The Truth About Building Wealth Through Real Estate

Today’s Markets episode is one of our favorites from the archive (Scott spills the tea on the nine businesses he’s started). 

In this issue, we’re responding to what you, our readers, requested in recent polls by taking a deep dive into housing.

Scott writes in The Algebra of Wealth that real estate is one of the best tools for building long-term wealth, because buyers can lever up 5 to 1 with a low down payment, deduct interest payments (more on that later), and grow their investment tax-free/tax-deferred.

In a recent No Mercy / No Malice, Scott covered why housing has become so unaffordable, and what our elected leaders should do about it. You can read that here. Now, we’re taking a more practical look, asking questions that are top of mind for Gen Zers and millennials. 

When are you ready to buy a home? How much does it actually cost? Can you achieve economic security without homeownership? 

If you’re already a homeowner, congratulations! Now, spread the wealth. There’s probably someone in your life who's curious about homeownership but unsure where to begin. Send this their way.

The American Dream?

84% of Americans say they’d like to own a home one day. This is astounding, as 84% of Americans don’t agree on much. In fact, more Americans are united in their desire to purchase property than brush their teeth twice a day (61%). 

Buying a home is a more popular wealth accretion strategy than other, arguably simpler strategies. Only 66% of Americans save any amount of their typical paycheck, and only 42% of Americans have individual retirement accounts (IRAs). 

Why is buying a home so much more popular? First, it’s a tangible goal that’s easy to work toward, second it can be a great investment, and third, because it’s what the National Association of Realtors, the largest trade organization in the country, wants you to think. 

What is the National Association of Realtors (NAR)?

• The No. 1 lobbying organization in America last year, representing real estate agents, property managers, and others involved in the industry. 

• They also control a national system of home listings that real estate agents need to do their jobs. Membership fees are about $800 a year.

• They have a vested interest in convincing you that buying property is always the smartest move.

The NAR and HGTV manufacture homeownership FOMO and shape what we think financial security should look like. But the truth is, homeownership isn’t always a smart move — or a fulfilling one. 

• Ninety-three percent of buyers in 2023 have regrets about their home-buying experience (while interest rates were at a two-decade high).

• Forty-five percent of residential real estate investors say that a bad investment almost ruined them financially.

Do You Even Want to Own a Home?

If all of your friends were jumping off a cliff, would you jump too? The line we tell kids to steer them away from FOMO is applicable here. Before house hunting, consider whether buying a home is consistent with the lifestyle you actually want … or if it’s just what you think you should be doing. 

While homeownership may have made sense for most people in previous generations, the world has changed. People are staying single longer. Remote jobs let people work from anywhere. Ask yourself:

“Do I want to live in the same place for at least the next five years?” 

Generally, the longer you stay in your home, the better your investment performs. At least five years is the minimum threshold for most markets. The typical American homeowner sticks around for about 12 years.

Owning your home for longer allows you to build more equity (the gap between how much you owe on your mortgage and how much your home is worth) and take advantage of the appreciation on your property’s value.

• Home values typically appreciate 3%–5% annually, though this fluctuates by location and market condition. 

• But it’s important to remember: Your home doesn't just gain value automatically. The local market, condition of the home, and interest rates affect valuations. Like stocks, homes can lose value, but unlike stocks, homeowners typically invest additional capital in maintenance, repairs, and improvements. 

“Do I want to be responsible for a home?” 

When you purchase a home, you’re not just committing to mortgage payments. You’re committing to hours of weekly repair and maintenance work. To paraphrase the poet-pugilist Tyler Durden from Fight Club, the home you own ends up owning you.   

• In a 2023 survey, one-third of homeowners said they would be less stressed if they didn’t own a home. 

Do you get irrationally excited about home improvement TikToks? Excited enough to spend more than 11 hours a week (the average) on home repairs?

Do a risk tolerance check: If the idea of your fridge dying and you paying $2,000 next week gives you a panic attack, homeownership might not be the right path. 

“Can I afford it?” 

