Is a House a Good Investment?

Smith, Margaret; Smith, Gary
April 2004
Journal of Financial Planning;Apr2004, Vol. 17 Issue 4, p68
Academic Journal
The article analyzes whether a house is a profitable or unprofitable investment. The largest and the most profitable investment many clients will ever make is the house they live in. Financial planners need to be able to reasonably assess whether a particular house for a client is likely to be profitable or unprofitable. Some observers compare monthly mortgage payments with monthly rent for a similar property. Others look at the house's P/E: the ratio of the house's market value to its annual rental value. Both of these methods are flawed. A more accurate method for gauging whether a house is likely to be a good investment is to determine the net present value of the anticipated cash flow. This is a robust and well-established procedure widely-used to value bonds, stocks, business projects, and commercial and industrial real estate. The question posed when buying a home is the same posed for buying a stock: is it cheap or expensive? The financial implications of a home purchase depend on several factors. Two key ones are the net rental savings plus the capital gains and the impact of leverage on return. The guiding principle of the analysis is to determine the after-tax cash flow each year.


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