Should I buy a home before RE investing?

General Real Estate Investing
1

I pay approx. $630/month for rent. I pay approx. $800 for rent & utilities. I live in a nice area in the Dallas (1 block from million dollar homes). I’ve seen people make the statement that you should first buy your primary residence, then invest in real estate. But what advantage am I getting in this situation.

I know you will get a tax break. But let’s say I buy a house that has a mortgage around $1,000. And taxes and insurance adds another $300. That means I’m paying $1,300 not including utilities and maintenance/repairs. In the apartment, I can always call the maintenance personnel.

Does the tax break savings make up the difference between what I pay for the apartment and what I would be paying for the house? What other reasons would having a home benefit me in RE investing?

Terrell Owens

2

Generally speaking, the answer is yes, you should buy your own property before trying to invest in REI. However, there are literally a ton of “IF’s” to quantify that response. Just a few:

IF you actually want to own your own property. This is the biggest ‘IF.’ To buy a OO prop just to ‘get a tax break’ isn’t a good enough reason to buy. If you don’t want to own your own property, then it isn’t doing you any favors by buying one.
That said, owning your own property has many more advantages besides tax breaks (though, using your figures, you’ll likely come out ahead figuring those in, but that is the job of your tax pro). Just one, you build equity (hopefully, bought right and already have equity) in your property. Equity can be turned into available cash. Cash is King.

IF you intend to stay in the property for at least 2 years. That is the current tax law time frame to get a major tax break on selling. After 2 years, up to $250K (single) or $500K (married) of profit is not taxable. That’s major! In fact, I know of an investor that makes his living buying a property, living in it those 2 years while rehabbing, then selling. Tax free income.

If you ever plan on owning your own property. Most people that want to invest in REI never buy the first property. Those that do never buy another. If you want to own your own property, then play the odds and buy yours first. You can use it as a pretty safe buffer learning experience. Try to buy a fixer/investor type property. That way, if you do good, you get tons of equity and are off to a great start. IF you blow it some, then it’s your personal res and you’re still not as bad as some people at this point because you at least TRIED to buy at a discount.

Raj

3

For an accurate comparison, you have to compare apples to apples. You can’t compare your apartment rent to the cost of single family homeownership.

Instead, take the house that you could purchase. Let’s estimate your mortgage, taxes, insurance, utilities, and upkeep at $1400 per month. If your loan payment is $12000 per year ($1000 per month), then you will have probably paid $9600 in mortgage interest. If you are in the 25% tax bracket, and are able to itemize your deductions. the home mortgage interest deduction will reduce your income tax bill by $2400. This makes your effective cost of home ownership $1200 per month. The property tax deduction may further reduce your tax bill by another $300, further reducing your effective cost of home ownership to $1175 per month.

Now, the question is how much would you pay in rent to live in that same house. If the market rent is less than $1175 per month, then I would suggest that you rent and invest the difference.

Of course, as a renter you sacrifice the appreciation a homeowner would receive, but in todays climate, I don’t expect market values to appreciate very much over the next few years if your market reflects the national averages. So maybe renting your $800 apartment is the better decision for you for right now. That $175K house may still be available for $175K a couple of years from now. When your local housing market improves, purchasing your primary residence may make more sense, but for now, I think I would continue to rent in your situation.

4

Why not buy your first home as you would an investment, which is to say, look for an opportunity to build equity through buying at a discount and/or fixing it up?

The interest on your home is tax deductible, so look at the after-tax cost of home ownership when figuring the monthly cost. Also, if your area is appreciating, you can enjoy that, too, whereas with renting it is not possible.

You’re smart to look at both sides, however. There are certainly cases where renting makes a whole lot more sense.

5

There are also various down payment assistance programs etc that are only available on your first home purchase and that must be owner occ. You don’t want to lose those benefits by buying your first peice of real estate non owner occ. Talk to a mortgage broker about these programs.

6

yes, that is the place to start in my opinion and allows you to gain some experience. Prchasing(or selling for that matter) is a multi-step process with many possible forks in the road. You need to know how to handle those.

also, I’m a big believer in NOT trying to time the market. Yes, I buy on cycles, but not trying to time to buy “at the bottom” becuase utlimately you will not know your are at the bottom until its already past. Rather this is now a buyer market and you need to position yourself to be bear sitting by the side of the stream waiting for the fattest, tasty salmon (deal) to swim by. After you have gone out and looked at 50 or 100 houses and considered what the market is doing, you will being to understand what that salmon(deal) might realistically look like.

