $172,000. That means it took us 6 years to pay off $172K of that 30-year jumbo loan.
Next, let’s summarize some high-level numbers before we do the final ROI (return on investment) calculation of owning & selling our home:
Sold for $3.4 million
Commissions for selling: 4.5% of sale price = $153K (yikes!)
Loan payoff: $1,178,000
Home renovations: $235K (write-off)
Misc expenses/fees: $40K (write-off)
Now, we have the numbers to calculate our ROI. Here goes:
$3.4 million (sale price) - $1,178,000 (outstanding loan balance) = $2,222,000
Then we subtract commissions we paid, home renovation expenses, and misc fees to get $1,794,000.
So all in all, adding our $450K down payment with our $235K in home renovations, we sunk $685K into the home. But it ultimately turned into a whopping $1,794,000!! That’s a 262% ROI!
Stock Market Performance
If we hadn’t purchased the home and rented instead, we would’ve been able to invest our entire $450K down payment into the stock market instead. So let’s do some math and see what that $450K could have turned into!
First, let’s take a look at how the stock market performed in the years we lived in the home:
2016: +11.93%
2017: +21.78%
2018: -4.42%
2019: +31.46%
2020: +18.35%
2021: +28.66%
So $450K would’ve turned into $1,173,566 over those 6 years! That’s a 261% ROI!
We also have to take into account how much we could have saved by renting. First, we have to estimate how much we really paid to live in the primary residence.
Over 6 years, we paid ($5K per month x 12 months x 6 years) = $360K towards our mortgage. But remember that we paid off $172K of our jumbo loan. That $172K belongs to us, not the bank. So in reality, our monthly mortgage was: ($360K - $172K) / (12 months * 6 years) = $2,611 per month. Adding a $2K/month property tax bill means we paid $4,611 per month for our primary residence.
If we rented instead, I think we would have paid an average of $4K per month. So our savings would’ve been “just” $611 in savings per month. That comes out to $7,332 in annual savings by renting.
We also should assume that we would have invested the savings of $7,332 per year over that same period of time. Just like we did with the $450K down payment earlier, using the S&P 500’s historical returns for those years, that looks roughly like:
2016: $7,332 x (1 + 11.93%) = $8,207
2017: ($8,207 + $7,332) x (1 + 21.78%) = $18,923
2018: ($18,923 + $7,332) x (1 - 4.42%) = $25,095
2019: ($25,095 + $7,332) x (1 + 31.46%) = $42,629
2020: ($42,629 + $7,332) x (1 + 18.35%) = $59,129
2021: ($59129 + $7,332) x (1 + 28.66%) = $85,509
So investing $7,332 per year over the past 6 years straight into the S&P 500 would’ve turned into another $85,509!
To tally up all the stock investments that we could have had if we didn’t own our primary residence the past 6 years, we’re looking at: $1,173,566 + $85,509 = $1,259,075, a 255% ROI!
My Partner Was Right
All these years, I complained to my partner that our primary home was eating away at our savings rate and was preventing us from investing more. While I would’ve been right had we kept the home forever and never sold it for profit, it didn’t work out that way for us. So as much as I don’t want to admit it, my partner was right. Our primary home was a much better investment than what would’ve happened had we just invested our additional savings and down payment into the stock market.
$1,259,075 is approximately what we would’ve ended up with had we rented instead. But thanks to my partner (apparently the better investor), we turned $450K into $1,794,000 in just 6 years! That averages out to a 25.9% return per year!
To sweeten the home investment even more, $500K of the profits on the home sale can be completely excluded from capital gains taxes, unlike stocks. You also exclude any expenses for home upgrades and any commissions you paid when you bought and sold the home from capital gains taxes!
What’s Next
The housing market has been just as hot as the stock market, perhaps hotter, over the past few years. With stocks near all-time highs, wealthy techies have been eager to fight for a highly sought-after home like ours, pushing home values in Silicon Valley to sky high levels. Our home nearly doubled in value over the past 6 years, and we are now reaping the rewards after finally selling our home and relocating to Dallas.
And with so much cash coming from our home sale, coupled with a large stock market correction, I am even luckier with our timing. It feels like we sold just in time at a peak and will be cash rich and ready to scoop up stocks at a discount.
I’m super excited to lump sum a significant amount of the home sale proceeds into stocks, but not all of it will be invested there. I’ll queue up another blog post on what I will do with all the cash, so stay tuned and subscribe below!
