Small Business Taxes & ManagementTM--Copyright 2020, A/N Group, Inc.
Buy or rent? When it comes to a house, the usual, quick answer is buy. A house is a great investment and, while your house payments may be more than rent, you're building equity (not much in the early years with a 30-year mortgage, but it grows over time). That's the argument for, but there are situations when buying doesn't make sense.
Factors to Consider
Job Stability. Buying may not make sense if you're moving frequently. The up-front costs of buying and the costs of selling can take a couple years' bite out of any profit. Get a good idea of the closing costs, any immediate fix-up costs, etc. before committing. The closing costs can vary around the country and with the price of the house. You won't recover much of them when you sell. The same is true for fix-up costs. If you've got to remodel the bath even before you move in, you'll probably be out a minimum of $8,000. You might not recover much more than half of that when you sell. If you're doing the kitchen, the number is going to be much larger.
Job stability is also important for projecting your income. If you're a professional or have a readily marketable trade, even in a small town you should be able to find another job nearby if your employer lays you off. If there's only one employer in town you can work for, you're on riskier ground.
Profit on sale.In part, any gain is much like playing the stock market. The idea is to buy low and sell high. Fortunately, market movement in real estate is less volatile than in the stock market. A bad earnings report, and your stock could be down 15 percent in a day. But it took close to 10 years for many properties to fully recover their value after the 2008 real estate crash. That's a long time to wait. Of course, some properties came back much quicker.
Where the house is located is often a big factor. As a result of the pandemic suburban locations have jumped in value; inner cities have declined. Some areas, heavily dependent on tourism have taken a disproportionately bigger hit. When things get back to normal will the trend reverse? A new factor is remote work. With more jobs workable from a home office, suburban homes have increased in value, particularly those with a home office--or a room that can be converted to one. This trend could be long lived.
Stretching your finances. Most younger couples leave the closing with little cushion. It's not unusual to stretch a budget to buy a bigger or better home. Don't forget to leave something for basic moving in costs. That could include renewing hardwood floors, replacing a garage door, etc. If you've had a house before you'll have an idea of the costs--if not be aware they can add up quickly. Floor work for a couple of rooms and a new garage door could easily be $2,500. Even the cost of a moving company could be $3,000. Some work can be delayed. The deck can be left to next summer, but moving furniture to renew the floors can add to the cost.
The mortgage lender will do an assessment of how much you can afford based on your income, but that may not take into account individual factors such as education expenses, medical bills, etc. That can take any cushion out of your budget.
Things are different if you've managed to accumulate a substantial stock portfolio or you have realtives with assets and they are willing to gift or lend you funds for an emergency. You may be able to get cash from your retirement plan, but that comes at a cost and should be used only after careful consideration. How handy are you? Maintaining a house isn't cheap. There's always some repair or renewal job needed. If you can do your own lawn maintenance and basic landscaping you might save $500 to $1,000 per year. Same goes for the swimming pool. Replacing an electrical outlet may only take half an hour, but you could pay an electrician $75-100. It all adds up. These items aren't much of a factor in a condo.
Where's your family? If you have older parents, or parents or siblings with special needs, locating nearby could be important at some time. That may not be a critical factor, but you may want to include it in your planning.
Leverage. This refers to financial leverrage. The less you put down on a house, the bigger your profit percentage if you sell at a gain. On the other hand, the less you put down, the bigger the risk should the price of the home decline. For example, you buy a house for $100,000, putting down all cash. A year later you sell it for $110,000 (we're ignoring expenses to make this simple). That's a $10,000 profit or 10 percent on your $100,000 investment. Now assume you buy the same house with only 20 percent ($20,000) down, again selling the house a year later for $110,000. That's a $10,000 profit on a $20,000 investment or a 50 percent gain. But that profit multiplier goes against you if the price declines.
Many conventional home loans require 20 percent down unless you get mortgage insurance. Insurance will increase your monthly payments until you can show the requisite amount of equity in the home.
Time at location. Some years ago the rule of thumb was that people, on average, moved every seven years or so. That's no longer true. Most people stay in the home longer. Telecommutting is likely to stretch it even further. Companies no longer want to pay out significant amounts to move an employee and the tax laws are currently disadvantageous for relocating. That's generally a plus on buying.
A good investment? Yes and no. Over a 30--year period a rough guess would be that you'd get a 6-percent return. Better than in a bank, but probably not as good as the market. But, even with the possibility your home could decline in value, it still carries lower risk than the market. Of course, some markets have done much better and leverage will increase your return. You've also got to consider you've got a place to live and, if it were not for the house, you'd be paying rent. Moreover, your mortgage payments are locked in, but your rent could increase every year.
Keep in mind that most homeowners make signficant investments in their property over the years, either in the form of capital improvements (such as an added bath, new landscaping) or in significant maintenance expenses. Your neighbor may have bought the house for $100,000 and sold it for $350,000, but he might have put in $100,000 over the years that he hasn't considered.
The motto may be, buying a lot more house than you need in anticipation of a big profit may not be a smart move, but buying a home instead of renting can be if you're willing to do some work and you're holding onto the property for four or more years.
Copyright 2020 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 10/20/20