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Top 10 Reasons Rich People Own Real Estate

March 1, 2009 by  
Filed under Featured

Money

  1. Rent vs Buy : You are building equity. A 30 year mortgage means at the end of 30 years you have paid off the loan. The house is all yours. If you had a fixed rate mortgage, then that was 30 years without a rent increase. If you were renting, then you paid off your landlords mortgage, and your rents went up year after year.
  2. Value Appreciation : In the short term, we have seen prices drop. In the Maryland area, the price drops have been relatively mild. Prices have dropped the equivalent of going back four or five years. Looking back ten years prices are still double now than what they were then. There is the cost of ongoing maintenance, but a maintained home 30 years from now is likely to have quite a bit of value. Where are all those people that have decided not to buy going to live? They all have to rent from someone.
  3. Leverage : From three and a half percent down with an FHA mortgage to the classic 20% down of the no mortgage insurance conventional loan, you are controlling the full value of an asset by paying only part of the cost up front. A dollar invested in a 20% down mortgage means one percent value appreciation translates to 5% return on your dollar. That is five times the gain. This is a two edge sword, as the value can drop too. But, in the long term the increases have been greater than the drops. Of course the down payment is just the start, you have to make ongoing mortgage payments. The alternative however has you making ongoing rent payments. The scenarios where your rent payments are substantially lower usually means apartment living, or are a temporary situation that can’t be counted on for the long term. So your ongoing housing payments are part of your budget one way or another. Investors see leverage as a way to pyramid into more rental property owned than they could buy with cash. With 20% down it might seem like the investor can buy 5 properties, but since the tenants are paying a substantial part of the mortgage, a much higher ratio is possible.
  4. Forced Savings : Financial planners tell us that a necessary ingredient to building a nest egg for the future, is to pay yourself first. Putting money aside for savings should be a budget item like food. Yet, the reality is that much of us don’t follow the advice. Budgets stretch thin, and savings is the first to go. Well, every payment to your mortgage includes a bit of principal. In early payments most of what you pay is interest, but by the last payment, most of what you pay is principal. The principal payments are what lower your loan balance and increase your equity balance in your home. Home owners without any financial discipline still are managing to save through their mortgage payment.
  5. Better Interest : Interest rates on fixed rate mortgages are at historical lows not seen since the 1960’s. Still, interest paid on your savings account is much lower than the mortgage rates. The reward for putting money into your savings account is pretty slim compared to under your mattress. Putting extra money into your mortgage payment for most mortgages is a payment towards your principal. One hundred dollars extra is one hundred less dollars owed on your mortgage. If you have a 6% interest rate, that is like getting 6% on your hundred dollars. And you don’t have to pay income tax on your “earned” interest, so the compounding effect on your savings is not diminished. On my first home, I was paying 10.25% interest. But, I figured out that adding $100 to a particular payment, meant a bit more than two payments that I would not have to make at the end of the loan. My mortgage payment was about $900, so I saw that has $100 paid now is $1800 I won’t have to pay later. That is a pretty good return on $100 and was pretty motivating. My pay myself first plan was given a healthy boost with this. The power of this is strongest at the beginning of your loan, since most of your payment is interest. As time goes on, more and more of your payment is principal. But, when those times come, the new motivation is watching the loan balance drop substantially with each payment. Realizing how much of your payment is not lost, but just stored as equity is a great feeling.
  6. Control : Do you have money invested in GM, but wish the company had invested in making more fuel efficient cars? Maybe you own stock in Starbucks, but wish they didn’t open so many stores so near each other. Stocks as an investment means putting your faith in the current and future decision making of other people. The value of your home is not completely in your control, but you do have substantial control. You can take an ugly duckling of a house, and give it some tender loving care, and transform it into something magic. Many times these changes don’t have to be that expensive in the scheme of things. You really get to see the value of your house when you try to sell it. Fresh paint, with Martha Stewart colors will get your home noticed. So many homes are filled with clutter when they are for sale, that if you stick stuff in storage, your home will compare nicely. You can add gingerbread and moldings to upscale a house. You can add insulation and reduce your heating bills. There are so many ideas for increasing the value of a house, that I will stop here and make that a future blog post. The best part, is you can make the improvements now, and you too get the benefits of enjoyment. That is powerful motivation.