Also, if you have a reasonable time horizon of the few years then , if what you purchases goes down, then so what?. As long as you keep making payments you will have a roof over your head and appreciation will come.

I was hiking with a guy the other day who told me how he bought in the 90’s in SoCal and got under water as the market further declined. He stuck it out, took on roommates, etc and still owns the property (got about 3x appreciation after many years of pain). His buddy got cold feet, bailed out and went back to being a renter…and still is one today more than 10 years later (and probably always will be).

I purchased my first home in 1994 for $82k (3BR, 2ba ranch). More than 30+ deals later, I own 2 residences and more than a dozen multi-unit properties. You have start somewhere and your own home is a good place.

7

P3G, I didn’t want to buy right now (as house prices are dropping like flies.) so I had to look at the long term advantages for my situation. Real estate investing or not, I don’t have to deal with not finding a parking space when I come back from the ER w/ a kid who had a 104.8 temp. busted waterbed overflows etc. etc.

If you can, buy with equity. Another perspective or two - don’t buy ‘dirt cheap’ (unless it’s in a desirable neighborhood, and the numbers work to rehab it) buy dirt cheap value.

… buy the house the next buyer wants. Another is to think of your house as a low-interest credit card that you can live in.

I also had to get comfortable with the price tag of my home. The last time I purchased, very large homes were going for a little over 100k. Now, starter homes are over 200k. You also may have sticker shock of sorts.

Buy efficiently, I love free cash flow, so I was in the same spot as you, analyzing why I should buy. Think like an investor. Even with modest credit, you have a little tool in your back pocket - a house key. 3-6 months on time MORTGAGE payments vs. rent payments says a lot about you, and your character, to a banker.

Keep your DTI good, and cash flow - i.e. not at the tip top of affordabliity. I bought a starter home with rich neighbors. What do I see for the future? A couple or young family will want to come here to enjoy the benes of the school that the taxes and perceived value of my wonderful neighbors added to the community.

Research your local landlord/tenant laws. Then get yourself a roommate. Let them pay your mortgage. Rent that basement or attic level in your house.

Check your local “Your town” center. Soo many free programs, incentives, closing help… promote your state flower fund … ok I 'm exaggerating. You could own and keep your acquisition costs very low.

Then set that cash aside, accumulate - if you haven’t already - liquid reserves for living expenses/emergencies, then buy as much value stock as you can … CFC, Toll, F, – remember cyclical… I also found benefit researching what stocks were profitable during the depression. Not to say we’re going to that extreme again, but as recession looms… I sought to research which were the companies that were profitable. ca ching.

As for education… or anything else for that matter… go free and/or low cost. The library is Sooo overlooked. I prescreen what books I can there for free. Then order if it’s a keeper, or I have more than 5 post it tabs when I read it. Property manager’s book is worth getting w/o the prescreen. The basis of that decision was… how long would it take me to accumulate all of his posts and read. and /or how big a blunder would I have made if I hadn’t spent $ to know better 1st.

If you don’t know about stock investing… again, library.

Another way to cut expenses, frugal living. Research the websites on the topic. Lots of useful ideas. You may not be into line drying your laundry to save money by not using a dryer, but you get the idea. I made a substantial cut my grocery bill for a family of 6 using some of their tips.

I made a game of it. Remember to keep your goal in mind, and adjust your perspective when you hear yourself getting negative, doubtful, or uptight.

Ask, How can I prosper from this? What can I do to be ahead of the game when this opportunity presents itself again? etc. Scavenger hunt for home furnishings. Make it a big cheesy used car commercial… how loooow can u go.

good luck and keep postin.

8

Thanks everyone for your replies,

I know by owning a home I can build equity and get assistance with down payment & closing costs. But I can save a lot of money right now for investing if I am renting vs buying a home. There are pros & cons on both sides. Maybe the best thing to do is “buy right”, then go from there. And to save as much capital as possible.

And, yes, education is key.

9

Analyze your opportunities. I expect residential real estate appreciation to run about 1 or 2% per year for the next three to five years.

