Housing appreciation isn't all profit
By Greg McBride, CFA • Bankrate.com

Homeownership may not be the moneymaker you think it is. Instead, you may be lucky to get back the money spent on closing costs, mortgage payments, property taxes, property insurance, maintenance, homeowners association fees, and real estate commissions by the time you sell.

Wait! Stop! Don't send that angry e-mail yet. I'm not disparaging homeownership. It clearly maintains distinct advantages to renting, where there is no end-of-term rebate. It is, however, crucial evidence in the case against entering a budget-busting commitment by buying more house than you can comfortably afford. It bolsters the idea of living within one's means and not being "house poor." Unfortunately, this is the antithesis of what many have done by stretching to buy a first home or upgrade to a bigger home, particularly in high-cost areas.

Homeownership is still a positive move because you can live essentially "rent free" if you earn back the money expended.

However, your actual profit isn't as simple as saying, "I bought the house for x, sold it for y, and pocketed the difference." Neither is the accumulated equity stake by the time the home is sold an accurate depiction of the profit earned. Instead, compare that accumulated equity stake -- net of all sales costs -- with the amount invested for initial closing costs, all monthly mortgage payments, annual property tax bills, property insurance premiums, and costs for maintenance and upkeep, plus any ancillary fees such as homeowners association dues or assessments.

Consider the out-of-pocket costs over the course of several years and the annual rate of appreciation needed just to earn them back. Let's take a look at a home that you buy for $200,000 today. We'll assume the following: The buyer makes a $20,000 down payment and finances $180,000 at 6 percent on a 30-year fixed mortgage, with closing costs of $5,500. Our buyer is in the 27 percent marginal tax bracket, pays property taxes fixed at 2 percent of purchase price, property insurance of $100 a month, forks over $50 a month to a homeowners association, and spends $100 a month on maintenance and upkeep. When the house is sold, there's a 5 percent real estate sales commission paid.

Here's a look at how the break-even point changes over time:

Itemizing on taxes, and thereby deducting interest expense and property taxes, boosts homeowners' returns. Notice the smaller net investment and subsequent appreciation required to recoup the costs for a homeowner that deducts mortgage interest and property taxes.

While itemizing can make a big difference, not everyone can or does itemize. Currently, just 32 percent of households itemize their deductions, while more than 68 percent own their homes.

The price appreciation needed in the above examples is just to return the money expended to that point. It does not factor in the time value of money, the concept whereby $100 expended two years ago is worth more than $100 now. Nor does this appreciation factor in any return on the money invested, other than that recouping expenses incurred over the period of ownership amounts to living rent-free. Even a 20 percent down payment has only a modest impact on the annual appreciation needed to return to break-even. One significant reason is that the repayment of principal in the early years of a 30-year loan may be outweighed by property taxes -- even after the tax deduction -- which waters down the impact of making a larger down payment and borrowing less.

Shorter holding periods put you in particular peril of failing to recoup your costs. Over the long haul, the steady accumulation of equity works to offset the hefty transaction costs for buying and selling, in addition to the other ongoing costs of homeownership. As a result, the average rate of price appreciation needed to recoup all costs declines with time.

The transaction costs involved in buying and selling a home and the day-to-day costs of upkeep and debt service amount to a significant sum of money. Fortunately, homeownership provides the ability to recoup many, if not all, of these expenditures when the house is sold. But homeownership to the exclusion of investing for retirement, saving for a rainy day, or lifestyle choices such as travel, recreational pursuits, or charitable giving may ultimately prove less financially rewarding than expected.