With the economy perceived to be improving, and interest rates still historically low, people everywhere have gotten caught up in real estate fever. I’m no different, and have been doing my best to acquire as many properties as possible! Currently, I’m working on closing my third property within the last year. Clearly, everyone wants a piece of the American Dream, right?
So, what differentiates me from the masses of other homebuyers? What am I doing that’s so “unique” and “special”? Well, whereas most folks are flocking to secure their own personal residence (the giant house with the white picket fence), my version of the American Dream marches to a different beat — that of freedom.
If you’ve ever read Rich Dad, Poor Dad by Robert Kiyosaki, one of the major points he brings up is that a home is NOT an asset. The book has become mainstream, and I was even forced to read it in High School (kudos to my Economics teacher, Mr. Castro), but apparently the message has still gotten lost in translation.
So, let’s repeat this key point once again:
“A Personal Residence is NOT an Asset!”
The sooner this message gets across, the wealthier you will become!
Mainstream media, and even the president are constantly urging American citizens to invest in real estate. They say your biggest asset is your personal residence. This could not be further from the truth. If we go back to the basic definition of what assets and liabilities are, it’s this:
“Assets are things that put money in your pocket.”
“Liabilities are things that take money out of your pocket.”
So, then, how can a personal residence possibly be considered an asset? Owning a personal residence will not make you richer. Every month, you have to pay for: mortgage, property taxes, insurance, repairs/maintenance, etc.
What about the tax breaks for home owners? Yes, it’s true that interest payments are tax deductible. But how could that possibly be considered a wise investment? Would you pay your credit card company interest every month, just so you could reclaim a portion of it come tax season? No, you would never do that. You would use your hard earned capital to invest in real assets like stocks to put money into your pocket, instead.
But hold on. What about appreciation? That’s the ace up the sleeve that all homeowners hold, right? If you’re counting on appreciation to make you rich, you are playing a fool’s game. We only have to look back as far as 2007-2009 to see what can happen to folks who speculate on appreciation to make them rich. If the market corrects and the homeowner/investor can’t afford to make the mortgage payments, the end results won’t be pretty. That’s when the market will get flooded with short-sales and foreclosures. Whether you are a homeowner or investor, playing the appreciation game is akin to playing with fire.
The Numbers Don’t Lie
If you still aren’t convinced, let’s run some numbers to prove why investing in a personal residence is a losing proposition. This is especially true if you live in an expensive part of the country.
Everyday, I see co-workers excited about buying their first home residence. After closing, they truly feel like they’ve made it, and arrived in this world. They’ve FINALLY achieved the American Dream. I don’t say this aloud, but inside I’m thinking to myself, “congratulations! You’ve just signed yourself up to work for the MAN for another 30-40 years.”
The numbers don’t lie. Here in the Bay Area, a typical single family starter home looks like this:
Again, the price tag might shock you, but this really is the going rate for a starter home in the Bay Area. At $600,000, you really aren’t purchasing too much. It’s a single family home that was built in 1970, in a B neighborhood. The interior is in decent condition, but don’t expect anything remotely resembling turnkey.
So, let’s run the numbers as see for ourselves:
For a 25% downpayment, this requires you to have $149,750 in funds. Further, by “investing” in this home, don’t forget you are now also responsible for $376.25/month in property taxes. And don’t forget the insurance either. When you rent a house, you get accustomed to making a single payment to your landlord that covers everything (plus his profits). 😉 Most new homeowners make the mistake of assuming that the mortgage is their only bill. The total monthly bill ACTUALLY turns out to be $2812.64.
For the above calculations, I’ve left out vacancy and property management since these items won’t apply for a personal residence. For a single family home, you would most likely have to pay for landscaping and utilities, even if you rented, so these numbers really just wash out. They are set to $0 to keep things simple. Maintenance, which used to be handled by the landlord, would be another new expense for the new homeowner. Again, let’s keep things simple and set this to $0.
Now, suppose you ran the math and realized what a lousy “investment” this personal residence really was. At this point, you’d want to look onto Craigslist or Zillow and determine what the market rates for rent are in your area.
