It is quite common to hear people say that houses are poor investments, and folks should now rent. They point out that that real estate doesn’t appreciate as fast as the stock market, and it’s not advisable to have all your investment eggs in one basket – and after all, homes are not liquid investments – you can’t just call your real estate broker and tell him to sell and have your money in a few days, like you can with your stocks.
You know what – they’re correct. But they are wrong in a big way!
Recent statistics from the Federal Reserve show the median net worth of homeowners is $234,000, and for renters it is $5,100. Buying a house may be like a forced savings plan, where you can not only shelter your money and your family but also build up your net worth.
Most folks are going to have to spend their money on rent, if they don’t buy – of course unless they are still staying with Mom and Dad, or a generous friend. And that rent expense is most likely their major expense. But when you buy a home you have the opportunity to make your housing expense serve two purposes - you not only have a place to live and keep you warm in the winter, you also have the opportunity to build up a nest egg. Your stock and bond investments don’t protect you from the weather and don’t give you an asset that has real value for your family! And it takes discipline that many folks just don’t have to pay rent and also invest in stocks and bonds. With your home, because of its value as your place to live, you are kind of forced into making those payments each month, and over the long term you are building a substantial investment.
Right now in Salt Lake County, the average purchase price of a home is around $250,000, and since I became a real estate agent in 1968, property values have increased about 6 percent per year. The first homes that I sold were priced in the $12,000 to $20,000 price range. I purchased my first home in 1970 in Sandy for $17,500. It was a ranch style home with a little more than 2,100 square feet. I just checked the tax records and that home is currently assessed at $196,900 (January 2012) – which is somewhat down from where it was valued a few years ago. I put that value into my HP calculator and that comes to an average annual appreciation rate of 6.24 percent, a little more that the average annual rate of 6 percent that the National Association of Realtors said that property values have increased throughout the US since 1968, when I started working in real estate.
There are some significant financial benefits to buying – first, unlike renters, you lock in your housing payment. You also get some substantial tax deductions, and you have the opportunity to cash in on some tax-free profit when you sell.
As an example, let’s say you buy that home in Sandy for $200,000 and you pay a 20 percent down payment of $40,000. Let’s look at your return if the home goes up in value 6 percent or $12,000.
The Principal of Leverage
Purchase Price of Home $200,000
Initial Investment $ 40,000
Increase in Value (6%) $ 12,000
Return on Investment 30%
Your return on investment is 30% - not bad. Makes you wonder why it is that the average homeowner has a net worth more than 45 times that of the average renter. But the above example does not take into account the substantial tax benefits of home ownership. By itemizing their taxes, homeowners can deduct the interest and taxes they pay on their mortgage from their federal income taxes.
With a $188,000 mortgage at 5 percent annual interest for 30 years you’d have principal and interest payments of $1,009.22, and say you’re in a 20 percent tax bracket here’s what you would save in taxes each year:
Tax Savings Each Year
Interest Paid in Year 1 $ 9,337
Taxes Paid in Year 1 $ 1,564
Total Deductions $10,901
Tax Savings (Based on 20% Bracket) $ 2,180
You would get $2,180 in tax savings that you wouldn’t get if you were renting! Additionally, when you sell your home at a profit, that profit is not taxed as long as you’ve lived in the home as your primary residence for two of the last five years – up to $250,000 of profit tax fee if you’re single and up to $500,000 tax free if you’re married filing joint returns.
Should You Rent or Buy?
When you buy, your monthly payment stays relatively constant, when you obtain a fixed rate loan. Adjustable loans are usually fixed for 5 to 10 years. I remember my first home that I bought in Sandy for $17,500 – my payments were $153 per month, and I remember trying to sleep, unsuccessfully, concerned that I would be able to make those payments. As time passed, however, those payments of $153 seemed like a piece of cake to make. However, if you rent, it is almost guaranteed that your payments will go up. Recently, rents have been increasing at about 4 percent per year – but over the past 20 years they have been averaging closer to 3 percent per year annual increases. By keeping your payments constant when you buy, you are controlling inflation and saving over the long term. Let’s say you spend $1,200 per month to either rent or purchase a home - and say your rent only increases 2 percent per year for the next 10 years, so your rent would increases from $1,200 to $1,434 in year 10 – this is how the rent versus buy comparison would look:
Rent or Buy Comparison
Rent Expense for 10 Years $157,676
Mortgage Expense for 10 years $144,000
Total Savings $ 13,676
That’s quite a large savings, over $13,000 – and what if your home increases in value the same 2 percent per year. Your $200,000 home is now worth $244.000 – a $44,000 gain. But wait, what if your home increases at the 6 percent rate that homes have been increasing over the last 44 years since I began selling real estate – your $200,000 home would now be worth over $358,000 – an increase of $158,000. And if you decide to sell - as long as that home has been your primary residence for 2 of the last 5 years - all of your profit would be tax free.
Timing
Of course, all of us have experienced that real estate values can also go down. But, when it comes to your future, I think that it’s wise to look at the long term. Even those who purchased real estate just prior to The Great Depression – if they held their investment for 15 years, they had a handsome return. Those that purchased real estate in the depths of that Great Depression, achieved spectacular gains. In all of my 43 plus years as a real estate agent in Salt Lake, I have never seen a time when both prices and interest rates dramatically decreased. In the 80s, when prices came down – interest rates were sky high – mortgage rates were over16 percent. With the current market conditions, and the sound economic future that is likely for Utah, it seems to me like an ideal time to venture a real estate purchase. Yes, there would be risk – the future is never guaranteed – but if you rent, you’re guaranteed to lose money!
What to Buy?
Does this mean that you should go out and purchase a home that would be a real financial stretch. I don’t think so. My advice is to not put yourself in financial stress – purchase a modest home with payments about what you would pay if you were renting. To keep your payments at $1,200 per month, assuming a 5 percent interest rate, you would limit your mortgage to no more that $224,000. Try to stay conservative, and realize that there’s always risk to any investment – but it may be better to have an investment, rather than no investment, as a renter.
There is one thing to consider, however, that might work against your decision to purchase – if you are likely to move in the short run, since real estate is not a liquid investment and you may not be able to sell right away. But even in this scenario you would have the option of renting your property, if you need to make a quick move. A real estate management company can handle the rental – and in the long run, you will most likely be financially better off for having that one rental property. Had you purchased that home that I bought in 1970 in Sandy for $17,500 – that is now worth about $200,000 – and it would have been paid off for the last 12 years, grossing you a rental income of about $14,000 per year, which would be around $10,000 per year net after paying expenses, including taxes, insurance, management, and maintenance.
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