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Is your home an investment?


actuary
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Given the geographic diversity on the board, I thought it would be fun to see members' comments on whether they think of their homes as investments. I'm curious about how you all evaluate the tradeoffs of buying vs. renting, one house vs. another, renovation projects, selling vs. finding tenets, etc. What do you expect to get from your homes, financially and otherwise?

 

Real estate investments have always scared me a bit due to the leverage, illiquidity, carrying costs (some which of which can be large and unpredictable), and all of the emotion involved. I'm thinking mainly about primary residences and vacation homes, not the securitized or at least more scaled investments discussed in other threads.

 

In my current situation, it is difficult to find the right sort of space as a renter. And the market is such that I think buying a primary residence is one of the best financial investments I can possibly make.

 

I live in a moderately sized southeastern US city with decent culture, schools, hospitals, weather, demographic trends, and COL. In this market, the cost of renting attractive space with more than two bedrooms and bathrooms eclipses the carrying cost of owning a more attractive home with substantially more space. Around here, you can find nice homes in established, upper middle class neighborhoods for maybe 2/3 of their depreciated replacement cost (which to me seems like a conservative measure of IV). Since this is the situation, I'm purchasing more of a primary residence than I need before having multiple children. My expectation is that, regardless of when I sell it, I will not lose money, transaction costs included. I also expect the house to be worth at least depreciated replacement cost in 5 years, provided I spend 6-10% of the purchase price on updates. In the event that we stay in the house long term, I expect it can stage a lot of great memories.

 

Maybe this is too optimistic due to the emotion of a first time home purchase? The carrying costs could rise for potential buyers if interest rates spike... but that would probably happen in an inflationary environment that reduced the real value of my (fixed rate) mortgage debt. To me, the biggest risk seems to be getting accustomed to a certain lifestyle that could be a lot more expensive in another city if I needed to move for work-related reasons.

 

How do others on the board think about their homes? Buffett paid cash for a nice home and never moved again... but I suspect that is not a realistic choice for many here.

 

 

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Investment?  You bet.  I bought it several years ago, and have been "receiving" imputed rent ever since.  When I bought it, the effective cap rate would have been ~6-7% after tax with effectively no risk since I am my own tenant.  My view at the time was that getting a ~6-7% after tax return would be similar to the broad return from the stock market, but that there would be no volatility and effectively no risk because I am my own tenant.  My thinking at the time was that I hoped that the eventual selling price of my house would simply track inflation, and the that only real benefit from it would be my residency there.

 

Things have worked out much better than I expected.  In addition to the imputed rent, I have had a price increase of about 7% per year, which far exceeds inflation.  In Canada, that capital gain on a principal residence is tax free, and my imputed income is in after tax dollars, so it's worked out well.

 

I would not buy a house at today's prices.

 

SJ

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Investment?  You bet.  I bought it several years ago, and have been "receiving" imputed rent ever since.  When I bought it, the effective cap rate would have been ~6-7% after tax with effectively no risk since I am my own tenant.  My view at the time was that getting a ~6-7% after tax return would be similar to the broad return from the stock market, but that there would be no volatility and effectively no risk because I am my own tenant.  My thinking at the time was that I hoped that the eventual selling price of my house would simply track inflation, and the that only real benefit from it would be my residency there.

 

Things have worked out much better than I expected.  In addition to the imputed rent, I have had a price increase of about 7% per year, which far exceeds inflation.  In Canada, that capital gain on a principal residence is tax free, and my imputed income is in after tax dollars, so it's worked out well.

 

I would not buy a house at today's prices.

 

SJ

 

Did you include estimated annual maintenance expenses in your cap rate? If so, could you please share that rate?

 

I am currently evaluating buy/rent decision and kind of conflicted on this one. I currently pay $3000 monthly rent on a house that the owner would be willing to sell around $575K. It is a 10 year old house, property taxes of $6K. Assuming home owners insurance and other costs that I am not paying to be about $2k, I get a cap rate of about 5%. Assuming about 1% in annual maintenance costs, I get a cap rate of 4%.

