19/09/2019
SHOULD YOU BUY or RENT a HOME?
- A common misconception that Your House is An Investment and Property Investment mistakes some of us make.
The Truth is; Your House that You Buy to Live In is Not an Investment. As a Property Expert, and having worked both in the Mortgage Lending and Property Market Sectors, I can vouch that Indeed Your Home is Not an Investment.
Typically when you purchase an investment, it doesn't require an ongoing investment of cash. But a house certainly does. Not only do you have to make monthly mortgage pre-payments, but you also have to pay property taxes (Rates), homeowners insurance, sometimes mortgage protection insurance (should you lose your source of income to maintain your mortgage repayments), utilities, security, maintenance and improvements.
If you buy a house for say P1million, lets say and you pay around P9,000 per month on the mortgage pre-payments, excluding rates and levies, electricity and maitainance etc., The total cost might amount to P11,000 per month of un avoidable payments for 240 months.
Now you see, life as we know it, as we come of age, comes with many fears - one of which is the fear of public perceptions, the need to be respected and the ambition to achieve certain things based on what society prescribes that you should be somewhere at a certain age - buy a home at 30, start a Family at 35 etc.
Like I always say; show me a man who does not wish to be respected, and I will show you a man with little to no ambition. However, the problem arises when the desire to be respected, evolves into an obsession with impressing others โ whether with our our lifestyle, or the successes of our careers and businesses. It is this very obsession that breeds the uniformed decisions and unwillingness to ask for professional help, primarily because of how we think others may perceive us.
I will be the first to admit that I was very guilty of this at one point in my life โ hiding my personal challenges behind my towering walls of pride. I however learnt that this kind of deception helps no one, and your best option is always found in being honest and transparent about your journey. Decent people are drawn to such sincerity โ including some who may be able to
When it comes to Property Investment and Home Ownership, It is very common for people, especially the young adult ages of 25 to 35 - to think of their house as an investment. Especially if they have to buy and live in it. This line of thought clearly misses the mark of property investment on a few fronts.
Based on a number of factors, a single-family home that you live in is not an investment. I am not saying you should avoid homeownership, but if youโre leaning towards buying because you think youโre making a smart investing, think twice.
From my Property Valuation point of view, I can say that the idea that your primary residence can be an investment comes from the fact that, historically, property values rise. Itโs likely that we all know someoneโa parent or grandparent, perhapsโwho bought their home decades ago for less than say P100,000, and itโs now worth many times that sum.
Again as a Valuer, I can also tell you that your primary residence is not an investment just because it appreciates. For the sake of this argument, let us ignore the fact that, over the long run, average residential property values appreciate only slightly more than inflation. (if you have time, check the average local property values gains are, when adjusted for inflation, over a period of time).
Therefore, assuming a homeโs value increased only at the rate of inflation, a property purchased in 1970 for say P100,000 would be worth, say approximately P700,000 today, approx. 600% increase (depending on the rate of inflation). The real reason your grandfatherโs house appreciated so much over 40 years? is simply inflation.
Again, I am not saying that real estate values cannot appreciate dramatically. They can, and they do sometime. But such appreciation is more likely in specific locations and desirable real estate markets. And guess what?, there arenโt many good locations and desirable real estate markets out there. So, It really doesnโt matter whether or not your homeโs value outpaces inflation, there are other reasons your home isnโt an investment such as:-
a. A true investment requires more than the prospect of an increase in value.
b). A house has a more important primary purpose
From my personal and undesputed professional opinion, I would also say that probably the single biggest reason why a house is not an investment is because its primary purpose is providing shelter - a basic human need. It is the most significant purpose of a home.
As for other forms of investments, one of the most basic factors that makes an investment an investment is your ability to control the timing of your ownership. That means that you can buy it and sell it at times and under circumstances that are likely to maximize your investment return. We can think of traditional investments, such as stocks, bonds, mutual fundsโeven rental propertyโas providing this ability.
Using this perspective, since your house is your personal residence, you will have little control over the purchase and sale from an investment perspective. Youโll purchase the house when it is needed for shelter purposes, and sell it only when it no longer serves that purpose, and itโs time to move on. For example, in the USA - during the Financial Meltdown, the lack of control over the timing of buying and selling a house had a major negative effect on houses as investments.
Before the Financial Meltdown, many people bought houses at the top of the market because that was the time that they needed a home for their families. But still others were stuck having to sell after the market collapse, due to a negative change in their own personal financial situations. That forced them to buy high, and sell low. This case is not unusual when it comes to residences, and largely disqualifies a house as an investment.
A house canโt be an investment if you never plan to sell it
While it is true that houses generally increase in value over time, thereโs only a limited ability to tap into that increase. The most effective and efficient way is to sell the house after it has experienced a significant amount of price appreciation either due to what i call โcosmetic improvements".
However, selling a house is highly disruptive because it means you have to move and perhaps more significantly, when you do sell, you will most likely have to use the equity if any at all, from the sale to purchase the next house. After all, you will be moving from one residence to another.
This means that in a real way, home equity is actually "trapped equityโ. In my experience with property, I have observed that, the only time that house does not fall into this โtrapped equityโ category is when you plan to sell the house, either to seek relief from an unmaneageble mortgage and debt, or to move to a rental situation. In that way, you will sell the property and cash-out on the equity if at all there is any. Mostly, by the time you decide to sell, you are buried in debt - an undesirable state of financial being.
