Is a House a Good Investment?
House buying season is upon us. Is a house a good investment?
Let’s see. You buy a house for $150,000. 10 years later you sell it for $300,000. Sounds pretty good? The realtor gets $21,000 at the sale. Your equity was $225,000. Now it’s about $200,000. Was it a good investment?
What if you bought the house for $150,000 and 10 years later interest rates are back at 8%. Buyers are not willing to pay and there is glut on the market. You realize that, just like the stock market, you bought high. Buying high in real estate is buying when interest rates are low. People are willing to pay more for the house because their mortgage payments are the same or lower than they would have been a few years ago for a lesser house. When interest rates go back up, people are not willing to pay as much for the house. Many people are also preferring to buy new. And there are fewer people coming along in the younger generations to buy homes.
You put down or roll over from your last house a total of $50,000. You pay a mortgage at 6% and with property taxes that totals $1000 a month. (In 10 years that is $120,000) You pay a lawn and snow service $1500 a year. You budget 1% of the house value for repairs – furnace, roof, appliances, water damage. You budget another 1% for landscaping and structural changes and for a bathroom or kitchen upgrade or for painting the inside or outside of the house. Utilities run about $250 a month on average.
At the end of ten years, in our example a minute ago, you made $225,000 when you sold the house. The house provided absolutely no positive cash flows while you lived there – unless you consider the fact you did not have to pay rent.
So here’s the math. Total made - $225,000. Total spent $266,000. Doesn’t sound like an investment to me. Even if you subtract $800 a month it cost to live somewhere else the difference would be $170,000 leaving you $55000 of “profit” after ten years.
Not understanding the math of houses keeps a lot of people poor.
Houses tend to be an emotional purchase. There are some schools of thought that figure just about everything to be an emotional purchase. Part of the American Dream is to own your own home. A log cabin outside Hamilton, a gentleman’s farm in Tully or a condo in Armory Square. For some people their home is a great financial decision. For others it becomes an emotional and financial disaster. Sometimes external issues over which we have little control create the benefit or trauma. Mudslides, neighborhood upkeep, the builder of the development disappearing and not completing he plan – so the existing structures have less value.
When you are buying a home there are smart things to do and some things that are not so smart. If your realtor is using the MLS system – multiple listings – get the houses – or at least the area – in advance or when you get home, jump on the web and do a little research. Housing prices – and taxes – are based on comparables. Most homes in the county and city can be found at www.ongov.net. You’ll find a property tax assessment area on the website that will take you to an area where you can see what the house you were looking at and the other houses in the area are valued at. Finding other houses similar in size and style and contents will give you an idea of whether the house you are considering is a good value.
The MLS pages will give you the info you need to find the house you were looking at. To find others in the same area – or in similar areas – you may need to go for a ride and note down similar homes with their addresses to look up.
Do yourself a favor – do a little research. After all, this $150,000 home could cost you $540,000 over the next 30 years.
The largest financial investment many people make is their home.
They say it costs $250,000 to raise a child – not including college. Certainly we invest a lot into our retirement plans. Could it really be a bigger financial investment to own a home?
On Monday we looked at the cost of owning a home over a 10 year period. In the example we used – a $150,000 home – the costs, including down-payment and real estate commission at sale in 10 years, were more than the growth if the home doubled in value.
Using the rule of 72, a home doubling in value in 10 years was growing at a 7% rate. We haven’t seen that much around Central NY but in other parts of the country – where housing is tight due to land shortages – values have shot up with this recent reduction in interest rates – at least temporarily. A friend living in Denver bought a house for $500,000 back about 15 years ago that quickly dropped in value when housing took a tumble in that area. It’s just now getting back to what he paid for it. That happens periodically.
Back to our house example. With the expenses for upkeep, renovation and repair built into the house costs – plus property taxes – the house is costing $18,000 a year to live there. Even without counting inflation in the property taxes and expenses of upkeep, without counting the investment value of the dollars used, that amounts to $540,000 over a 30 year period. For a $150,000 house. Could that house be worth more than $540,000 in 30 years? Sure. Could it be worth less? Uh huh.
So is a house a good investment?
Is a house a good investment? To figure that out, we have to talk a little about intrinsic value.
In the book Rich Dad Poor Dad, the author promotes investments that produce cash flow. Your money working for you as well as you working for you. Your investments taking over paying for things you would have to pay for yourself. Using before tax dollars in your company to gain big benefits. That’s how to get ahead.
When you buy a stock and pay cash for it, you are buying the growth power of the company you invest in. If you pay $1000 for a stock that pays a 2% dividend you get $20. If the stock also appreciates by 7% you make 9%. When you are buying a stock one of the questions you have to ask is – is it cheap or is it expensive. We won’t get into price earnings ratios and all that. Let’s keep it simple for now.
In looking at a house purchase there is no cash flow – unless you are buying a two-family home to live in. You have to ask yourself – is it worth what it costs – and, of course, you have to figure out the real cost of living there. It’s not just the mortgage and property taxes. Many houses end up being like the house in that movie – The Money Pit I think it was called.
So one of the intrinsic values of owning a house is you don’t have to pay rent to someone else. You can sell the house at some future date and not pay taxes on the gain up to $250,000 apiece. You can deduct property taxes and the interest portion of the mortgage payment as you live there.
A study done by Harvard in 2002 reported that the average cost to renters was $481 a month. The average after tax mortgage cost for a median homebuyer was $821. Certainly the average apartment is not the same situation as the median home – but this does point out that you can pay a lot for a lifestyle decision.
Will your home purchase mess up your finances?
A house purchase is a ‘want’ expense – not a ‘need’ expense. If you can bring yourself to a place of reality when purchasing a home you have to figure out how much house you really need. If you overbuy, your finances will suffer in other areas. You may end up having to sell the house to be able to afford to retire in 25 years or refinance it to pay for college – because a house overbuy means there is not enough money to go around for other things. It’s house poor.
Be realistic when you look at a home purchase. What will the debt cost? What are the other expenses to live in the house? If you were living in an apartment, the cost of everything will go up. The property taxes paid by the previous owner will likely be higher for you. Factor that in. Repairs and renovations to make the place ‘your own’ and furniture, if needed all should be considered. Know the background of the house is important I looked at a wonder place in Chittenango years a few years ago. I was rapidly falling in love with it – until I visited the basement. There was a octopus furnace and a retaining wall that bowed out into the basement. Then there was the mowing. The present owner was mowing 5 acres. They said they mowed a little every day. They were cooking cinnamon on the stove – perhaps to eliminate mould smells? There was no way I wanted to have my life tied to a house that required that much care.
Can the house be resold? I’ve seen several home being build right next to Route 92 on the way to Manlius. Who will buy a home in the future that is that close to the road? Someone may, but the resale market for a home like that is much smaller – which generally forces the buyer to lower their price. Don’t let someone – or don’t let yourself – talk you into buying a house and ignoring the future resale.