 

Vinod

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I am getting a good deal renting a home in Montecito for about a 3.1% net rental yield.

 

I could own a REIT in my RothIRA yielding 6% and easily cover that rent -- nearly 1/2 the cost of ownership. 

 

To other folks it's harder if that yield is taxable -- especially in California with the added state income tax.

 

 

 

 

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Guess I'll be the one that goes against the grain since I do not view it as an investment.  Under the best of scenarios you will make money on your house but can easily go underwater if the market tumbles.  I know a few people that had to forgo jobs bc they were underwater on their house and could not afford to move.  Even when you sell the house, most of the money will be plunged back into a new house unless you expect to live out of a car.

 

A house can be a hamstring on many different levels.  You gave up the ability for mobility,  battling with contractors over work that needs to be done (AC goes out, water leak, roof damage, septic tank replacement etc) and drain on cash flow to name a few.

 

  With a rental something breaks and it's not your problem and will be fixed in about 24 hours.

 

If I was married and had kids I would own a house though.  If for anything else, so the kids have a place to play and call home.

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one thing I'll add, even when you buy a house you are unlikely to ever gain anything off the sale, unless you go back to renting.  e.g., you are unlikely to ever own a cheaper home as you age, so that money is permanently gone, essentially.  comparing it versus renting (as this thread is doing) does make sense though.

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Investment?  You bet.  I bought it several years ago, and have been "receiving" imputed rent ever since.  When I bought it, the effective cap rate would have been ~6-7% after tax with effectively no risk since I am my own tenant.  My view at the time was that getting a ~6-7% after tax return would be similar to the broad return from the stock market, but that there would be no volatility and effectively no risk because I am my own tenant.  My thinking at the time was that I hoped that the eventual selling price of my house would simply track inflation, and the that only real benefit from it would be my residency there.

 

Things have worked out much better than I expected.  In addition to the imputed rent, I have had a price increase of about 7% per year, which far exceeds inflation.  In Canada, that capital gain on a principal residence is tax free, and my imputed income is in after tax dollars, so it's worked out well.

 

I would not buy a house at today's prices.

 

SJ

 

Did you include estimated annual maintenance expenses in your cap rate? If so, could you please share that rate?

 

I am currently evaluating buy/rent decision and kind of conflicted on this one. I currently pay $3000 monthly rent on a house that the owner would be willing to sell around $575K. It is a 10 year old house, property taxes of $6K. Assuming home owners insurance and other costs that I am not paying to be about $2k, I get a cap rate of about 5%. Assuming about 1% in annual maintenance costs, I get a cap rate of 4%.

 

Vinod

 

 

Vinod,

 

Your cap rate is lower because it's not 1999 anymore.  :-) 

 

Back in 99, I had no trouble finding houses that would give me a cap rate of 6-7% even after 1% for maintenance.  Of course, five-year mortgage rates were 5.6% at the time, and everybody thought I was nuts for not going "all in" on Nortel.  ::)

 

Today, I don't think I'd be a buyer because the price-to-rent ratio has gotten silly over the past 5 or 6 years.

 

 

SJ

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In USA, a single family home in an absolute worst investment with zero real return, and if you are lucky, you get some nominal return.

 

the hidden costs are

1) maintenance of lawn, shrubs,

2) periodic painting inside and outside

3) constant upgrade to keep up the appearance, like upgrading outdated kitchen, bathrooms etc

4) rising property tax rates, this is like paying annual capital gains tax on a stock that hasn't been sold

5) constant replacement of HVAC, & other stuff

 

You make money if you are lucky enough to buy before a bubble and sell it at peak of a bubble.

 

In places like India that has high inflation rate, house is one of the few investment that protects you against raging inflation, you don't gain anything, but get to protect the purchasing power to an extent.

 

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In USA, a single family home in an absolute worst investment with zero real return, and if you are lucky, you get some nominal return.

