Your wife is afraid of the stock market but interested in a house?
She should come to my neighborhood. Prices tanked in 1987. Prices tanked in 2001. Prices tanked in 2008. Not clear what will happen now. The folks who “stretched”-- either for an investment/rental property with its “guaranteed to appreciate/plus cash flow” allure, or for the primary home-- find out what happens when prices either drop overnight (2008) or drift downward (2001).
It’s fine if you buy a house to live in, and have some control over when to sell (do we move? downsize?). It stinks- and can be ruinous- if you have to sell for whatever reason. I know lots of people who have sold when they are underwater and it is very destabilizing financially.
Buy a low fee, highly rated index fund and sleep like baby at night.
@oldfort I don’t believe second homes get the same treatment on capital gains when they are sold. Am I wrong about that?
Where I am, the real estate prices are very high right now, with low interest rates for financing. In more urban areas, real estate prices seem to be more favorable with those same low interest rates.
Wondering where this OP is buying this house. It’s very possible the value will decrease before he sells.
True story…friends bought a very nice condo for their daughter in a very nice area of the college town in which she resided. Kid lived there for 4 years, and had roommates whose rent basically covered all the costs. Fast forward to her graduation…they could not sell the place despite its great location and very reasonable price. They ended up being long distant landlords for several years, and finally lowered the price to less than what they paid for the place.
I’d be careful with this type of purchase especially if you don’t plan to keep it.
Thanks so much for the input. The market this house is in has really not had a severe downturn . The Texas economy has been more stable , I have not really been too concerned about the house losing any significant value. I appreciate everyone bringing that up . I may be a little naive in my thinking there.
Agree that there are 2 separate questions. 1, is it a good investment relative to renting and 2, what is the best way to finance it, 100% equity or with debt.
On 1, it really depends on the local real estate market and this particular piece of property. Does it historically swing up and down or do values hold pretty steadily especially in this neighborhood. When housing prices are driven by high rental demand, which is often the case in university towns, especially those with large medical centers (undergrad, grad students, faculty, healthcare professionals), values tend to hold and are driven by rental returns. In OP’s case, if the house/condo can generate $1,300 in monthly rentals on a $200k house/condo, that looks to be a pretty good investment with the caveat that the home is in a stable/safe neighborhood reasonably close to the university and is in reasonably good shape with no major repairs likely in the next 6 years. If what we look at is the rental economics of this property, assume 20% down and a 3.8% 30 year mortgage, the annual mortgage payments = $9k vs income of $15k±. There is $6k± in income before tax, insurance and repairs. OP is suggesting that he will be cash flow neutral if he finances it, but remember the mortgage payments also include pay down of principal which add to his equity when he sells. When OP resells the property after 5/6 years, the value of the home will likely be driven by the rental economics at that time under the above caveats.
On the financing question. If OP would otherwise keep the $200k in cash/cash equivalents, yes he is benefiting to the extent that his cost of borrowing would be greater than his return on cash. But I agree with @blossom that putting 100% equity in real estate does not strike me as the “safest” investment. Having cash/liquidity is valuable in of itself. If you finance at the current low rates, you can always choose to accelerate your payments. That is within your control. If you put this into the home, it is tougher and more expensive to get that money out if you have a better use for it in the future. Also, if we can assume that that the housing market here is not driven by speculation but by already existing reasonable rental rates with captive high rental demand, it’s more likely than not that the property will appreciate with increases in rental rates. Having a levered investment will magnify your return vs being 100% equity invested. On the other hand, one of my best friends was a senior mortgage backed trader and they thought their products were safe until they weren’t.
Where we live one thing to think about would be dealing with winter maintenance, such as shoveling when it snows. I have never lived in Texas but my guess is that snow is not an issue there. Someone would need to mow the lawn unless you are buying into a condo – which seems like a reasonable choice.
Presumably you would have insurance to cover disasters such as a hurricane (which we do not need to worry about) or a tree falling on the home (which we do need to think about).
This gives you the issue of trading off the potential gain in value of the property (minus taxes) versus the risk and effort.
Given the amount of money that has been printed over the past 11 years with relatively little inflation, it seems to me that inflation showing up at some point seems likely. Economic weirdness tends to go back to the normal from time to time. One concern that I would have is that interest rates for mortgages are very low right now so that if rates go up this could impact housing prices. inflation of course could have an impact on interest rates.
To me right now this seems safer than the stock market, and more likely to keep up with inflation compared to a money market. However, I see it as an investment with some risk. There is a danger that 5 or 6 years from now might not be a great time to sell. Housing has been quite marketable for a while. However, there were periods in the late 1970’s and again in the early 1990’s where at least around here selling real estate was tough.
Location is everything. I believe we are in a housing bubble in many areas of the country and I would not buy a second home in one of those areas, especially if I plan to sell it in 5 or 6 years.
Secondly, nothing wrong with investing in the stock market if you have a well diversified portfolio of domestic & international stocks, bonds, REITs, dividend paying companies, etc. You can be as conservative or as aggressive as you have the tolerance for.
If I had a considerable amount of money in savings, I would put some into the stock market as you are actually losing money each year “inflation risk”. The one thing to think about is if a new administration if elected into office, they have talked about changing the capital gains rates where gains would be taxed as regular income instead of at the much lower capital gains rates of 0% (up to 80K) and 15% (up to 496K).
I would not do anything right now until we see what the make-up of congress and the presidency is after the November elections.
