Having traveled the world as a real estate nerd, I always study the real estate market and tax structure of any country I visit. I have found that no government subsidizes homeownership as much as the United States. Two of the great benefits enjoyed by many homeowners include the income tax deductibility of mortgage interest paid and the deductibility of property tax payments. But clearly the greatest benefit of all is the tax exemption of the first $500,000 in capital gains that married couples make on their primary residence. While these benefits are nationwide, they are of particularly great value in California since we pay the nation’s highest taxes, and thus the value of this tax exemption is worth more here than elsewhere.
Overall, I believe that buying your primary residence in Silicon Valley is the best investment you can make. This conclusion is best proven by empirically showing the difference in post-tax effective profit you would have made on your housing investment when compared to an investment in the NASDAQ stock exchange of the same amount.
To use real numbers, let us compare using funds to either buy a NASDAQ index fund or a primary residence in Palo Alto. Let us presume that the home or the stocks were both bought on January 1st, 2011, and sold on August 24th, 2015, which has been a good investment period for both options (even with the recent volatility in the stock market).
With mortgage rates being near historic lows, the cost of a mortgage for my clients is generally at or below their rental rate, making the cost of homeownership similar to renting. Due to this parity in costs, I am not including any additional costs to homeownership in our equation, but if mortgage rates rise greatly, these costs should be accounted for, as well.
While considering the housing investment, assume that a 20% down payment was made for a home bought in 2011 in Palo Alto, which translates to $284,000 based on the median home price in Palo Alto in 2011, which was $1,420,000. Assume this home was then sold on August 24, 2015, when the median home price year-to-date in 2015 for Palo Alto had appreciated to $2,666,000.
For stocks, let us assume that same investment of $284,000 was invested in a NASDAQ index fund. The NASDAQ appreciated a great deal from January 1, 2011 (when at 2,653), to when we assume the index was sold on August 24, 2015 (when at 4,526).
These years were great years for both the stock market and the Silicon Valley housing market. During this period of under five years, the rate of appreciation for the Palo Alto median home price was 88% versus an increase in the NASDAQ of nearly 71%. However, the purchase of the Palo Alto home was a much more spectacular investment due to two major factors—the leveraging of the down payment by using a very cheap (and generally tax-deductible) mortgage, plus the tax exemption of the first $500,000 in profit on a primary residence for married couples. For both asset classes, I presume a 37.1% capital gains rate, which is composed of 20% for the federal government, plus 3.8% for the Affordable Health Care Act and another 13.3% for the state of California.
The after-tax profit differential between these two investments is simply staggering. Due to the tax exemption on the first $500,000 in profit and the leveraging of the down payment by utilizing a mortgage, the net appreciation from a Palo Alto personal residence is more than 7.5 times higher than stocks, even with stocks also having a very high rate of appreciation during the same time frame. Note that the tax benefits discussed for housing decline once there is $500,000 in appreciation, for then the government gets 37.1% of all future appreciation just as they do with stocks. This illustration, reflective of the great investment that Silicon Valley real estate has been in the past, shows why we confidently believe that owning a home in Silicon Valley is your best route to after-tax wealth and the security it brings.