 

the hidden costs are

1) maintenance of lawn, shrubs,

2) periodic painting inside and outside

3) constant upgrade to keep up the appearance, like upgrading outdated kitchen, bathrooms etc

4) rising property tax rates, this is like paying annual capital gains tax on a stock that hasn't been sold

5) constant replacement of HVAC, & other stuff

 

You make money if you are lucky enough to buy before a bubble and sell it at peak of a bubble.

 

In places like India that has high inflation rate, house is one of the few investment that protects you against raging inflation, you don't gain anything, but get to protect the purchasing power to an extent.

 

 

Obviously, the cost and returns from real estate is location specific.  However, there is an old adage that applies to nearly all assets which is, "There's no such thing as a bad asset.  It's a question of pricing."  My observation for housing is that you'll generally get a positive return if you are not paying more than a 10:1 price-to-rent ratio.  That gives you a pre-expense cap rate of ~10% before property taxes and repairs (which as others have noted tend to be surprisingly expensive).  If you can end up with even a 5% net cap-rate, then that's not too bad (ie, 5% basically risk free after tax is equivalent to 5% / (1-tax rate) = ~7-8% on a pre-tax basis.   

 

But, the key is to not pay too much for the asset to begin with.  Prices in Canada seem to be in the range of a price-to-rent ratio of 15 to 25, depending on where you live.  At that price, it's pretty hard to get a fair return on your investment.

 

SJ

 

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I don't think of my home as an investment.  It can be an investment, but you'd have to look at it differently than I look at mine, so to me it isn't an investment.

 

My first home I bought in 1997 for $132K and sold it in 2002 for $281K, so that worked out well.  I put almost nothing into that home so I made out like a bandit.

 

My second home I built in 2002/2003 and put a hell of a lot of work into it in the 8 years that I lived there.  I calculated that I was into it roughly $580K and I sold it for $435K. 

 

My new home is an 18th century farm house built in 1768 with a huge barn built in the 1850's.  I have chickens, rabbits, goats, and a dog.  I simply couldn't have this set-up if I was renting in the city or a sub-division.  I'm not sure if I'll make money in the end on this home, but I'm going to enjoy living here regardless.  I can't detach myself from it and look at it unemotionally to evaluate it as if it were an investment.  I love the place and that is going to color my analysis.  My first home I didn't love so I was more calculating.  My 2nd home and my current home I put a lot into and I enjoyed living there for reasons other than eventually making money on them.

 

So the short answer is yes, a home can be an investment, but no they are usually not.

 

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Buy a house because you want to live there and think that the price is such so that you won't lose your shirt.  Anything more than that is just conversation.  There is so many unpredictable variables in owning a house that it's virtually impossible to speak about it in purely financial terms.  Owning a house brings to mind O'Toole's Law, i.e. that Murphy was an optimist.

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Also the risks of real estate are grossly understated. I spent more than 10 hours driving around downtown/mid town Atlanta. I saw rows and rows of blighted neighbourhoods. These properties used to sell for 200K and above and are going for <10K. When you drive, all you'll see is some old drug addicted folks, walking by.

 

People in Detroit have their sob stories as well. My guess is that, collectively people would have made more money investing in homes than in stocks (due to less trading).

 

The other risks are HOA covenants, rise in crime, rezoning etc

 

Also no one ever includes sweat equity; all the calls, drives, fixes go undocumented.

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I am getting a good deal renting a home in Montecito for about a 3.1% net rental yield.

 

I could own a REIT in my RothIRA yielding 6% and easily cover that rent -- nearly 1/2 the cost of ownership. 

 

To other folks it's harder if that yield is taxable -- especially in California with the added state income tax.

 

How do you calculate the net rental yield? Is this the yield after paying the mortgage?

