As a prodigious wealth builder, it's important to assess your local real estate environment. Get into the real estate investor's mindset and live the way you believe.
I'm down in the Sunday open house trenches to get a first hand view of what's going on. I talk to Realtors about their property listing durations, understand why the sellers are selling, and get opinions on the market.
You can never fully trust a Realtor because to them, it's “always a good time to buy or sell property.” By going to open houses yourself, you can at least observe the amount of foot traffic and listen to the enthusiasm or lack thereof.
Real Estate Investor's Mindset And The Reasons To Own A Home
1) You have to live somewhere.
2) The homeownership stock is better quality than the rental stock to live.
3) Most people can't save for poop, so paying down principle is better than poop.
4) Tax shield on income, which is especially helpful for those in higher brackets.
5) The long term trend is always up so long as there is limited land and population growth.
6) You can potentially make a lot of money over time.
7) More control over your lifestyle e.g. never have to move, remodel as you will.
8) Build real assets that can be passed along to your children.
9) Inflation hedge as your mortgage becomes cheaper in real dollars.
10) Inflation play as your asset inflates.
11) The first $250,000 in profits is tax free for singles, $500,000 for couples.
Renting Is Fine Too
There's nothing wrong with renting if you don't have the money, don't know what to do with your life, have a lot of debt, or are not sure whether you want to live in one place for more than five years. The mobility of being a renter is wonderful, so is the lack of responsibility for property taxes and maintenance. Just know the return on rent is always -100% every month. At least with homeownership, you have a chance of making some money.
This post isn't about the merits of homeownership. This post discusses how to think about your current living situation and whether it gels with your investment outlook. Remember, the name of the game is passive income, increasing assets, and creating financial freedom.
The housing market is likely going to stay strong for years to come post-pandemic. Let me share with you the mindset of the real estate investor and the mindset of the renter.
A RENTER IS NEGATIVE REAL ESTATE (Renter Mindset)
A renter benefits when home prices and rents go down, which is why I say renters are “short” real estate. If rents and home prices go up, renters get “short squeezed” as they have to pay more of their disposable income on rent, a downpayment, and a mortgage.
The concept is the same with the stock market. If you short Apple stock at $520, it means you believe you can buy back the stock at a lower price and pocket the different. If Apple rebounds to $600, you may have to buy back the stock at $600 and lose $80 a share.
With inflation, population growth, QE3, QE4, QE Infinity, and limited land, the natural trajectory is “up and to the right” for rent and housing prices. Housing costs are a key component of inflation and something we must all pay in some way or another. A renter is a price taker, just like a car driver is a price taker of gasoline. As a renter, you may actually not want rents to drop because that signifies a weakening economy.
If you are still renting 40 years from now, you won't have a place to live rent-free in retirement, nor will you have an accumulated asset you can pass down or draw from. Like gasoline and tuition, the rent you pay now will undoubtedly be much higher when you become a senor citizen. Don't believe me? Just ask your parents or grandparents what they were paying in rent during their working days.
A ONE PROPERTY HOMEOWNER IS NEUTRAL REAL ESTATE
When it comes to investing, everything is relative. Given you have to live somewhere, if you live in your home, you are neutral on real estate. If the market goes up, your house value goes up, but it doesn't matter because you aren't selling. You can take out a home equity line of credit to buy a Porsche 911 Turbo instead of a Honda Accord, but that's not very wise.
Let's say your $500,000 home appreciates by 20% to $600,000 over 10 years. You put 20% down ($100,000) and now your equity is worth $200,000 for a 100% increase. Awesome! But the house you want to upgrade to now costs $1 million from $800,000, because it too has gone up! The only thing that allows you to purchase more house is not your own home equity, but your savings and investments.
Conservative Real Estate Mindset
On the other hand, if you want to downsize from a $1 million dollar house to a $600,000 house, you have benefitted more financially if you are OK with the downgrade. You made $200,000 ($800,000 to $1 million) and only have to put $120,000 down on a $600,000 house. You therefore bank the $80,000 and pay a smaller $480,000 mortgage if you are fine with simpler living. As a homeowner, you are in a neutral positive situation.
On the flip side, if your $500,000 home loses 20% of its value to $400,000, you're not really affected either because you aren't moving anywhere unless you can't afford the payments. Interestingly, that $1 million dollar house you've been eyeing may have also lost 20% of its value down to $800,000.
You no longer have to put $200,000 down and take out a $800,000 if you want to move up. You can now put $160,000 down and assume a $640,000 mortgage instead! In a declining market, those who have the financial means to “upgrade” are the ones who benefit.
