NEW YORK ( BankingMyWay) -- A house is a home. No, it's an investment. OK, then, it's both. And that's problem -- a muddled view that can be used to rationalize an unsuitable property. If the home's too expensive, we figure, well, it's a good investment. And if the value isn't rising as we'd hoped, we say, well, it's a good home. In fact, the property may not be serving either purpose as well as it should. Disentangling these two functions is key to making the homeownership decision more rational. That's becoming more important as some experts warn about a new housing bubble, at least in some parts of the country. "Bubble Fears Emerge As Experts Predict Home Value Appreciation Will Remain Above 5 Percent This Year," proclaims the headline on a recent press release from Zillow ( Z), the mortgage and home-selling website. Zillow said its survey of 105 economists unearthed growing concerns that low mortgage rates will push home prices up too fast. If a bubble follows and bursts, homeowners would be left underwater -- owing more than their homes are worth. To avoid this, you can keep the home you already have or rent instead of owning. But renting means you don't build any equity. So how do you figure how much of your home expense is an investment that will grow in value and how much is the cost of shelter -- a cost you'd have whether you rent or own? Actually, it's fairly simple. The investment portion of your cost is the down payment and principal portion of the monthly payment, plus the cost of major improvements. That's the money actually put into the home you hope to get back after a sale, plus gains from appreciation. For the investment to pay off, the value must grow enough to leave you with more than you put in, accounting for costs of buying and selling such as the real estate agent's commission, real estate transfer taxes, legal and document fees and so on. Imagine you'd bought a $300,000 home with 20% down and 4% for transfer tax and other purchasing expenses -- an initial investment of $72,000. Now assume you had a 3.5% loan for 10 years and put the home on the market. Your investment would come to $126,176 -- the initial $72,000 plus $54,176 in principal through your monthly payments. (In other words, your loan balance would have dropped from $240,000 to $185,824.) If the home sold for $400,000, you'd pay $24,000 in commission, plus, let's say, $3,000 in other costs, so you'd net $373,000. After paying off the loan balance, you'd have $187,176. So you'd have made $61,000 on your $126,176 investment, or about 4% a year.
The home would have been a good investment if you found 4% an acceptable return. Generally, that would mean a bigger return than you could have earned on other investments of similar risk. But wait, you had the use of the home for shelter. Yes, and that value can be measured separately, as the total of all the other costs -- mortgage interest, property tax, homeowner's insurance, routine repairs and maintenance. (For interest and real estate tax use an after-tax figure to account for the federal income tax deductions on those expenses.) These are unrecoverable expenses that come on top of the investment. That means they are expenses you would not have with other types of investments, such as mutual funds. These costs are comparable to rent, which is not recoverable. They are what you pay to be able to use your home, just as you'd pay rent for the right to use an apartment. If these costs exceed what you'd pay to rent a comparable property, you're paying too much. They're not part of the investment, which was already analyzed separately. Keep in mind that as the years go by the interest portion of your monthly mortgage payment will get smaller while the principal portion will get larger. In other words, your shelter cost of housing you own -- equivalent to rent -- will get smaller, while the value of your investment will rise. That's why owning makes financial sense if you keep the property long enough. Note that other shelter costs, such as taxes, insurance and maintenance, will rise with inflation, offsetting some of the progress you make from the shrinking interest cost. But if you rented, that cost would probably rise with inflation, too. The ideal homeowning situation is one in which you are happy with the investment return and have a shelter cost below what you'd pay for rent. If the investment return will be exceptionally high, you might feel it's OK to pay more for shelter. But if the investment return will be low, a high shelter cost would just make things worse. A final thing to note: For this analysis, it doesn't matter whether the home is expensive or cheap. Either way, it can be a good investment or a poor one, depending on how fast you expect home prices to rise -- 3% to 4% is the long-term average. But if you buy a cheaper home, the consequences won't be as bad if you bet wrong.