This post is NOT about Rent verses Buy … it’s about Investment … and the factors that determine how good, or not good, the investment in your home really is.
Face it, “home” is an asset that you own – or may buy – for which future value is a very important issue. Plus, taking a hard look at possibly your most-valuable asset that may involve debt for decades is just common sense. “Home, sweet home” sentiments can come later … preferably with the comfort of knowing “home” is adding to your wealth.
Yes, ladies, buy a home you want, but if one you want is not a good investment, keep looking until you find one you want that’s also a good investment.
Renting sometimes Best
The high transaction costs of buying and selling real estate dictate that someone moving frequently is likely best in a rental. For most areas, this discussion applies only to those living in the property at least five years. Renting may also be necessary for a while to build credit and/or a down payment, but sooner is universally better as long as that initial home investment is a “wise” choice.
Five Home Investment Components:
- The cash you pay to purchase the home.
- The cash spent on initial renovations to make the home as you want it to be, if any.
- The cash you save by not paying rent to live in that home … market rent minus owner expenses such as insurance, upkeep, taxes and the loan payment if the purchase is financed. This should be a positive number that increases the longer you are in the home … because no investor is going to knowingly suffer a negative cash flow … and every owner is going to increase the rent at least occasionally.
- The cash you spend to prepare the home for sale, if any.
- The net cash you get when you sell the property
#3, #4 and #5 are discounted to get a “Net Present Value” for the actual value of the investment, but common sense consideration of these can yield a valid go/no-go decision.
For #2, how much cash would be required to (1) get the home to acceptable condition, and (2) get it to the nature you want to live with. If a lot for either, move on. For #3, if market rent in the area is less than owner costs … Why? Likely because of low demand … move on. #4 should not be significant if good condition is established and maintained, unless your taste for features, décor and style are in sharp contrast to the market. This does happen. For #5, what has been the appreciation rate for the area over the last five years compared to other areas. If below average, move on.
Several fundamental factors impact the above investment components:
- cost of the home compared to your income
- cost of the home relative to the overall local market … Top Tier, Upper, Moderate, Low Side
- where property is located … city/town and specific community
- nature of the property … structure type, ownership type, age, updates, features, size, condition
- market demand … for the area and that specific property
- amount and terms of financing, if any
- owner cash available post-purchase for needed repairs or renovations
Being “house poor” is NOT wise. The debt-to-income ratio limit … all debt payments divided by income … currently used by most lenders is 43%. Note that this is a limit number. Lower is advised.
Low Down Payment
High leverage is NOT necessarily dangerous as long as (1) your debt-to-income ratio is not excessive, (2) you have money you could have spent for down payment, and/or (3) you put that cash into the property … like renovations after the purchase. What you’re qualified for and what you can afford are two different issues. Fit home cost into the budget just like all else.
Buying a “fixer” but not ever fixing it is also not wise. A home in poor condition will have little or no appreciation even when homes around it are appreciating nicely.
Fixed Housing Cost
For homeowners, there is no rent increases. Housing costs are largely fixed, or at least relatively stable. Property taxes, aging property maintenance and HOA costs, if any, are going to see increases but nothing like is common for rents in communities with decent demand. For very high-demand areas where new construction of homes and apartments cannot come close to keeping up with the net in-migration, rent increases are likely to be exorbitant.
A wise home purchase also creates an automatic/forced savings … for an appreciating property …plus the reduction in loan principal with each payment for a financed purchase … except not where the equity is taken out by a home-equity loan or line of credit. A home used as an ATM is NOT an investment … it’s a speculation, and not relevant to this discussion.
In areas at the top-tier of pricing for a community, there are likely to be relatively few home sale transactions, and small fluctuations in supply and demand can cause big swings in prices. If this is your home search price level, take great care … beware of bubbles and don’t overpay.
Point of Reference
From 1975 through 2000, a well-documented 25-year segment of time, house prices rose at a compound rate of 5.8% a year, according to data from the Office of Federal Housing Enterprise Oversight. Put the typical rent-savings and this capital gain together and you get a highly respectable annual return from housing of about 12% … pretax.
Mortgage-interest payments are deductible. Plus, the first $250,000 in price gain from a sale for an individual, or $500,000 for a couple, is tax-free if the house sold is a primary residence and the owner has lived in it for two of the previous five years … and there’s no limit on how often you can take this tax break. With respect to taxes, a home may be the very best “investment”.
In much of California, the New York City area and up the east coast north, and other areas, home prices are way beyond the means of many would-be residents, as well as current residents needing to move. What to do? What else … settle for a smaller house, rent and hope for a downturn, or take a look at the virtues of other places … like metro-Phoenix, particularly for those in California.
Those “other places” may be basically better places to live as well as more affordable.