As a one property homeowner, you're like a small boat who happily floats along the rolling waves. Unless you are easily susceptible to sea sickness, the movements don't really matter.
A MULTI-PROPERTY OWNER IS BULLISH ON REAL ESTATE
The only way to really benefit from a real estate recovery is to buy more than one property. When the markets are hot, you can raise the rent or sell the property to realize a gain. If you only own one property that you live in, you can't do much at all except for downsize.
Why do you think there are countless examples of real estate magnets like Li Ka Shing, Sam Zell, and Donald Trump? They made their money (and lost some as well) through buying multiple properties on debt. Many have also gone bust buying at the wrong time, being over levered, and not holding on long enough. Over the long run, property has proven to be a consistent wealth builder for so many.
To recap, the point of this post is to get you thinking about how your outlook on housing and the economy fits with your current living situation. If you are very negative on housing, then owning multiple properties doesn't make sense. If you believe there will be a multi-year housing market recovery like I do, renting doesn't make sense because you'll get squeezed. Rental yields are much higher than mortgage rates, which makes for an instant positive carry while you wait for capital appreciation.
Make sure your living situation is congruent with your real estate investor beliefs. Live the way you believe and everything will fall into place over time. Please understand the real estate investor's mindset if you want to make money.
Invest In Real Estate Wisely
If you have the real estate investor's mindset, you want to invest in real estate beyond your primary residence. Take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City. But cap rates are over 10% in the Midwest if you're looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It's free to look.
There is no substitute for knowledge. When you see the very best doing what they do, they always seem to know more than those around them. Real estate investors with large portfolio simply know more about what drives markets, how to time market cycles, and which things to watch out for.
I know this is an old post – but I just thought I would add: yes, rent goes up, but so does taxes, maintenance costs, repairs, and opportunity costs. It’s not like owning a house is immune to inflation. There are plenty of scenarios in which renting your primary home makes great sense or is preferable. That said, I agree that one should definitely have at least one or two rentals and/or heavy exposure to REITs if not.
[…] recommend everybody be at least NEUTRAL the property market by owning their primary residence. Being neutral the property market means you are no longer a […]
do you have any views of what will happen to real estate prices if interest rates increase in the coming years? i’ve noticed a big theme of your posts revolve around refinancing to lower rates, but surely rates can go up as well if the economy continues to recover.
thank you,
jason
Rates have been coming down for 30+ years in a row. They could rise, but I don’t think by more than 2% over the next 5-10 years on all mortgage durations.
Rising rates means stronger economy, higher inflation, higher real estate prices. I’ll take it. In real estate, you are hedged both ways if you hold on long enough. Compare to renting over 30 years. You’re only losing with higher rents/inflation.
I am in the negative real estate category! I am active duty military, so I have moved around a bit and never been a homeowner. I have a fresh opportunity where I am moving to Hawaii for at least 4 years. I may have a chance to do a consecutive tour there adding my total time there to 8 years but its not guaranteed.
What is a man to do? I don’t want to be in the negative category no more. Should I grab a nice SFH or condo? It is just me and my wife. I can use my VA loan which requires zero down. I am afraid of taking a loss when I leave. I could try to rent it out since most military members do not buy. I think renting it out to peers would be fairly easy.
I am a noob to your blog but it is on point! Look forward to more reads.
Sounds good Jane. When do you plan to sell it? It is hard to make money work for you (Money Strength), so considering building up other income streams in the mean time.
I like your point of reference to the stock market with these real estate examples. It definitely made it easier for me to understand and I agree. With low interest rates and all of this QE I agree that it is inevitable we see a huge bull market in real estate. My only concern is that when inflation starts to get out of control the federal reserve with raise rates which in turn SHOULD lower home prices since buyers are predominantly concerned with the monthly mortgage and not the price of the home.
The Fed and other Central Banks have made publicly stated they won’t be raising rates until 2014 or before unemployment goes below 6.5%, and we should believe them.
With 7.7% unemployment, there is too much slack in the system to see inflationary pressure imo.
Lots of bullish sentiment for real estate on this thread. There is very good reason for it, in SF and NY. My guess is not too many FS readers from Detroit, those impacted by Hurricane Sandy, or San Bernardino County.
I would like to hear some bearishness on RE to make sure I’m not missing anything. I’m just reporting what I see in SF, and how it translates. Different viewpoints are welcome.
