Home might be where your heart is, but it isn't necessarily where your wealth grows.
With American homeownership in a steady decline, according to the U.S. Census Bureau, many households are not living in the passive asset that is a house.
Homeownership is a long-term play, and for most families, true wealth only materializes when the mortgage is nearly paid off. Renters have an array of alternative strategies for building wealth, but doing so requires an extra dose of self-discipline to save money in the absence of a mortgage that converts an essential cost of living to an asset.
"The costs of ownership are so high in so many areas that it does make sense to rent -- if you can invest the difference," says Rachel Podnos, a financial planner with Wealth Care LLC, based in Merritt Island, Florida.
Start by validating your decision to rent, recommends Yuval D. Bar-Or, assistant professor at the The Johns Hopkins Carey Business School.
"Map out those two scenarios so you can make a detailed comparison," Bar-Or says.
Bear in mind that property appreciation must be weighed against the costs of property ownership, Bar-Or says. Those include property taxes, maintenance, improvements, homeowners insurance and the fact that you'll lose about 6 percent of the value of the property when you sell, thanks to realty commissions.
Still, many Americans view a mortgage as a forced savings plan that converts a basic cost of living into property ownership. If that's not part of your plan, you'll want to think about how to integrate similar long-term asset growth into your strategy.
"The more diversified your assets, the more choices you have in the future. Real estate is a traditional mainstay among asset choices. By not investing in your own home, you're taking direct ownership out of your nest egg," Bar-Or says. "So the question is, how can you get diversification with the same characteristics of real estate?"
Advisors sketch two ways to capture long-term gains: equities and real estate.
Bar-Or recommends two categories of equities that are likely to diversify the typical retirement portfolio and serve as a stand-in for home equity: foreign stocks and domestic small-cap stocks.
Another route is to approach real estate ownership purely from an investment standpoint, advisors say.
The two ways to accomplish this are through investment vehicles or direct ownership.
Real estate investment trusts and real estate-based funds invest in real estate, as opposed to stocks. Typically, REITs hold commercial and large-scale rental properties, although some specialize in portfolios of single-family homes, and others, in the stocks of publicly traded homebuilders.
Directly owning rental properties is closer to home -- maybe too close, experts say. Renting while owning rental properties is, in some ways, the worst of both worlds, says Bar-Or, because you can't control your landlord's decisions about the rent you pay, while you are, in turn, a landlord at the mercy of your tenants. "If you're nearing retirement or very busy, this may be the last thing you want," he says. "But on the positive side, if you are able to identify a good business investment -- a good price, good location, and build equity with profitable cash flow -- then if it's a good business decision, it stands on its own."
One key consideration, he adds: Is there, or will there soon be, sufficient cash flow to hire a property management firm to buffer you from the daily headaches?
Consider testing your tolerance by owning a single property. If it's worth the hassle, buy several more rental properties and "gain economies of scale" that let you farm out maintenance and management, he suggests.
Check your assumptions about the investment returns on owning single-family rentals. According to recent research conducted by Velma Herbert, an associate professor with the College of Family and Consumer Services at the University of Georgia, houses that are rentals when they go on the market typically sell for 8 percent less than similar houses. That's only the case for properties that have not been rentals for long; properties that have been rented for years don't suffer the same discount.
The difference might be explained by landlords' reluctance to polish properties they know they will be selling soon, or it might have to do with how such properties are presented and marketed, Herbert says. But the implication is that you might get less than you think if you buy a house that has been owner-occupied and figure you'll capture some rental income while local values increase. "You need to pay attention to the longer term and to the whole span of investment," Herbert says.
Even if you think you might want to buy a house eventually, renting can give you some perspective on home economics, Podnos says. She says long-term returns for real estate are about 2 percent, while long-term returns for equities are about 6 percent. "All you have to do is look at that and say, 'I understand I want a home, but it's not an investment,'" she says.
"Building equity is not the same as gain through investing," she says. "You might sell at the right time and make a profit, but you can't count on it. Your motivation for buying a home should not be that it's an investment. Do it because you want the security of having a home and building equity."