You need to consider the benefits of buying real estate along with the risks.
Homeownership used to be considered the American Dream. Most baby boomers grew up with a goal of owning their own home. Now, many members of the younger generation question whether it is a good idea to buy real estate.
No wonder – having watched the housing market collapse five years ago, combined with a difficult job market, buying a house or condo may not be a wise move anymore. Homeownership has been steadily falling from its high of 69.2 percent in 2004 to a current rate of 65 percent, according to the U.S. Department of Housing and Urban Development.
So, is it a good idea to buy a house or condominium? To be clear, this is a question about purchasing real estate as a residence, not as an investment. When considering whether to buy, there are three major issues to consider: liquidity, return on investment and the personal use value.
Liquidity is the first issue to consider. Buying or selling real estate is timely and costly. It is generally not a good idea to make a purchase unless the property is expected to be owned for a long enough time period to recoup expenses and not result in a fire sale if circumstances require moving. For example, it may not be a good decision to buy a one-bedroom condominium if you expect to have a child in the next few years or to commit to a house if a pending job change may require you to relocate to another city. Obviously, if there is the possibility of buying a new house without selling the first, the illiquidity of real estate is not a problem. However, most people don’t have enough liquid cash reserves to invest in multiple houses and wait out the market for an opportune time to sell.
A second issue is the return on real estate. Real estate has not seen the same capital growth as the stock market over the past quarter century. Nonetheless, real estate provides diversification to a portfolio and returns can be amplified by leveraging the purchase with a mortgage. For example, an individual buying a house for $100,000 with a $20,000 down payment will realize appreciation on the full $100,000 from the date of purchase. Although the rate of return on housing does not change, the gain on the investment is significantly higher.
Finally, it is important to consider the personal-use aspect of housing when making a purchase. This concept can actually work in two directions. When purchased as a residence, houses are providing personal use as well as an investment return. This means a homeowner can live in the house and avoid paying rent while also experiencing gain on the house through appreciation. Yet that appreciation is locked in because the homeowner cannot tap into it without selling the house and losing the place to live.
The personal use of a house is very important. An initial comparison between renting and buying might compare rent to combined costs of mortgage, maintenance, insurance and taxes. However, this does not take into consideration particular attributes of mortgage payments, which is that they are fixed and finite. The principal and interest portion of a fixed mortgage will remain the same over time (although taxes and insurance might rise) whereas rental costs will increase. In addition, the mortgage should eventually be paid off, providing the homeowner with a rent-free place to live. This can be a great planning technique for retirement – if the mortgage is paid off at the time of retirement, there will be a reduction in expenses at the same time income falls.
Although the personal-use aspect of a house brings benefits to the homeowner, this also means the investment return is difficult to access for other uses. If a family downsizes its house as children leave home and less space is needed, then cash can be pulled out. Other ways cash can be taken out come from using a home equity loan or a reverse mortgage. However, many people are reluctant to use reverse mortgages to tap into the investment value of their house. Reasons for this hesitation include high closing costs, reduced inheritance left to family, continued responsibility for maintenance, tax and insurance and the need to pay off the loan if the house is sold.
The bottom line is that owning your residence can be a good decision financially, provided it does not cause liquidity problems and provided there are separate sources of retirement income. However, each individual or family is unique and will have to evaluate their options based on their specific circumstances.
Investment advice offered through Monument Advisory Group, LLC, a registered investment advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate, please consult your financial advisor prior to investing. All performance referenced is historical and is not a guarantee of future results. All indices are unmanaged and may not be invested into directly.