The Real Estate Trap: Don’t fall for bad advice
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If you look around you, it might seem crazy not to be buying a house right now.
In parts of the country, people are in bidding wars, homes fly off the market, and house prices are rapidly increasing.
But real estate is not always a good investment. It’s important to consider all the angles before making what's usually one of the largest purchases of your life.
Advice Isn't Always Good
Often, friends, family, co-workers, or even your realtor will provide real estate advice. But it isn't always good input.
Before buying, make sure you consider the following pieces of common real estate advice that may instead be the worst guidance you could follow.
Questionable Advice #1: Buy a House as Soon as You Can
It’s easy to feel like you’re missing out on the benefits of real estate if you’ve been renting for a while.
In our society, buying a house can feel like a rite of passage, a box to tick off on the way to adulthood, along with a job, marriage, and kids.
When you’re just starting, you may think you should be saving up a downpayment for a house so you can get off the renting train and enjoy the benefits of real estate.
But there are lots of reasons to delay your first home purchase, aside from financial ones.
First, when you’re younger, you’re probably not as established in your career. Your current job might not be your career-making job. You may be required to move, perhaps even several times, for other opportunities.
Owning a home not only makes it more difficult and expensive to move, but it also creates a psychological hold over you.
You may have to pay a fee to break your lease, but you can give your landlord a few days’ notice, then pack up your things and go.
But if you have to sell a house, you’re more tied down. And you may not be as willing to take a chance on a job in a new location.
Second, your priorities will probably change, perhaps even drastically, during your 20s and 30s. If you plan on having kids, you'll most likely choose a house, at least at some point, by its school district.
If you grow your family, you may need a larger home or value the number of bedrooms differently. If you adopt a pet, your backyard requirements and distance to the park will undoubtedly change.
Most people forget that selling a home can end up costing up to 10% of the purchase price, with realtor fees, closing costs, taxes, and repairs.
While your home might appreciate, it also might not (more on that below).
When you review an amortization schedule, you realize the first few years of living in a home are the most expensive due to high mortgage interest levels.
That’s why you won’t build up a lot of equity in your first few years of owning a home.
To avoid selling in those first few years, make sure you don’t rush into buying a house, especially to avoid FOMO – the fear of missing out on homeownership.
Questionable Advice #2: Buying is Cheaper than Renting
While a mortgage payment can sometimes be less than the cost of rent, you have many more costs to factor in as a homeowner than as a renter.
First of all, you need to think about the yearly cost of property taxes.
Property taxes are usually thousands of dollars, averaging 1.1% of the price of your home nationwide. However, that can vary widely, depending on whether you live in a state like Alabama (.4%) or New Jersey (2.2%).
In New Jersey, when you buy a house for $350,000, you’ll need to pony up $7,700 per year in property taxes. Ouch.
You’ll also have home insurance averaging .5% of your home’s cost per year. Even if these costs are included (escrowed) in your mortgage, you’ve got other costs to consider.
The highest and most unpredictable costs as a homeowner are maintenance costs, which most experts estimate are 1-3% of your home’s price yearly.
When you’re renting and your roof starts to leak, you just call your landlord. But if you own the house, you may be on the hook for replacing your entire roof.
In some areas of the country, like Manhattan or San Francisco, renting makes a lot more sense than buying. Use this Rent versus Buy Calculator to help you run the numbers on buying versus renting.
And remember, when you buy, you’re losing one of the key benefits of renting–flexibility.
When you rent, you’re able to move around much more quickly than if you have a house to sell. There’s also a good chance it will cost you less to move.
Questionable Advice #3: Buying a House is a Great Way to Build Wealth
Kristy Shen, co-author of the book Quit Like a Millionaire: No Gimmicks, Luck, or Trust Fund Required, felt pressure, from her parents, friends, and family, to buy a house as soon as possible in the pricey Toronto housing market after graduating college and getting a job.
After looking at run-down homes costing $500,000-$1 million, she and her husband, Bryce Leung, opted out of buying and invested their money instead.
That decision allowed them to retire early and travel the world since they were debt-free.
They write in their book,
The typical family who keeps the majority of their net worth in their property never accumulates much money. They think they’re getting ahead as they see [the house] value go up, but they don’t realize that all the extra costs add up to the point where most of their gain has vanished.
Shen and Leung realized that even when you buy a house outright with cash, there are so many costs for homeowners you cannot accumulate as much wealth as you think over time.
Also, there’s a problem with liquidity. If you want to access the equity in your home, you would have to sell it or take out a home equity line and pay interest.
In many markets, home prices have shown strong appreciation. But your ownership costs can eat up almost all of that gain. Maintenance on your home can be about 1% per year.
Homeowners Insurance is about .5%, property taxes average 1.1%, and on top of that, you pay interest on your mortgage.
What about the wild appreciation that can occasionally happen in different markets?
Counting on future appreciation is not a sound investment strategy; it’s a form of speculation.
While you could purchase a home and hope it appreciates, it could just as easily depreciate. Something that happened across the US in 2008-2009.
A Stanford research team calculated the loss in net worth for the average American family during this period at $200,000 due mainly to the tremendous drop in home equity.
If you want to build long-term wealth, the US stock market has a historical appreciation of around 8% per year. And you can find index funds only charging you .05%.
When you’re looking to build long-term wealth, there are much better ways to do it than using your primary residence.
Questionable Advice #4: Real Estate Always Appreciates
“Just buy a house already! Real estate always appreciates, so if you have to sell, you’ll just make money!”
For those who owned real estate during the 2008-2009 recession, the fallacy behind this argument is clear. Appreciation varies wildly by market, and home prices can stay essentially flat for decades.
DQYDJ used the Census Bureau’s data on median new home sales and Shiller housing price index data to show a mere 1.9% increase in average home prices from 1953 to 2020.
That’s before considering how much larger new homes are today than in 1953.
While many real estate markets have shown steady appreciation around the 6% mark over several decades, that doesn’t guarantee your market will continue to increase.
What about markets showing wild appreciation, like San Francisco?
Bay Area Market Reports show that from 1984 to 1990, the San Francisco real estate market appreciated by an astonishing 100%, only to drop 11% after the 1989 San Francisco earthquake.
From 2002-2007, the San Francisco market appreciated by 59%, then dropped 27% during the Great Recession.
Since 2012, the market has appreciated by 88% thanks to the Tech Boom, but Covid could spark a new dip in prices.
While the San Francisco real estate market has appreciated tremendously since 1984, several unanticipated events caused housing to depreciate steeply.
These events–the San Francisco earthquake, the Housing Crisis, and Covid-19–were “black swan” events: unexpected, unpredictable events causing massive drops in the housing market.
If you planned to sell your home during one of these downturns, you would have either had to take a steep decrease in your home’s appreciation or wait and hope your home’s value went back up in the next few years.
Like the stock market, the real estate market seems to be a market where a “Buy and Hold” strategy is best. But, to access the appreciation in your primary home, you’ll need to sell it.
And even when you downsize, if you stay in the same area, other houses have appreciated as well. Meaning you’ll be paying more for your next home too, or needing to move out of the area to a lower-cost-of-living part of the country.
While many houses and buying situations can be beneficial for home buyers, even for your primary residence, don’t assume that buying a house is guaranteed to be a good investment.
Remember, you're making a substantial financial commitment when you buy a home. So take the time you need to make a thoughtful, rational decision, and make sure to get lots of unbiased opinions before making an offer.
Article written by Laurie
Laurie is a team member of Women Who Money and the founder of The Three Year Experiment, a blog about building wealth in order to become location independent.