Is Real Estate a Good Investment in Today’s Market?
In today’s episode we will be talking about real estate! There are many ways to invest in real estate, including your personal home, a second home, rental properties, and we will even touch on interest rates today and commercial real estate. As we were processing this episode on real estate, we decided to dig deep into the word of God and there are many references pertaining to real estate in the scriptures! Of the many passages, one stood out in relation to this episode. Let’s read Proverbs 24:27:
“Prepare your work outside; get everything ready for yourself in the field, and after that build your house.” (Proverbs 24:27, ESV)
One thing is clear in this passage: the necessity of priorities! Look at this verse as concentric circles. Starting with the innermost circle (the number one priority), would be to prepare your work outside. The next few words explain the first few, specifically stating the need to prepare or get the field ready by way of using farming terms.
Here’s another way to state this passage: Before you build your house, which is the last part of this verse, you must first make sure your financial house is in order!
A new testament verse that touches on the same concept of Proverbs 24 is Luke 14:28-30:
“Suppose one of you wants to build a tower. Won’t you first sit down and estimate the cost to see if you have enough money to complete it? For if you lay the foundation and are not able to finish it, everyone who sees it will ridicule you, saying, ‘This person began to build and wasn’t able to finish.’” (NIV)
There are some great similarities here between these two verses. The principle is clear, count the cost! Make sure you have your financial house is in order. I would even go as far as saying don’t go into debt. Bring in the needed money first or as much as you can, before you begin building!
So in light of our topic of “ should I invest in real estate”, the first question that should be asked before investing in real estate is is, ‘do I have my personal financial house in order?’
Investing in Real Estate: Your Primary Home
Do I have my financial house in order so I can make a purchase of my first, and primary home? First, let’s talk about down payments on a new home.
- 20% of the purchase price is the norm for a down payment on a new home.
- It is important to know that if you put less than 20% down on your home purchase, you need to get PMI, (private mortgage insurance), which will increase your monthly payment until you meet that 20% principle.
- Real life house example: Let’s say you want a $250k house.
- Down Payment size: $50,000 (20%)
- You will owe the remaining $200,000 on a mortgage loan. Your monthly mortgage payment (30 yrs w/ 6.5% int) will be around $1,264.
- The average property tax in Pennsylvania (PA) is 1.58% of the property value. So for a $250,000 property, the estimated property taxes would be around $4,000/year depending on where you live. This would equal roughly $340/month.
- The average mortgage insurance in PA is around $100/month.
- Monthly PITI payment (principle, interest, taxes, insurance) = About $1,700/month.
The 28% Rule
When it comes to how much house one can afford, here is a good rule of thumb:
- The “28% rule” states that you should spend 28% or less of your monthly gross income on your mortgage payment (e.g. principal, interest, taxes and insurance).
- At the Life Institute, we recommend between 25 and 30% of your take-home pay going towards your PITI payment. Our preference is to make it closer to the 25% figure so that you have some financial breathing room.
- With the example above (regarding our $250k home) you should be taking home about $6,100/month ($1,700 is 28% of $6,100) to afford your mortgage.
Making a House a Home
A very important first step before purchasing your first home, or new home, would be setting up a detailed budget so you can see on paper what’s your income and expenses are currently, and what kind of adjustments can be made for a new home purchase mortgage and also getting settled into the new home. Expect to spend 10 to 20% of the purchase price to make the house a home! Paint, draperies, Hardware, furniture, fencing, and the list can go on and on and on! So count the cost. Many people can buy a house, but it takes additional income to turn it into a home!
If you can financially afford it, it is always good to make a house purchase instead of renting.
- For some, renting will make sense, especially if your job is transitory. But for many, gaining equity in your own home is a very wise choice.
- Most of the time (but not all the time) real estate, home prices go up, not down. But, real estate prices can go down. Here are some of the reasons why:
- The economy, the environment (including schools), maintenance, foreclosures and short sales, amenities, seasons, internal and external appearances.
What Makes Your Primary Home an Investment?
- It creates equity that you can later access if needed.
- Selling a home to afford a down payment on a bigger home.
- Selling a home to afford end-of-life care costs.
- You can make the house/property how YOU want it, rather than being chained to the landlord’s desires. (YOU are your landlord). You have the freedom to paint, renovate, and change things according to your desires.
- It creates a long-term financial expense plan. Once you sign a mortgage, you have a pretty good idea of what you will pay over the next 15-30 years. But landlords can increase your rent on a whim. A fixed rate mortgage will at least guarantee some consistency.