 

Thanks

 

Vinod

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Vinod,

 

Your cap rate is lower because it's not 1999 anymore.  :-) 

 

Back in 99, I had no trouble finding houses that would give me a cap rate of 6-7% even after 1% for maintenance.  Of course, five-year mortgage rates were 5.6% at the time, and everybody thought I was nuts for not going "all in" on Nortel.  ::)

 

Today, I don't think I'd be a buyer because the price-to-rent ratio has gotten silly over the past 5 or 6 years.

 

 

SJ

 

I understand why my cap rate is lower. What I am trying to think through if a cap rate of 4% could still be attractive when one can borrow at under 4% pre-tax and around 3% after tax deduction of interest. I am sure this would not be enough of a margin of safety for investment, but for making a rent vs buy decision it seems buying would be slightly cheaper.

 

Vinod

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I am getting a good deal renting a home in Montecito for about a 3.1% net rental yield.

 

I could own a REIT in my RothIRA yielding 6% and easily cover that rent -- nearly 1/2 the cost of ownership. 

 

To other folks it's harder if that yield is taxable -- especially in California with the added state income tax.

 

 

How do you calculate the net rental yield? Is this the yield after paying the mortgage?

 

Thanks

 

Vinod

 

I'm figuring if he had no mortgage -- he has my rent checks and he has to pay for property tax and other things.  The remainder of cash he has left at the end of the year after expenses, I'm guessing is about 3%.

 

That's 3% of what I think the property is worth, but my valuation estimate is about 77% of the tax assessed value appraisal.  If the tax assessor is more accurate then it's only a 2.8% yield.

 

 

 

 

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Not an investment.  A safe store of cash perhaps.  An inflation hedge, assuming you have a mortgage.

 

The frictional costs of home ownership are huge.  7-8% fees when you trade.  Some of my stocks pay me dividends - my house doesn't - an external real estate investment would.  Otherwise it is mostly a money pit.  Requires work and money to keep it's value stationary.

 

I honestly would prefer to have the cash available from the house to invest, and just pay rent, but then I am not most people.  Most people can't compound their money as well as many of our board members. 

 

Canadian's are brainwashed into the belief that home ownership is desirable.  I guess it comes from not having a war on your soil in ten generations. 

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from WEB this weekend when commenting on investing in gold, to paraphrase, its an investment if it produces something. I think a home provides a "utility value" but is mostly a money pit.

 

Would recommend home ownership as perhaps a safety net (at least you will have somewhere to live if your other investments go in the tank)- just don t go crazy.

 

Real estate agent will tell you it is an investment.

 

I don t think WEB thinks his home as much of an investment. What impressed me was how modest his house and office is. As with all other things re investing I think he provides a good model.

 

Agree with Uccmal.

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I am getting a good deal renting a home in Montecito for about a 3.1% net rental yield.

 

I could own a REIT in my RothIRA yielding 6% and easily cover that rent -- nearly 1/2 the cost of ownership. 

 

To other folks it's harder if that yield is taxable -- especially in California with the added state income tax.

 

 

How do you calculate the net rental yield? Is this the yield after paying the mortgage?

 

Thanks

 

Vinod

 

I'm figuring if he had no mortgage -- he has my rent checks and he has to pay for property tax and other things.  The remainder of cash he has left at the end of the year after expenses, I'm guessing is about 3%.

 

That's 3% of what I think the property is worth, but my valuation estimate is about 77% of the tax assessed value appraisal.  If the tax assessor is more accurate then it's only a 2.8% yield.

 

I am scratching my head on how this could be an attractive investment or is there is a non economic reason for this investment?

 

Vinod

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A home is never an investment it is first and foremost a place to live. As you begin to accumulate wealth you will do so by being thrifty and saving most of your earnings. However, when you have saved enough to satisfy your investment portfolio needs, a home is a great way to keep a sizeable amount of capital safe and secure and over-time tends to rise with inflation. The key is to buy a home in the best area you can afford. High-end properties have compounded as well as Berkshire Hathaway in cities like New York, Los Angeles, and London/Hong Kong. Here in Toronto things are out of control they are already higher per square foot than most cities in the US with the exception of certain high-end apartments in Manhattan, but tangibly higher per foot than Miami/Los Angeles/Chicago etc. Toronto is projected to absorb an additional 200,000 financial services jobs by 2020 eclipsing London for financial services jobs. I believe if this holds true property prices in Toronto will reach London-like prices.