For this property, here is what Zillow found:
Rent is estimated to be $2421/month, which sounds about right for this area in San Jose. So, the difference between renting and buying comes out to be:
In this example, which applies to most of the Bay Area (and many parts of the country), by electing to purchase a primary residence, you will be throwing away about $400/month!
Yes, I realize the interest portion of the mortgage payments can be partially reclaimed during tax time. And I realize you can depreciate the home for 27.5 years, which is why I elected to throw away the maintenance costs. Still, overcoming $400/month difference is no small task.
But that’s not even the worst part about owning. Here are some other cons:
-Fixed mortgage payments. Try missing one mortgage payment, or property tax bill… you’ll see who REALLY owns the house.
-Exit strategy is dependent on state of economy. In a downmarket, you’ll have difficultly selling for “fair” value.
-Opportunity cost. In this example, that’s $400/month in investments you’re missing out on.
-Lack of mobility. You tie yourself down to a particular area.
And the worst part of all…
You’re probably signing yourself up to work another 30 years!!!
The Alternative Play
I often get asked, “How come you don’t own your own personal residence, yet invest in rental property?” The simple answer, going back to our discussion about assets and liabilities, is because my rental properties pay me! When I own a rental, I don’t care about property taxes, or mortgages, or insurance, etc. because my tenants pay for all of that. As an investor, I’m only interested in the bottom line, which is positive cash flow.
So, how would I attack the personal residence conundrum? I wouldn’t. I’d keep on renting. Actually, what I would do is re-define what the “American Dream” really is, and put that downpayment to better use! For myself, the American Dream is freedom. I desire to be free and not have to work for anybody. Owning rental properties will help me achieve this vision, as you’ll soon see.
This is what I would do with that very same $149,750 downpayment:
-Invest in two 2-flats in Chicago ($45,000 each)
-Invest in two single family homes in Indianapolis ($25,500 each)
Total Investment: $141,000
Which would help generate the following revenue:
-Chicago #1: $650.49
-Chicago #2: $650.49
-Indianapolis #1: $443.97
-Indianapolis #2: $443.97
Total Monthly Revenue: $2188.92
Please see this post for more details on investing in out-of-state properties (and for more details on the numbers).
What a HUGE Difference ONE Decision Makes!
Going back to our personal residence example, the Bewcastle property would have cost us $2812.64/month to live in, had we chosen to “invest” in home ownership. By electing to NOT buy, and rent instead, we could pick up that very same property (or one just like it) for $2421/month. By opting not to buy, we instead invested our downpayment into purchasing 4 rental properties. Our rentals now bring in $2188.92/month. Our cost to live in (but not own) Bewcastle has now been reduced to only $211.08/month.
Let that soak in for a minute. Now, instead of making regular monthly payments in the amount of $2812.64 for 30 LONG years, we only need to pay $211.08/month to live in the EXACT SAME HOUSE. Better, we own 4 rental properties that will one day be fully paid off. When that happens, the income stream will become overflowing!
Also, what this does is it frees up our future capital. And that’s really the most important point. Each month, we have an additional $2601.56 (we went from paying $2812.64/month in rent to $211.08/month) we can use to invest in assets, or on anything else we desire!
By accomplishing the above, we’d be able to basically live rent free forever after. We could even eliminate that $211.08 spread by finding another rental that was slightly cheaper. Or, If the local market’s rents increased, we would simply raise rents on our rental properties to offset any differences. It sure is nice to be in a position of power!
So, there you have it. You could follow conventional wisdom, be like everyone else, and be tied down to a mortgage payment for the rest of your life. Or you could continue renting, knowing that this is by far the better financial bet, and invest your capital more wisely elsewhere.
This is exactly what I’m doing. I’m building up my capital each month to buy more rental properties. As the rental paychecks come in, I simply let them snowball and work towards building up for the next downpayment. Lather, rinse and repeat.
In closing, here is a motto I’ve heard and believe to be most true: “Live where you want. Invest where it makes sense.”
The choice is up to you!