Chapter 27 – Should I Buy a Home?

I’ll just relay one story, which was when I got married we did have about $10,000 starting off, and I told Susie, I said, “Now, you know, there’s two choices, it’s up to you. We can either buy a house, which will use up all my capital and clean me out, and it’ll be like a carpenter who’s had his tools taken away for him. “Or you can let me work on this and someday, who knows, maybe I’ll even buy a little bit larger house than would otherwise be the case.” So she was very understanding on that point. And we waited until 1956. We got married in 1952. And I decided to buy a house when it was about — when the down payment was about 10% or so of my net worth, because I really felt I wanted to use the capital for other purposes.~Warren Buffett, 1998

In the last several chapters, we’ve done a deep dive into the home building industry, the home ownership industry, and how changing the debt culture could improve how we purchase homes and our personal finances.  I’m sure by now, you may be wondering, “Should I buy a home?”

I’m simultaneously a huge supporter of real estate investing and an opponent of it.  Real estate investing (when done correctly) has provided outstanding returns for decades, just like the stock market.  But, while a great majority of people understand the risks of investing in stocks, many people think real estate investing is the safer option.  According to Investopedia, the average annualized rate of return for housing increased 3.7% compared to stocks returning 9.5% during the same time period.[1]  More worrisome is that people confuse home ownership with real estate investing.

Home ownership is purchasing a primary residence.  It doesn’t become an investment until you’re renting it out or you sell it for profit.  But simply purchasing a primary residence is neither a bad or good decision in itself.  Real estate investing is owning properties for rental income or purchasing properties with the sole purpose of selling them for profit.

A key to both smart home ownership and success in real estate is getting a good return on investment.  Buying a property is not safer than investing in stocks because a home is basically a never-ending liability.  Assume I use $10,000 of discretionary income to buy stock, and the stock becomes worthless.  I simply lose the $10,000 I invested.  With the very recent decision for brokerages to stop charging fees, I can now invest with no real charges.  So, if that stock became worthless, I would now lose the $10,000 without any fees or overhead costs.  Additionally, you can offset capital gain losses with gains.  This is not true if you buy a property, unless you have multiple properties, which is a less common scenario than someone having multiple stocks.

When you purchase a property, you have to pay many costs regardless of how its purchased.  Even if you buy a property without a realtor and in all cash, you’ll still pay processing fees, insurance, and you’ll always pay property taxes—forever.  So if you use that same $10,000 to put a down payment on a $100,000 house, and it drops to $50,000, you’ll still have to pay your mortgage, which isn’t affected by the home’s value after you buy it.  You can deduct the interest from your taxes, if you’re in the 10% of people projected to itemize after the tax recent changes[2], but you can’t claim the unrealized loss on the value of the home.  You’ll still pay insurance, and you’ll always pay property taxes.

So the key to buying a successful property is to focus on return on investment.  Buying a house at a discount or in a market where the home goes up in value can provide a good return on investment.  When your property increases in value, then the interest you pay on the mortgage can be deducted, only if you itemize, on your taxes based off the original mortgage loan.  If your house doubles in value, your mortgage stays the same, the interest stays the same (assuming a fixed mortgage), and you can deduct that interest from your personal taxes.  Property insurance and taxes will rise regardless of housing prices because that’s how insurance companies and how the government work, concepts I will go in detail in upcoming chapters.

So, when I’m asked, “Should I buy a home?” I answer the question with a lot of questions—which people typically dislike.  What’s your current financial situation?  What are the details of the house?  What kind of financing are you considering?  The answers to these questions determine my answer.  Unfortunately, people have a belief that buying a home is a smart and necessary financial decision.  Changing this belief is important as I discussed in the last chapter.

Another problem I see all the time is the confusion behind real estate economics.  Under normal circumstances, interest rates and home prices are inversely proportional; however, most people think a lower-interest environment is better for buying a property.  This is because lenders and realtors have tricked us into focusing on the monthly mortgage payment.  All the fees, taxes, etc. are hidden in the mortgage payment and people focus on that.  Car salespeople do it all the time.

Buyer: How much is this car after all the fees, insurance, and taxes?

Salesperson:  It’s only $300 a month!

People like me:  That’s not what I asked.

One of the scariest philosophies I regularly hear is when military members believe we should buy a home at every assignment.  Depending on which service and career field we’re in, we could move frequently.  The idea is buying a home and then renting it out creates a large rental income portfolio.  There are many mainstream news articles that propagate this philosophy.  I’ve researched literally dozens of these articles and behind every successful rental property acquisition, is a purchase based off return on investment.  The articles we don’t see however, because they’re not written, are about the countless military members stuck with bad acquisitions.

The liabilities I discussed earlier mount up and consume all of their discretionary income, and they end up selling at a loss, short selling, or foreclosing.  All of these outcomes could have negative impacts lasting years.  In the 20 years I’ve been in the military, I’ve seen more unsuccessful property acquisitions than successful ones.

So, before asking, “Should I buy a home,” first consider if you’re financially ready.  Then make sure it’s a good return on investment.

  • Do you know how long you intent to stay in the home? Decide how long you intend to keep it, so you can see how much risk you’re willing to take with the purchase price.  The longer you plan on staying in the house, the more price volatility you can absorb.
  • Are the total housing expenses under 30% of your salary? I’ve always been a fan of the vanilla financial advice of not exceeding 30% of your salary (take-home pay is preferable), on all housing expenses (including utilities, insurance, and routine maintenance).  People who spend too much money on their household care called, “Money poor, cash rich.”  That’s not a good thing.
  • Do you have 10% or more for a down payment? The goal is to get to a 20% loan-to-value ratio so you can stop paying Premium Mortgage Insurance (PMI).  If you’re using a VA loan, you won’t have to pay PMI, but you still should have a sizeable down payment.
  • Are you in a secure job and, for all intents and purposes, in good health? Like I mentioned above, buying a property is a gigantic liability.  If you lose your job or experience significant health issues, then you won’t be able to make your payments.  You may be able to settle with your mortgage company on delayed payments, but nothing stops the tax collector.  Federal and state taxes exponentially go up with the fees and interest of missing payments.
  • If all of these conditions are good, then if you were to ask me, “Should I buy a home,” then my answer would be yes. If you answer no, to any of these, I would tell you to be cautious and that you’re certainly not making an investment.

 

[1] https://www.investopedia.com/ask/answers/052015/which-has-performed-better-historically-stock-market-or-real-estate.asp

[2] https://taxfoundation.org/90-percent-taxpayers-projected-tcja-expanded-standard-deduction/