 

Asians use Condo's in Canada as their RRSP's. It is not uncommon for a Chinese middle-class or upper middle class business owner to send his children to school @ U of T or UWO or BC and buy them a condo for $200-300k, in this way he is able to keep some money outside of China, and his son/daughter can live there while they study. These buyers mostly buy cash or with 50% mortgages.

 

Here in Hoggs Hollow, a friend just sold a house he paid $3.2m for in 2009 for $6.2m - you heard it right...Moreoever, our currency the loonie is stronger than ever, which makes it even more interesting for sellers of Canadian real estate.

 

Friends involved in commercial real estate here are selling, but everyone believe the high end neighborhoods will retain their value.

 

I went a little off tangent, but my advice is, the first step is to be thirfty until you advance in your career or have built an investment portfolio which can support the next step. Ultimately, the decision between buying a home and/or investing is one you should make but depending on your skills as an investor, it should be easier to invest successfully over time than buying a generic home. If however you have accumulated enough money to buy a special home in the best area in town, and it won't affect your investment portfolio too much- go for it.

 

In general overhead of a home should not exceed 3-4% per annum but you must remember that if one was renting there would be similar costs, finally a home is where you will share the best memories and so there are qualitative/intangible which are well worth those costs.

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I am getting a good deal renting a home in Montecito for about a 3.1% net rental yield.

 

I could own a REIT in my RothIRA yielding 6% and easily cover that rent -- nearly 1/2 the cost of ownership. 

 

To other folks it's harder if that yield is taxable -- especially in California with the added state income tax.

 

 

How do you calculate the net rental yield? Is this the yield after paying the mortgage?

 

Thanks

 

Vinod

 

I'm figuring if he had no mortgage -- he has my rent checks and he has to pay for property tax and other things.  The remainder of cash he has left at the end of the year after expenses, I'm guessing is about 3%.

 

That's 3% of what I think the property is worth, but my valuation estimate is about 77% of the tax assessed value appraisal.  If the tax assessor is more accurate then it's only a 2.8% yield.

 

I am scratching my head on how this could be an attractive investment or is there is a non economic reason for this investment?

 

Vinod

 

Owner bought the house in 2007 for 2.2m, sunk "about a million" into upgrades/renovations, and is holding onto it until he can get his money back out.  He moved into a lower cost home after having some health deterioration and needing a care giver.

 

You should see some of the homes for rent in Montecito, it's hysterical.  www.realtor.com

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I believe when one gets into renting luxury homes, the prices no longer make any economic sense for the "investor", so just forget about cap rates.  Plus, the tenant doesn't even need to pay for any of the gardening (the landlord can't afford to have the landscaping neglected).

 

This one rents for only 2.5% of the asking selling price (granted, an extreme example).  Throw in 1% property tax and the "investor" has only 1.5% yield left before expenses:

 

For Sale:

http://www.realtor.com/realestateandhomes-detail/730-Picacho-Ln_Santa-Barbara_CA_93108_M13138-12656

 

For Rent:

http://www.realtor.com/realestateandhomes-detail/730-Picacho-Ln_Montecito_CA_93108_M24779-74131?rental=1&row=3

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One way to turn your home into an investment, if this is something you really want to do, is to buy a multi-unit property and live in one of the units while renting out the others.  With 3 or more units you may even be able to bring in enough rent to cover all expenses (mortgage,taxes,your utilities, etc).  This way you live rent/expense-free and you are living there so you can keep a good eye on your investment property.  You do need to make some sacrifices to do this though.  For one, you end up living in an area that has multi-unit housing.

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