To afford the median U.S. home, a household needs to earn about $121,000; that’s 53% more than the current median household income of $79,000.

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The minds behind Zillow are democratizing vacation homeownership.

After helping millions buy their first homes, Zillow co-founder Spencer Rascoff and executive Austin Allison launched Pacaso to transform how people buy, own, and enjoy second homes.

Pacaso’s innovative model makes luxury vacation homes more accessible by enabling co-ownership in the world’s most sought-after destinations. In just a few years, Pacaso has facilitated over $1B in real estate transactions and helped 2,000+ owners purchase second homes in 40+ top markets. And now they are expanding overseas, including new properties in London, Paris and beyond.

Backed by major firms like SoftBank, Maveron, GreyCroft and high-profile individuals like Howard Schultz, Pacaso is positioned at the forefront of a $1.3T industry ready for disruption. Plus, Pacaso just announced they reserved the ticker symbol “PCSO” on the Nasdaq Stock Market, signaling an intention for further growth and expansion.

Whether you’re a second-home buyer or a partner looking to shape the future of real estate, Pacaso is building the platform redefining how we live, invest, and escape.

Learn more at www.pacaso.com/profg

*Reservation of a ticker symbol does not guarantee a future listing on the Nasdaq Stock Market, nor does it imply that Pacaso currently meets any of Nasdaq’s listing criteria.

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How to Determine If You Can Afford a Home

When you’re shopping for a mortgage, lenders typically utilize the 28/36 rule to assess affordability.

28%

Also referred to as your front-end ratio, this rule stipulates that your monthly housing payments should be no more than 28% of your gross (pretax) monthly income. Housing payments refer to either your rent or mortgage, interest, HOA or condo fees, insurance, and property taxes. 

• Property taxes vary by location; for example, New Jersey has one of the highest property tax rates at 2.23% of your property’s market value, while Alabama has one of the lowest at 0.38%. Also, some states, like Florida and California, cap annual property tax increases, while other states like Nevada and Virginia allow property taxes to rise based on the home’s value.

• Homeowners insurance costs can range from $610–$6,210 per year, depending on factors like location and home value. But as insurance companies factor in climate change to their risk assessments, premiums are rising, and in some areas insurance companies have canceled policies and pulled out of the market. 

36%

Also called the back-end ratio, or the debt-to-income ratio. Your total monthly debt obligations (including mortgage payments, car loans, credit cards, student debt, etc.) should not exceed 36% of your gross monthly income.

Hidden Costs

• Maintenance and utilities: A common guideline is to budget 1%–4% of a home’s value per year for upkeep. Homeowners also spend more than $150 per month more on utilities than renters do. 

• Emergency fund: Even after closing on a property, you should still have 3–6 months of expenses left in the bank. 

The Mortgage

When you apply for a mortgage, lenders consider your front- and back-end ratios, as well as your income, savings, and credit score.

Down Payment 

A down payment is a percentage of your home’s purchase price that you pay up front when you buy a home. Down payments usually range from 3%–20% of the home purchase price. 

• The average first-time homebuyer puts 6% down. 

• A larger down payment reduces the amount of interest you have to pay and allows you to avoid private mortgage insurance (PMI).

• Private mortgage insurance is an extra monthly fee for conventional mortgage borrowers who put less than 20% down. It ranges from 0.3%–1.5% of the original loan amount per year. 

• But don’t let the name fool you. Homeowners are buying an insurance policy in case they default, but their lender is the beneficiary. You can cancel PMI payments once the mortgage is less than 80% of the purchase price — a threshold met either through appreciation or paying down the principal on your loan. 

Types of Mortgages

Conventional loans: the most popular form of mortgage. You can put down as little as 3%, but you’ll need a decent credit score (>620), and you’ll have to pay PMI.

FHA loans: As these are insured by the Federal Housing Administration (FHA), you can get an FHA loan with a lower credit score (>580) and 3.5% down, but you typically can’t borrow as much money. The home’s condition also has to meet minimum livability standards, meaning an FHA loan likely won’t help you buy a fixer-upper.  

