What Is the Investment Return On My House?

Note: This article was revised on 7/3/2024 due to minor formula corrections on mortgage interest.

Investing in a home in a vibrant community like Devonshire can be exciting and rewarding. However, understanding the potential return on investment (ROI) is crucial for making an informed decision. Here’s a guide to calculating the ROI for buying a house in Devonshire and living in it for 10 years.

First, calculate your initial cash expenditures, including the down payment, closing costs, and lender-required deposits (prepaids). For an FHA loan, the minimum down payment is 3.5% of the purchase price. For a median home price of $285,000 in 2014, the down payment would be $9,975. Adding estimated closing costs and prepaids of $9,025 brings the total “cash to close” to $19,000. For a conventional loan, these costs would be higher.

Next, determine your primary housing expenses, including mortgage, taxes, and insurance. In 2014, the FHA mortgage interest rate was approximately 4.2%, resulting in a monthly mortgage payment of $1,345 and an annual cost of $16,139. Additionally, mortgage insurance premiums for the FHA loan would be about $1,200 per year. Over the past decade, taxes and HO insurance averaged $12,000 annually. Thus, the total annual primary housing expenses for the $285,000 house were about $29,000, though this could vary based on specific purchase and financing details.

Consider HOA fees and home maintenance costs. HOA fees were $420 annually in 2014, increasing by an average of 4% per year to $618 by 2024. Home maintenance expenses are estimated at $3,000 per year on average. For the Devonshire homeowner who bought a median-priced home in 2014 with an FHA loan, total average annual housing expenses were around $32,435 during the first 10 years of ownership.

An important offset to these expenses is the “imputed rent,” which estimates the rental income homeowners would earn if they rented out their homes. This reflects the economic value of homeownership, as it considers what you would pay to rent a similar house. In Devonshire, the typical home would have rented for $2,000 per month in 2014 and $2,900 per month in 2024, with a 4.5% average annual growth rate. Over 10 years, the average annual rental income was about $28,754.

Next, factor in tax benefits from mortgage interest, property taxes, certain home office expenses, and mortgage insurance premiums. Multiply these expenses by your marginal income tax rate. Assuming a 20% tax rate for a Devonshire homeowner in 2014, the average annual tax benefits were about $4,000. Therefore, the sum of imputed rents and tax benefits ($32,766) offsets the housing expenses ($32,435).

Additionally, home values typically increase over time. In Devonshire, the median home price increased by 5.5% annually over the past 10 years. A home purchased for $285,000 in 2014 would be worth about $488,000 in 2024, a 71% increase. Meanwhile, the original $274,643 mortgage would be paid down to $218,129. Selling the home would involve broker fees and closing costs, but you’d also receive a refund from your mortgage escrow account. After these adjustments, you’d have approximately $211,000 in cash equity from the sale. As your primary residence, you would pay no capital gain tax.

In summary, to calculate your ROI, add your cash equity ($211,000) to imputed rents and tax benefits ($32,766 x 10 years), then subtract your initial cash to close ($19,000) and housing expenses ($32,435 x 10 years). This results in $192,000 of net savings. Dividing this by your initial investment ($19,000) yields an ROI of 10.7x. Starting with $19,000 and ending with $211,000 of cash equity is not too shabby! Consider the equivalent annual investment return is about 26%. Excluding tax benefits, the annual investment return is 18.5%. By comparison, the total return from the S&P 500 (with dividends reinvested) during this time period was about 12% annually. In other words, the Devonshire homeowner is much wealthier than the individual who invested the initial $19,000 of cash in the stock market and continued to rent.

In fact, the Devonshire homeowner would be about $70,000 richer than the stock market investor who rented – even if the additional tax benefits are ignored. The primary advantages of homeownership are price appreciation with borrowed money, loan paydown, imputed rent, and capital gain tax exclusion.