Sam, you are not missing anything, and I don’t think you miss anything, either. Both NY and SF have limited land, are great places to live, visit and be, and most importantly have an abundance of highly-compensated jobs. (Not too many $250,000/yr jobs in S. Dakota)
Places like Detroit (where jobs have been outsourced, offshored, relocated, and dislocated for decades) have homes that have been abandoned for back property taxes, and are available for $1. San Bernardino County has practically unlimited land, and a drive along the 210 past Riverside towards Palm Springs is an illustration of what easy money to builders, govt. incentives, and subprime lending produces…tens of thousands of abandoned home sites. Nobody paying taxes on any of it. Municipalities obligated to provide services that aren’t paid for. Underwater mortgage holders walking away. Personal, corporate, and finally county and city bankruptcies. Disaster areas (Arrowhead after a forest fire, Sandy, Galveston, New Orleans, Avila Beach after Chevron oil remediation) may be built up nicer than they were, but the insurance rarely covers the actual cost, let alone the PITA factors. Renters walk away.
The nice thing about being an ‘investor’ who is retired, such as yourself, is that you have flexibility on what, when, and where you buy. Things happen in life (job loss, divorce, etc.) and Real Estate is great when times are good, there is money in the bank, and a surplus of qualified buyers (i.e. NY and SF). I have seen a flip side to the market (15 years of decline in the Los Angeles South Bay, after the aerospace bust and the fall of the USSR). It is ugly and costly, and leverage works both ways. Getting in is easy (often when sentiment is bullish), but getting out is hard (even more painful/costly when it is forced by circumstances).
Personally, I have both made and lost money in RE, and am ‘neutral’. A paid-off home is the equivalent of a risk-free return on whatever the mortgage rate would have been, frees up cashflow, and pays a psychic return. Myself and family members have sold homes in the past few years, always disappointed with the selling price. The sentiment on this board seems to be from entry-level people on the buying side. For those who would like a concrete illustration, pick a property on Zillow, and go to the graph showing ‘home value’ over time; you will see price changes in both directions that are shocking.
All your reasons listed are very good ones for building equity over time. Life is long, and it would be nice to have something to show for it after a period of time.
Just curious, what reasons are you finding for people selling in the Bay area?
Thanks for your insights JC! One of the biggest thing that annoys the hell out of me is the monopoly pricing on real estate commissions. 5-6% is outrageous, especially for higher price locations such as SF and NYC. I am for a flat rate, or scaling flat rate, and that’s it. Why does it cost $50,000 to sell a $1 million condo in SF? It shouldn’t.
The reasons I hear from people selling in the Bay Area are:
* Divorce
* Trading up to a bigger house
* Empty nesters
* Sick of being a landlord
Of course there are probably those in dire straits, but those stories are not told to prospective buyers for obvious reasons. I would not be selling now. Life is short, but if you have enough life, than sellers will kick themselves in the head 10 years from now. BTW, if you would ever like to share your financial advice or story on FS, please feel free to let me know. I always enjoy your insights and I think others would too.
Love the 1031 exchange rule. Can’t beat not paying taxes on the first $250k in profits!
If you can build income streams that can eventually cover your rent, then go for it. It depends on your age as well. If you’re over 60, it might be better to just rent.
Also consider the speed of rising rents/inflation vs your income stream creation growth.
Real Estate is a big part of our plan for financial independence. I’m not sure that we will replace our current incomes solely with rental income, but it will be a pretty good percentage of our passive income for when we give up the day jobs.
So I’m just about to close on my first place after being against realestate to the core for sometime. I’m buying into about half of what I can actually afford with the thought that I’ll get a second mortgage down the road on a new place and rent this one out. Am I crazy for not just taking all the free money that I can (nothing interest rate) and getting a second place now to immediately rent?
What about waiting until you can afford 100% of the property just in case?
Isn’t your return on investment higher if you mortgage it?
Let me give you my case:
Price: $321k
Down payment: 20% ($64,200)
Mortgage: $256.8k
Interest rate: 3.375%
The place is kinda dumpy (in NYC area) but rented previously for $1,900 a month. I think with roughly $15,000 worth of improvements I can rent it out for $2,500 (it’s a 2 bedroom).
Based on my mortgage rate, down payment, taxes (very low surprisingly) and condo fees my monthly payment is a hairs breath above $1,500. That gives me a rough profit of $12,000 a year on a layout of $79,200. A return on investment of roughly 15%.
If I were to pay the entire thing (with no mortgage) I would have a base spend of 321k and a yearly profit of $30k. That would put my return on investment at roughly 9%.
Am I missing something? It seems to me that the low rates make it extremely attractive for those of us who have a solid income to leverage up to generate more income.
