A long-standing real estate maxim (and not, “Location, location, location!”) is “You make money when you buy.” That said, whether your purchase of a home will shake out to be a good investment really depends.
Let’s look at this from the specific view of buying a home, and not deal with real estate purely for investment purposes, which can be addressed in another article altogether. For our purposes here, let’s discuss briefly the basic financial benefits and risks of purchasing a home that you and your family will live in as your primary residence.
The simple thought, by the way, that buying a home might not be a good investment is a notion no one would have considered just a few short years ago. For as long as anyone could remember real estate values always found their way up, even if only in the long run.
That may still be true, depending on the definition of long run but we have an actual, significant and sudden drop in values that has occurred in many places around North America. The return to the previous peaks of past values is uncertain at best, so that even experts protect themselves by predicting a return of value way out in the future, such as five or ten years from now, if they are even willing to stick their necks out that far.
But there’s a silver lining to the previous paragraph. Values are pretty low. That means prices are pretty low in most places, and many would suggest there is good evidence that they have bottomed out. This may or may not be true. Whether values will keep decreasing or begin to rise depends on several factors.
The desire to own a home is still pretty universal. This is tempered by a lack of confidence and certainty with what one expects to happen in the real estate market in the near future. No one wants to buy a home for $500,000 only to feel like an idiot the next year when it’s worth $400,000 (a drop of only 20% and a possibility!) You might feel even worse making payments on the $500,000.
That’s a bad investment, but only if you had planned on flipping it after a year or for any reason need to move after living there only for a short term. This can happen if you expect or are surprised with a job change or some other life-factor that necessitates a move.
Long or Short Term
However, if you plan to remain the owner of the home for the long term, it can be a good investment even if the value drops! If the payments were and have remained within your ability to pay and still live a quality life, even if you’ve temporarily lost equity you could argue you made a good investment for the long term because eventually values will catch up and pass you, creating equity.
Mortgage Interest Rates
Even if that takes a while, your investment might give you some peace of mind if rates have risen. If you lock in a 4% rate and in a year they have gone higher you still have reason for self-esteem, even if your value has dropped.
So you see what is meant by this being a little bit of a maybe proposition. A good investment is simply something you put money into that at a later date yields you more money. With real estate there are many ways this can happen.
- Equity growth: If values rise above what you paid so does your net worth
- Cash flow increase: Even if you move and even if values drop you might hold on to the property and rent it at a rate that exceeds your outgo, yielding a nice, positive monthly cash flow. Some investors are willing to break even each month if it means someone else is gradually paying down their mortgage and creating equity. Be careful, though, because one major repair to the home can wipe out an entire year’s cash flow, and land-lording is a science.
- Tax savings: Even if all of the above remain static, if you itemize your deductions on your US tax return you can now write off your mortgage interest. This might not be much of a benefit if you take a standard deduction, however
There are many positive psychological factors that are present in a neighborhood of owners that are absent in a neighborhood of renters – including aesthetics, pride, and security. When strictly considering the financial probabilities of buying versus renting – because you generally must do one or the other – in the present market it can basically be evaluated on the basis of
- Time: How long you intend to own the home, either as an occupant or landlord. The longer the more likely it will be a good investment. Note if values start to skyrocket you can hold the home for a shorter period of time and still make money, but this is pretty unlikely right now unless you add value to the home with profitable improvements (another article!)
- Terms: Too much cash needed and too high an interest rate can make it a bad move. Perhaps in a year of improving your credit score or falling interest rates this can turn in your favor.
So, in summary, it comes down to time and terms. Consider those two big factors and you can see what your probabilities are. You have to live somewhere, so all of this is relative and should be compared to renting, which is not always a bad move depending on your future plans.