The rental property and the primary residence in the same neighborhood will both appreciate at the same rate. Which will give you the better total return on your money – the rental property with a positive cash flow and tax benefits, or, a primary home that only gives you a tax deduction?

In a rising market, the “buy your own home first” advice is usually correct. We are not in a rising market right now. Home prices have not bottomed out, yet. When your choices are rent and invest in income producing properties, and, invest in a primary residence, the better option in this market is to continue to rent for the next couple of years.

Just how I see it.

10

Generally sound advice. However, we’re not speaking generally. We don’t know Where’s My Money’s market at all. It may not be a depreciating market. I don’t buy into the ‘National market’ theory of value. A lot of a decision on what to do or not will depend on the market.

However, choosing to continue to rent, or rent and buy rentals, just because the market is flat or declining, in and of it’s self, isn’t a good reason to not buy your personal home first.

IF you follow the same principles that you would need to follow to buy an income producing property for your market when you buy your personal residence, then likely you would almost always come out better than renting. Chances are the your real world numbers of monthly rent vs. monthly bill would be cheaper AND then add in the tax benefits of owning creates a wide margin of difference. Add to that that by choosing to buy a rental/investment first, he would lose ALL of the first time homebuyer options if/when he decides to buy a personal res., the decision to buy investments first shouldn’t be taken too lightly.

Raj

11

My opinion would be to buy a duplex but buy as you would any investment property meaning you make your money when you buy it. This will give the experience of buying, renting, and investing. You get the benefits of the property being OO on the mortgage side and the tax breaks from the government for it being a rental.

Cake

12

Roger, I have a different perspective on this point. You may be right on with your advice. I just want to play devil’s advocate.

Your personal residence is not an income producing asset. In a declining market, you lose money as market values decline. Depending upon the rate of decline, the tax benefits may not be enough to keep you at breakeven. If you have to sell in three to five years, then sales commissions will likely put you in the hole. In WheresMy Money’s stated situation, his monthly rent is less than half of his cost of home ownership. No way that tax benefit of home ownership is greater than the savings he is enjoying by renting.

I agree that there are a few decently appreciating markets in the US. Nevertheless, I expect the national rate of residential real estate appreciation to average no more than 2 percent for the next three or four years. This rate of appreciation does not even keep up with inflation. If WheresMyMoney’s market is flat or low growth for the next two or three years, then he still comes out ahead by continuing to rent.

The money he is saving by renting can be used to invest in income producing assets. Even in a flat market, rental property can provide a decent return on invested cash and total net after tax income with a rental property will be greater than if he used the same property as his primary residence. When WheresMyMoney’s market gets stronger, then purchasing a primary residence could still yield a positive return on his invested capital if has to sell in three to five years.

13

Dave, I don’t disagree with the the point IF that point matches the facts, which we don’t know anything about.

For instance, his rent is less than half according to HIS figures, more than likely comparing what he is renting now .vs what he WANTS to buy. Did he follow your advice earlier and compare apples to apples? Don’t know.

To make your point valid, you have to have two basic assumptions about what will happen. One, he would buy a primary residence at current market value, and two, he would buy income producing properties at a big enough discount to actually produce cashflow.

Now, if the goal is to become an investor, why would you look for a primary at retail? One of the goals in buying primary first is to use it as a fairly safe method of learning the trade/market. Look for a major discounted (either offered or negotiated) property. That said, if you bought at 60-70% of current value, it would be difficult to NOT make money (and I wager MORE money than a rental) in 3-5 years, especially if you add in the tax breaks (especially the sell break).

The second assumption, buying cash producing properties, is a much larger assumption. Being new to the game and in a sluggish market, chances are good that that is NOT going to happen. It’s hard enough for experienced investors to find true cashflowing properties.

Finally, there’s a third assumption. That if he buys a rental/investment first, he will buy more later. However, data doesn’t back that up at all. Some 90-95% of wanna-be investors NEVER buy a property at all. Of those that do, some 90-95% NEVER buy another property.

Cake probably does have the best solution. Seek out a small multi (2-4 units) as a primary. Work it like an investment purchase (ie, get a deal) AND you can still get first time homebuyer benefits, AND tax breaks for homeowner AND investor.

Raj