VA loans: Guaranteed by the U.S. Department of Veterans Affairs (VA), VA loans are for eligible members of the U.S. military and surviving spouses. There’s no minimum down payment, mortgage insurance, or credit score requirement, but there is an extra cost, called a funding fee. Funding fees range from 1.25%–3.3% at closing. 

Closing Costs

Closing costs range from 3%–6% of the purchase price and cover loan origination fees, discount points, appraisals, title searches, title insurance, surveys, taxes, deed-recording fees, and credit report charges.

The Interest Rate Effect 

Interest rates can make or break affordability. For a 30-year fixed-rate mortgage of $500,000 with 20% down, assuming average property taxes and homeowners insurance:

• At 3.0% interest: ~$2,578/month

  • Total interest payments: $207,110

• At 7.1% interest (the current rate): ~$3,579/month

  • Total interest payments: $567,531

Tax Benefits 

Realtors, lenders, and your know-it-all uncle love to talk about how homeowners can take advantage of the mortgage interest deduction.

Reality check: To claim the mortgage interest deduction, you must itemize your tax return — something many Americans don’t do because they pay less by taking the standard deduction ($14,600 for single filers, $29,200 for married filers). Prior to 2017, 31% of homeowners claimed the mortgage interest deduction, but after a change in the law that number fell to 10%.  

But there is a tax benefit worth considering. Homeowners don’t pay federal income taxes on the appreciation of their home. When they sell, single homeowners don’t pay capital gains on the first $250,000 of profit, while married homeowners are exempt up to $500,000. 

Building Wealth

Homeownership isn’t the only path to financial security. Renters can achieve similar or even better financial outcomes by investing what they save on down payments, closing costs, property taxes, and maintenance in diversified portfolios. While residential real estate typically appreciates at 4%–8% annually, the S&P 500 has historically delivered around 10% average annual returns.

A helpful case study published by Business Insider illustrates this point: If instead of purchasing a $400,000 home, you instead invested the ~$41,000 down payment plus annual maintenance savings of $4,000 in the S&P 500, you could generate $1.8 million in profit over 30 years — nearly triple the $617,000 profit from home appreciation after accounting for all ownership costs. 

The counterpoint: You actually have to make those investments at regular intervals over 30 years, whereas homeowners essentially benefit from a forced savings plan by paying their mortgage each month. 

To Rent or to Buy?

The “right choice” depends on a suite of personal and financial factors. The New York Times offers an excellent calculator that can determine which option makes more financial sense based on your specific circumstances.

We spend a third of our waking hours actively pursuing wealth, but how many of us actually know what we’re pursuing? 

In The Algebra of Wealth, Scott writes, “Wealth is the absence of economic anxiety. Freed of the pressure to earn, we can choose how we live.”

This definition resonates, but against today’s economic backdrop, it’s also disheartening. For generations, we’ve been told that homeownership is the key to building wealth. But today, 70% of American households can’t afford to buy the median home. Does that condemn us to financial anxiety and the constraints that come with it? 

I wrote this post to understand and explain the mechanics of buying a home but more importantly to explore whether financial freedom truly hinges on a mortgage. 

The data favors homeownership: The median net worth of a homeowner is about $400,000, while a renter’s is about $10,000. But home equity accounts for only about half of this wealth gap. Eighty percent of homeowners have investments in stocks, bonds, or 401(k)s; fewer than half of renters do. 

So, no, missing out on a mortgage doesn’t necessarily put financial security out of reach. Renters who consistently invest their savings can build comparable or even greater wealth than homeowners, often with more flexibility.

• My generation has gotten a head start: Thirty percent of Gen Z started investing in college (vs. 15% of millennials, 6% of boomers)

Economic security — and the freedom that comes with it — isn’t about whether you own or rent. It’s about whether you have the discipline to pick and commit to an investment plan. In an era when traditional paths feel increasingly out of reach, I find this to be an empowering discovery. 

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