If the home is near a college and medical school, seems like there would be a lower chance of this being a “bad investment”. If prices fall when you planned to sell it, your would likely be able to rent it to students.
The cash vs mortgage would partially depend on what percentage of your nest egg $200K represents. The opportunity cost lost that would have accrued from investing the $200K in an index or fixed income fund along with the cost of purchase (the home price plus all the closing costs) has to be weighted against the rental savings minus taxes, maintenance etc. and the tax savings.
Good luck and congrats on two girls in med school!
If you are near NYU’s med school, property values and ease of sale or rental will rely on the entire Manhattan real estate market-- not the population of the med school looking for housing. Ditto for any of Boston’s med schools, or any other dense inner city core. If it’s a small city where the university population represents a significant portion of the rental market-- then yes, your thesis is correct.
I grew up in a college town and my parents knew several people who got burned with the whole “you can always rent to students if you can’t sell it” mentality. Property values DO go down. There are gluts in rental markets periodically which are driven by factors much bigger than students arriving in August and leaving in June.
I was living in a small city which had VERY stable property values for both sales and rentals for over a decade. I sold a house (had to- was relocating for work) 6 months after GE announced that it was closing a plant near town and moving those jobs overseas. The realtor who sold me the house had “sworn”- prices only go up. Except-- when a major employer is pulling out and there are for sale signs on every block in every suburb in every direction. I was lucky to get out with what I got-- but took a huge loss.
Good early lesson. For every real estate agent who “swears” that a property is a sure fire investment, there is a former owner who can attest to the fact that this is not always true. And the OP is someone who thinks equities are risky!!!
another issue to consider - I live in a medium size College town, capital, med school , law school etc… Knew few people who owned a few rental properties last 20 years (townhouse, condo)- rent to students after their kid finished… then post 2008 - several national developers built multiple student housing "complexes "(with pools etc…) in the area, someplace to park their money. fast forward 8 years later and these friends are all out of the college rental property business - some sold their properties at a loss. med , law, undergrad - why rent an older home/townhouse when you have multiple new apartment choices with amenities… so there are factors here beyond your control.
Good points on the potential pitfalls of thinking rentals will always be possible. In my son’s case, the newer apartments were not convenient too expensive for college kids (and may not have been willing to have groups of students) so the somewhat rundown cheaper homes remained in demands. I went to college in upstate NY and many of the former big employers have left, which undoubtedly impacted the real estate market. However, the rental market near the university and med school remained somewhat strong.
Such great info from everyone. I guess I am, a little naive on the real estate market nationally and all the things that happened with the bubble etc… in 2008 and after. This market is a university town, medical hub, law school, economic hub , and I have lived in the area all my life. The real estate market has just never took any big tumbles so I never thought of that being a possibility. I guess it could happen but I’m not aware that it ever has in the last 40 years. Thanks for everyone pointing out my blank spot there in my thinking. Still think we would be better off buying than paying $70,000 in rent in the next 5 years…
One of my first investments was buying a 2bdrm apartment to rent to my brother in Ann Arbor when he was in Med School. The apartment complex was within walking distance of the medical center and housed mostly med students, residents, nurses and technicians. Rules on passive investment losses were more generous back then and the rent my brother and his roommate paid made the investment cashflow neutral to positive. I could take depreciation so the property generated 0 taxable income. Also funny how I scheduled trips to check out my property on certain game days! When I sold the apartment after my brother graduated, it was an easy sell, and I made a decent gain that was magnified by the fact I only paid 20% down.
Sure investments bomb, but it sounds like you live in a very real estate price stable area where prices are reasonable, rent rates are reasonable and can easily support the $200k valuation. I’d just make sure you buy something relatively new, both for resale purposes and for less maintenance hassles and convenient to the university.
If it were me, I’d finance the purchase even if I kept the cash in a CD/money market because of the value of liquidity unless I had just a ton of cash on hand. Like I said upthread, you always have the option of paying off the mortgage or increase your monthly payments.
ShawD transferred after her first semester to a school near the Boston-area medical schools and lived in the dorm for the second semester of her freshman year. She hated dorm living and the terrible food in the cafeteria. She looked to rent an apartment and discovered that people did not want to rent a room in an apartment to an undergraduate. So, we bought a 2 BR condo nearby, in walking distance to the medical area. She lived in the smaller BR and rented the larger BR to two of her friends. We took out a mortgage, paid the condo fee, maintained it etc. Both her roommates and her 529 paid rent (the condo was owned by a family trust). This was probably net negative in terms of cash flow. But, we were able to take modest losses for tax purposes.
More importantly, the neighborhood is highly sought after and the condo appreciated substantially in value. We are now selling it, eight years later. There has been a very substantial appreciation. We will have to pay capital gains tax. We could do a 1031 tax-free exchange, but we decided to just pay the cap gains tax before the rates go up. Although we paid for her BSN/MSN with a 529 Plan, the after-tax gain comes pretty close to paying for 5 years of school.
It is hard for us to evaluate the returns you will get, but mortgage rates are very low. I think we came pretty close to breaking even in real time and then benefit from appreciation, if any.
It is really not that hard to figure out if it is better to rent or own. Just run the numbers on a spreadsheet. You can use various scenarios - from conservative to aggressive. It seems like you do know your local real estate market pretty well. Without knowing the location, it is hard for us to advise. This is a big country and there is no one size that fits all. It really depends…