3 Home Buying Myths

1. Buying is always better than renting.  Even though buying a home has tax advantages and secures consistent monthly payments, home-maintenance can be expensive and time-consuming. Typically, buying is only better than renting if you plan to live in your home for 5-7 years or longer, which is roughly as long as it takes for homeowners to break even. Fannie Mae recently revealed that 23% of renters are postponing their plans to buy, and the main reasons people give for purchasing a home are non-financial (43% cited safety as the primary factor while 33% said school quality). One way to estimate whether it's more beneficial to buy is by calculating if the home costs more than 15% of the annual cost of renting a similar home. If  so, you'll get a better deal renting. Still can't decide which option is best for you? Use the rent vs. buy calculator to help or contact me for personal guidance.

2. Real estate is the best investment. Today, investors earn a higher return on investments in stocks than they do on real estate. Within the past 10 years, home prices have risen by only 0.3% annually whereas the S&P 500 has returned an average of 8.26%.  Financial writer Jack Hough cites that over the long run, stocks have rewarded investors with 7% inflation-adjusted return over long periods, while homes earned their owners close to 0%. This is partially explained by the fact that homes don't produce anything. Unless homeowners take measures to actively upgrade their homes, they can only increase in value as the ability of the people to purchase them rises. Appropriately, another Fannie Mae survey illustrated that the proportion of people who believe that buying a home is one of the safest available investments decreased from 83% in 2007 to 70% in 2014. Ironically, only 17% considered stocks safe at that time.

3. The bigger the down payment, the better. Putting down a 20% down payment means you won't have to buy mortgage insurance and you ultimately will borrow less (thus paying less in interest). However, it is not always necessary. You can pay a smaller down payment in exchange for buying PMI (private mortgage insurance) until you have enough home equity (usually 20%) to remove it. Increasingly popular FHA loans accept down payments as low as 3.5%. Smaller down payments (with mortgage insurance) may actually gain you better interest rates than a 20% down payment without insurance, since lenders feel safer when loans are insured. Additionally, saving for a large down payment takes time-home prices may rise in the meantime, or you could miss the opportunity to buy a home you truly love. Smaller down payments ensure all off your money is not tied up in home equity, allows you to diversify your investments (for example, across stocks), and still permits you to pay off the loan early and quit paying mortgage insurance once you put 20% down.

What to Look for in Investment Property

Buying a piece of real estate as an investment property can be tricky. It can also be quite lucrative. Today more than ever, the rental market is booming. Increasing student debts have pushed back the median age of the first-time homebuyer. With inventory consistently low, many people who would have bought a home in other market conditions are deciding to rent, instead. If you are interested in buying a home to rent out, consider these factors:

Numbers. The most important aspect of investment property is profitability. It’s important to gauge profitability more on current performance as opposed to future predictions. In other words, if a property generates little income now but the area is “expected to appreciate,” it may not be your safest option. The ideal income property will offer appreciation value and cash flow. It’s better to use growth potential as a differentiating factor between areas that offer similar cash flow rather than a leading indicator. Does the neighborhood plan to build parks, malls, gyms, etc? This is not only important because it is a sign of growth, it also signifies growing employment opportunities (and thus a larger pool of tenants!).

Be weary of places with prices that are too good to be true—cheap properties are often accompanied by a high number of risks and problems. Look for something that is listed for a price similar to market value or above. You’ll also want to consider property taxes and rate of return, or “cap rate.” Research market conditions before you determine what a “good” cap rate is; this number continuously fluctuates.

Source. Be cautious of homes that have sat on the market for a long period of time. This is rather unique in today’s market, and there may be a good reason no one has yet bought that property. Likewise, a reduction in price may be a red flag.

Location. Considering price-to-rent ratios, you will want to avoid buying a rental property in a city’s nicest location. Aim more for average-priced neighborhoods, but remember that your tenants will reflect the quality of the neighborhood in which you buy. Homes in reputable school districts with low crime rates tend to hold value over time. Also consider vacancy rates and average income.

Condition. Ali Boone, an author of Bigger Pockets, advises that investors buy turnkey properties. At the very least, hire a home inspector to examine the actual condition of any property before you buy it.

Pros and Cons of Investment Property

Investment property isn't just about cash flow projections and planning. The investor must analyze a property carefully before purchasing, then manage it effectively. If successful (and lucky), one can become quite profitable from real estate investments. After all, The most significant asset of most families is the equity in their homes.

 

Advantages of Investing in Real Estate

High Leverage (the use of borrowed money with the intent to increase the investor's return on the cash invested). Few other investments offer the high leverage real estate does. Whereas stocks and bonds typically require at least a 50 percent down payment, most real estate investments can be made with 25 percent down payments or less.

Good returns. Many cautious and keen investors yield great returns, often exceeding 20 percent.

Income tax shelter. Most investments (ex: bonds, stocks, and mutual funds) require that investors pay taxes on all current income (dividends). Real estate investments often provide tax-deferred cash flows, primarily due to cost recovery deductions (depreciation). This allows investors to avoid paying taxes on cash flow until they sell the property. 

More personal control.  The purchase of real estate gives an investor control over the investment's operation and management. Even if the investor hires a property manager, the manager reports to the investor.

Disadvantages of Investing in Real Estate

Management time. Consistent management of an income property's operations takes time. The investor should achieve a higher return on investment to compensate for this.

High capital requirements. Investors need funds to acquire the property and must have reserve funds available to make renovations or cover unexpected events. If vacancy rates are high, investors may have trouble selling the property and may need to put more money into it to pay its operating costs and debt service until more stable ground is reached.

Poor liquidity. Investment real estate is a complex purchase, involving land-use requirements, environmental audits, maintenance inspections, lease reviews, and new financing. A seller must understand that it could be a year or more after listing the property on the market before closing a sale, even under normal or good market conditions. 

Personal stress. Property management requires personal interaction with tenants, unless an owner's properties are large or profitable enough to hire a manager. When the mortgage payment is due, slow-paying tenants can be a burden. Tenant complaints take time and people skills to resolve. If tenants leave a property in poor condition when they move out, the investor must restore the premises. Eviction is sometimes necessary and is a stressor to all involved.

High risk. Overbuilding in the market, causing high competition and lower rents, could lead to failure. Environmental laws may require costly retrofitting, or a large employer may relocate, resulting in widespread unemployment. This type of risk--dynamic risk--is not covered by insurance.