  7. Wide Market : Everyone needs a place to live. That means we are all potential home owners. Even gold isn’t all that interesting as a practical object to that many people. When you want to sell, you benefit from the wide utility of real estate. Aside from the home owner market, there is the investor market. Many investors see the value of owning multiple rental properties. You can rent your property outright, or if money was tight, you could rent out a room, or storage in the garage. Thirty years from now people will likely still be living in homes.
  8. Financial Cushion : Life is not predictable, and sometimes times get tough. The equity built up in your home is real money. There are plenty of mortgage products that will let you borrow against the equity to get access to the money without selling. For retirees there is even something called the reverse mortgage. This can allow someone to get ongoing payments from their equity into the retirement years. But, if you have to, you can sell the house. The Realtor professional is there to help you in this transaction. Many people have been thankful for the financial safety net they built by owning their own home.
  9. Liquidity : Real estate is widely criticized for lack of liquidity. But what is the story? A market valuation of real estate makes some assumptions. Comparable homes that have sold are used as a guide to establishing value on a house that has not yet sold. These sold homes were on the market for a number of days before a buyer found them and bought them. The estimated value assumes you are going to have this house on the market for about the same amount of time. Liquidity implies converting to cash in a short amount of time. A house is not your best choice to park short term funds. But, if maximizing value is less important than ready cash, you can sell a house in a surprisingly short amount of time. Even in slow markets, homes are selling. If you price your home low enough, then you are cutting in line so that your home is the one likely to sell next. Another option is to auction your home. This can be with a reserve price, or without one. And, as we discussed earlier, there are loan products for getting money out of a home.
  10. Tax Savings : Rent is 100% your money spent. Mortgage interest on your first and second home is deductible on your taxes. The Government is subsidizing home ownership through tax policy. To get this benefit you will have to itemize your deductions. The points you paid for your mortgage are deductible. The local property taxes are deductible. And, now that you are itemizing, ask your tax preparer what other itemizing deductions are possible. When it comes time to sell, if you have substantial gains in the value of your house, you will be delighted to know that under common circumstances you will owe no taxes on the gain. The small print is you must live in the home as your principal residence in at least two of the last five years. Single payers can shelter $250,000 and married couples can shelter $500,000. If you moved every two years, you could get this benefit every two years. Also, every dollar spent on improvements raises your basis and is tax free when you sell for any real estate. If you are an investor, you can sell one property and defer the gains into a replacement property with a 1031 exchange. This is powerful but technical, so seek competent advice. The investor also gets to depreciate the value of the house over time. Depreciation allows the rent payments to go substantially toward mortgage payments without having to pay income taxes with the money first. Claiming depreciation lowers your basis and thus increases your taxes when you sell. Taxes were just deferred. If you convert your rental into your primary residence, say in retirement, then you can shelter some of these gains with the same $250k/$500k benefit I mentioned above. That has its limits. Consult a competent tax adviser for all these items. Tax policy has changed many times over the years, but home ownership has been politically popular for a while.

I created HelpShop.com to be a tool for home buyers and sellers, investors and resident owners. With it, you can zero in on the hidden deals and the best homes on the market. HelpShop search let’s you really understand the market. Jump right in and try the search, or first watch some video tutorials that give a small taste of what the search can do. I will continue to add to the site, including more tutorials. If there is something you would like to see, give me some feedback.

When you are ready to see some houses in person, we will be happy to schedule the showings. My wife Maggie and I are low pressure Realtors. We are here to help you reach your goals. When you need us, send us a note, or give us a call.
 
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Photo credit, Andrew Magill