Investing in a Rental Property
Reasons why you should buy a rental property:
- Rental Income: After you have the house paid off, the income generated is an excellent passive positive cash flow.
- Property value appreciation: If you are holding onto property for the long-term, expect around a 3% or more increase in property value per year (average). There are some extenuating circumstances on what could make a property decrease in value so be aware of the environment around and the care of the rental.
- Tax benefits: Before making a purchase of a rental property, speak to a tax professional to see the tax benefits that you could have on the rental property.
Reasons why you should not buy a rental property:
- If you do not like dealing with tenants. There are complicated and difficult situations in which you could find yourself.
- Taxes tend to increase all too often!
- It may require a large amount of capital to make your first rental purchase.
- If You are looking at getting rich quick… Rentals are not for you!
Investing in a Second Home
Maybe you have purchased your home and have adequate income and resources to consider a second home, or a vacation home. Would this be a good choice?
“If having a second home, or a vacation home will improve the quality of your life and build great family memories, you should consider buying one,” Vander Stelt says of vacation homes. If you will only ever get to use the home less than 30 days of the year, stick to renting other people’s properties. Let them pay the taxes, maintenance, insurance and mortgage.
Here are some reasons to consider a second home property.
- If you’re looking for an investment property. Just remember that during an economic downturn, second homes and vacation homes are usually the first to be liquidated, which would reduce the income potential of that home .
- If you believe that you can make money renting it out during the times you will not be using it, consider doing so!
- Remember, if this is a second home, you will save on vacation expenses!
- You can take longer vacations because you own the home!
Here are some reasons to NOT consider a second home:
- It is expensive! Mortgage, taxes and all the monthly bills all add up very quickly.
- If you spend money on a second home, it is money you cannot spend elsewhere. Think through your personal budget end up coming expenses prior to diving into owning a second home!
- The location may grow old! Your dream place may become tiring after a while.
- Remember, you will have to maintain two homes now, and that can be costly. And, this second home, you will have to keep secure since it is not a primary residence.
- Are you a slave to work? Do you take your vacations? Most people do not use their full vacation time, so if you’re not going to maximize your vacation time can consider renting over purchasing.
- Do you have a good current income stream to afford this second home? It would be wise to have multiple income streams, or a very strong cash flow and a financial backup plan if you are looking at a second home.
- Is this a property where your family will enjoy it also? Or, is it just your dream? Make sure if you are married and have kids, that this would be a good choice for everyone.
- Remember, you need to have a positive cash flow in order to not have this second home be a burden, especially if some financial needs for the immediate family/home become a priority.
Here is a critical question: Do you have a sufficient down payment to make this home purchase so that your monthly payments will not exceed your overall cost of taking care of your family?
What About Interest Rates?
For the investor:
According to Investopedia: As mortgage rates rise, the effect on real estate investing can be positive. The market for rental properties will increase because fewer people can qualify for mortgages. That said, rising interest rates reduce prices, so it can sometimes be better to buy during a rising interest rate environment.
For the homeowner:
“As rates go up, the amount of home you can afford goes down. For every 1.00% increase in interest rates, your buying power decreases by about 10-11%.” (Mortgage Insider)
“For example, let’s say you can afford $1,252 on your monthly principal and interest payment. With a 30-year fixed loan, a 20% down payment, and an interest rate of 4.75% (assumed APR of 4.87%*), you could borrow $240,000 to purchase a $300,000 home.
But if rates go up to 5.75% (APR 5.88%*), the amount of home you can afford decreases to $268,100**, causing you to lose $31,900 of buying power. That’s a lot of buying power!” (Mortgage300)
Let’s answer the question: Should I Invest in Real Estate? Assuming your financial house is in order, YES. Whether it is creating a home for your family, securing a getaway home for your family, or creating passive income through rent payments and appreciation, real estate can be a powerful investment vehicle. Just be sure to have your own financial house in order before committing to something you may not be able to keep up with. It would be wise to talk to a financial professional if you are considering investing in Real Estate.
However, if your financial house is not in order, consider talking to a financial professional to figure out how to get on the right track.
This can help you honor God with the resources he has entrusted to you.
As we wrap up, I would like to circle back on the two passages of scripture that we began this episode with…
- Prepare your work outside; get everything ready for yourself in the field, and after that build your house. (Proverbs 24:27, ESV)
- “Suppose one of you wants to build a tower. Won’t you first sit down and estimate the cost to see if you have enough money to complete it? For if you lay the foundation and are not able to finish it, everyone who sees it will ridicule you, saying, ‘This person began to build and wasn’t able to finish.’” (Luke 14:28-30 NIV)
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