For financial advisers, it is a common situation: A client comes to you after a divorce. The family home was sold and his share of the profit is sitting in a savings account earning less than 1% in interest. The client then asks whether he should buy a house. He is looking at the purchase as a financial investment.
While a home purchase is likely one of the assets one will buy in their lifetime, a primary residence really should be viewed as a lifestyle decision, rather than an investment decision. Contrary to popular belief, not many people truly make a profit when selling their primary residence. They tend to forget the money spent on furniture to fill the space, housewares to decorate it, treatments to keep the lawn green and the pool free of algae, not to mention the repairs that went into the house over the years.
Chances are you will do things to the house that others won’t care about, like the beautiful deck you and your brother custom built, the granite counter tops in the kitchen that match the slate floor and the master bath that would be suitable for the Taj Mahal. Primary home real estate is not priced daily in the market like your stock investments. Pricing is heavily dependent on location, the neighborhood and the surrounding homes—influences you cannot control.
Homes are considered illiquid assets because they generally have far fewer buyers than those willing to buy stocks or bonds. Still, Investors tend to see illiquid assets in a good light because they are tangible, whereas stock investments are up one minute and down the next. While the home has an inherent value, the overall real estate market may not be right and could put the investor in a position to sell for a substantial loss.
There are pros and cons to both renting and owning a home. When you rent and come home to a dishwasher that won’t drain, you can simply call the maintenance office or your landlord and have it repaired for little to no cost to you. When you own, that repair responsibility falls on you. When you rent you pay money for the privilege to use the property. At the end of your lease, you walk away essentially in the same financial position as before. When you own, you generally pay a mortgage and build equity in your home. However this also depends on the value of the home, how much you borrow and the interest rate on the mortgage.
For example, let’s say you have $20,000 in cash. You choose to rent a place to live at $1,000 a month for 10 years and decide to invest the cash in the stock market. At the end, you would have spent $120,000 on rent and own nothing. If your stock investment earned 8%, you could have more than $44,000 in savings. Now if you decide to purchase a home, for $100,000, your $20,000 would serve as a 20% down payment, and you would have to get a mortgage for $80,000. At today’s rates, you could pay 4.2% for a 30-year mortgage. Not including taxes or insurance, you would likely pay around $392 a month, $111 going toward the principal and $280 in interest—much less than $1,000 a month. In 10 years, your mortgage balance should be around $63,400. If you invested the difference between rent and mortgage each month—$608 each month earning the same 8%—at the end of 10 years, your investment could be $111,231. Over those 10 years, you would have also written off nearly $30,000 in interest on your taxes.
However, this scenario is hardly reality. Over 10 years, rent will likely increase, you cannot be guaranteed 8% return on your investment, and you may decide to take out a home equity loan to install a pool or remodel the kitchen in the house. Even the deductibility of mortgage interest isn’t guaranteed as tax laws could change.
So, if you’ve decided not to purchase real estate for your primary residence, is a REIT a viable alternative for a real estate investment? REITS, or real estate investment trusts, are generally, publically traded securities that invest in real estate through mortgages or property (commercial and/or residential). A small portion of a REIT’s income or appreciation is derived from the inflation or appreciation in property value. Income is generally tied to the operational aspects of real estate investment, so in reality, owning a home and owning shares of a REIT are not exactly comparable. Furthermore, our current interest rate environment has negatively affected certain asset classes and real estate is one of them. When the cost of capital increases faster than rents increase, you may see a contraction in the operational income of that business.
Overall, there is nothing wrong with the lifestyle decision to own a home. With mortgage rates still low, it is a good opportunity to finance such a purchase for 30 years. Just keep in mind that whether or not buying a home is a good decision depends on many factors. If you want to know how purchasing a home may affect your overall financial picture, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