There is also an erroneous thinking of your house as an investment can lead to equity stripping
Some of us, if professionally advised, know that there is way that you can pull equity out of your house, but it is hardly a method thatโs risk free. You can borrow the money out of your house, based on the amount of equity you have. This can be done either through a home equity release or through a straight up cash-out refinance of your first mortgage. But always remember that when you do either, you are borrowing money against the house.
Remember that you are just putting more cash in your pockets for purposes unrelated to the house, but it also creates a corresponding liability. That liability not only creates a reduction of future cash flow via the monthly payments of your mortgage from your salary, but it also puts your house at risk should your salary be no longer available due to unemployment of any unfortunate eventuality - save for those with Mortgage Insurance Protection which in any case a temporary relief for a short period.
In the US, a lot of people found that out the hard way during the financial meltdown. As house values either went flat or declined, homeowners realized that they had no equity in their homes. That left them unable to refinance to lower the monthly payments, and unable to sell to move to a less expensive housing arrangement.
As we draw closer to the Festive and Holiday Season, I observe a lot of homeowners seeking revaluation of their houses with a view of cashing out for spending. Well, it is good for my business flow. However, I must say that this widespread use of equity releases and cash-out refinances makes a lot of people feel richer in the short-term, but it jeopardizes their long-term financial security in the process.
Thinking of their homes as perpetual investments, many engage in serial refinances and leave themselves โunderwaterโ on their homesโowing more on the house than the house was worth. Thatโs where thinking of your house as an investment becomes a dangerous assumption.
A house you live in is also not and investment because the carrying costs of a house are too high for it to be an investment
Typically when you purchase an investment say stock and shares, it doesnโt require an ongoing investment of cash. But a house certainly does. Like I stated earliar, not only do you have to make monthly mortgage payments, but you also have to incur other property related expenses. You also have to maintain the property, which means providing a regular series of repairs and maintenance as necessary.
These expenses are called carrying costsโthe costs of carrying the investment. Even more costly are the major repairs associated with homeownership. This can include replacing the roof, fixing broken windows and doors, carpets and flooring, and driveways. You may also engage in major remodeling, that will require replacement of kitchens and bathrooms. Each of those expenses individually can cost thousands of Pulas or Rands. Over the course of several years or decades, they can cost tens of thousands money.
True investments donโt require that kind of ongoing outlay of cash. You can rationalize those expenses based on the fact that the house is providing you shelter. But that gets back to the original premiseโa house is shelter, and not really an investment.
Carrying costs of homeownership can really work against you
Say, for example, you purchase a house for P2,000,000, and 10 years later you sell it for P3,000,000. Good investment? Only if you donโt look too closely at the numbers.
If the house cost you P10,000.00 per month for principal, interest, taxes, and insurance , plus P3,000.00 per month for utilities, you will have spent P156,000.00 per year, or P1,560,000 for the decade that you lived in the house.
If you spent another P30,000 per year on routine repairs and maintenance, you will spend another P300,000. And if you did some of the more major repairs, like replacing the roof and flooring, and remodeling the kitchen and bathrooms, you probably easily sunk another P500,000 in during the decade. Thatโs a total of P2,360,000 over a 10 year period, to get a P1,000,000 gain on the sale. While it is certainly nice to walk away from the house with P1,000,000 more than you paid for it, the math doesnโt support the idea of the house as a winning investment. And we havenโt even accounted for transaction expenses (like the 5 percent agents commission), inflation, or for the fact that the value of the house may not rise that dramatically over the next 10 years.
Your house is not an Investment if it wonโt generate cashflow
If you thought it would be bad enough if owning a house โonlyโ required heavy carrying costs, it gets even worse. FACT; A house you use as a primary residence generates no cash flow at all.
This is a critical consideration of another form of investment as opposed to a house. When you buy an investment, you usually expect to have some sort of cash flow on that asset, while you are waiting for it to increase in value. Thatโs certainly true when it comes to stocks, shares, mutual funds, and exchange-traded funds. You expect to collect dividends while you are waiting to sell your investment position at a future date for a higher price. Even stable investments, like bonds and certificates of deposit, provide interest income while you own them. This is not true of the house that you live in as a residence. You might make a case for a cash flow, if the house is a two-to-four family structure and provides rental income from the additional units. But if it is a single-family house, townhouse, or flat, thereโll be no cash flow.
Real Estate Appreciation is the magic ingredient, but itโs not guaranteed
Finally, the primary misconception why so many people consider their house to be an investment is due to the notion of an anticipated rise on the future value of the property. During times when the value of the house increases, people commonly think of their houses as investments. But during the financial meltdown, and particularly in certain markets, not only do property values decrease, but most fall. Some residential property markets fell spectacularly in the recent past - such as the USA. For people in that situation, not only was their house not an investment, but it had become a major liability.
Therefore, the possibility of a flat or declining housing market anywhere can no longer be discounted. Should that happen, youโll be forced to live in your house much longer than you expect, and youโll probably find that you can neither sell the property, nor borrow out the equity. That doesnโt sound much like an investment now does it? I say not at all. And itโs probably best that you think of it as a place to live, rather than as an investment.So, basically here: Donโt think of your house as an investmentโand make sure that you continue to put money into true investments, like financial assets or real estate that produces rental income. And then kick back and enjoy living in your house. Thatโs the real purpose of owning one.