Agree with your math. Am questioning you “buying half of what I can afford.” What does afford mean? I cannot know your financials.
There is no spoon.
Your return will be greater if you can get the bank to give you a mortgages to finance the property and rehab cost.
Based on your QE infity comments and the fact that rents would increase; do you still favor an ARM over a fixed mortgage?
QE shifts the money supply curve to the right, leading to a decline in interest rates. The output gap is sufficiently wide so I don’t believe there will be beyond normal 2-3% inflation for a while.
Yes, I still believe one will save money over the life of their homeownership with a 5/1 arm. Median homeownership duration is only 6-7 years too. If that is the case, then one will most certainly save.
I would not say I am a bully on real estate. We now have two properties. We just purchased our second home where we now live and our first house is being rented out. We are positive that this will be another good source of income for us.
I really like the Ten Reasons you listed for home ownership. Be it land or a second home, over the long term they have always been a reliable asset in ones portfolio.
We are definitely bullish when it comes to real estate. However, I like to invest in things that I understand and am comfortable with. We own two rental properties at the moment with plans to add more in the future. I wish now was a better time for us to buy additional rentals since things aren’t really moving in my area and interest rates are still so crazy low!
Why the sudden change of heart about Portland? Good value, lower taxes, free spirits! Where would u go?
Sam, I would like to buy a 2 family property soon, but given the interest rates being so low and in my situation I still have student loans would it make sense to jump in and buy something in a year to take advantage of interest rates or wait to pay off the loans? I think by the time I pay off loans, rates will be going up.
I would ignore your student loans. Take advantage of RE NOW with the rare convergence of low prices and low rates. Plus, the student loan debt isn’t frowned upon when you’re applying for a mortgage (assuming you don’t have any cash flow problems or debt-income ratio problems as a result of it).
If after doing the math and believing in the security of your job, I would gravitate towards property ownership if you have the money.
I bought my first place 10 years ago while I still had student loans. Just really do the math and make sure you plan to own for at least 5 years.
I think you should always have some real estate. Owning a home is a given, but any other investment can be in a variety of forms. You can own a second home, condo, apartment building, commercial property or a REIT. It should be part of any investment portfolio. The only caveat is, as the housing bubble showed, you should be careful. In other words, the prices have to make sense!
Thanks for the great analysis of the state of the real estate market. How do you feel about REIT funds? I rent my primary residence because I’m thinking of moving across the country within the next few years. Do you think REIT funds are a good compromise to be exposed to the housing market, even if I’m still renting?
Good question, and yes, REIT funds are a good compromise, but there are tons of REIT funds, so you’ve got to do your research. Would love to hear more about the economics behind renting out your own house and renting yourself.
I am heavily bullish on real estate, mostly because I like tangible assets and if the stock market crashes I still have a roof over my head and other places to rent. I started looking into land and own some in 5 countries, I believe there is only so much space on Earth and people have to live somewhere!
I strongly agree. I don’t even bother with other “asset” classes.
I’m very bullish on real estate over the next few years. Especially in my area where RE prices are low and there is finally some positive economic momentum building. My only hope is that I’ll be able to come up with another down payment or two before prices rebound too much!
I’m very bullish on the housing market for 2013. Housing related stocks will continue to boom for the next year. The housing market has truly turned a corner.
What do y’all think is a good percentage allocation of real estate as a percent of your networth? I’m at about 40% real estate and sometimes I wonder if that’s too high. Part of it is that I own a condo in San Francisco and it’s gone up quite a bit this past year. I’ve been renting it out for a while now and rent prices keep going up. How long will that last? I also just picked up a condo in Punta Cana to live there for a while and possibly rent out or sell in the future.
Depends on the cycle, income power, and ability to earn more money and whether you have an X Factor.
The median homeowner has something like 90% of their net worth in property. I wouldn’t go beyond 40% for any single asset for sure.
Thanks Sam, I agree that more than 40% in real estate would be too high. My income power has gone down a lot since I got out of the tech PR business and started teaching tennis and doing occasional music gigs. Fortunately I moved out of SF a few years ago, started renting out my apartment and living in much less expensive areas. Right not I’m in Montreal with my girlfriend splitting a $700 rent. . imagine that. Regarding the X Factor, I’m trying to figure out a way to make some serious income out of tennis realizing it may be a tennis school. Perhaps in Punta Cana. . anyone interested in investing!?
I agree with your assessment about the neutrality of real estate with one caveat. It’s important to buy your first property in a declining/declined market.