Homeownership and real estate

Written By Franky Yea

Very sensitive topic. Many people’s retirement plan are tied to home ownership. Put all their golden eggs in a single basket. Our goal here is to open your perspective on the subject and make your own investment decision.

Traditional Mentality: Study, work, buy house, pay off your house, retire happy, give house to your kids.

  • “Safe” “Stable” “Everyone understand” “Socially acceptable investment” “That’s how life is.” “Save money on the rent” “Renting is for poor people” “Renting is paying someone else mortgage.” “Real estate always go up.” “Stock market is risky”

New mentality: House is a real-estate investment part of your portfolio.

  • Illiquid investment (Hard to get in and out) + high transactions fee

  • High initial capital investment (20% downpayment)

  • Save on the rent

  • Can bring passive income

  • Lots of tax regulations and incentives

  • Inflation argument: Borrowing money now, which have more purchasing power than in the future.

  • Leverage argument: You put in 20%, “invest” with 80% more. (5x leverage)

·       e.g.: Down payment 100k, but borrow 400k = 500k total.

·       4% return on 500k = 20k

·       20% return on 100k = 20k

“Fear is just a lack of understanding.”

(1) Read article “Why houses are a scam?” by Millennial Revolution

TL;DR Article on not buying a house. Strong opinions on house as a life investment. People don’t know much about investment and just stick with what their parents or friends know: House.

(2) Define what does “house” mean to you.

  • Some life dream is to “own” a house. Feel the “security” of not paying rent. Knowing you have a physical place you can call “home.”

  • For others, it’s just another investment projects, which can bring passive income and have 5x leverage.

  • It helps to cover your insecurity about life’s success.

·       “At least in this lifetime, I succeed by owning a house.”

  • It increases your “Sexual market value”. Own a house, car and insurance shows financial stability, which makes a good provider as a potential mate.

(3) Crunching numbers - Buy house or rent?

Now that you know “why” you are buying a house.

Should you buy or just rent?

PWL 5% rule:

  • 5% rule: “Take the value of the home you are considering, multiply it by 5%, and divide by 12 months. If you can rent for less than that, renting may be a sensible financial decision.”

    • For example, you could estimate about $25,000 in annual, unrecoverable costs for a $500,000 home, or $2,083 per month.

    • e.g.: 500k house * 0.05 / 12 months = $2,083/ months

    • e.g.: 300k house * 0.05 / 12 months = $1250/ months

      • Conclusion: I should be indifferent between renting at $1250/ months vs buying 300k house.

More complex analysis:

  • Compare:
    someone who rent and use the downpayment and any additional expenses to buy S&P 500
    vs
    someone who buy and rent the house

  • Rent case:

    • No need account rent, assuming the house buyer rent too.

    • Mortgage downpayment + initial cost of owning a house -> invest in S&P 500

    • Yearly cost of owning a house -> invest in S&P500

  • Buy house case:

    • No need account rent, assuming the house buyer rent too.

    • Cash flow in: rental income

    • Cash flow out:

      • Downpayment on house

        Home appraisal fee

        Home inspector fee

        Title insurance fee

        Lawyer fee

        Land transfer tax fee + (First home buyer rebate)

        Sales of house

        Pay back remaining mortgage

        Realtor fees 5% fee + HST

        Break mortgage fees

        Property tax

        House insurance

        Utilities (electricity, gas, water)

        Rental income

        Mortgage payment (Principle + interest)

        Maintenance: Roof, HVAC, (1%)

  • After running some data on a simple example:

    • Example: 500k house, 20% downpayment, $2k rental income, 6% 5 year variable rate

    • Conclusions:

      • Because of 5x leverage -> house buyer win if house price increase faster than S&P500

      • If yearly 0% or -0.5% growth in 5 years, house buyer lose the downpayment 100k

      • If yearly 10% growth in house price, after 5 years, the 100k turn into 300k. 3x your downpayment

    • Conclusion Data:

      • Yearly growth 3.7% to break-even

      • Yearly growth 4.85% to beat s&p 500 6%

      • Yearly growth 5.8% to beat s&p 500 10%

      • Yearly 0% growth, lose -89.4k

      • Yearly -0.5% growth, lose -100k

      • Yearly 7.2%, double 100k -> 200k

      • Yearly 10%, 3x 100k -> 300k

Comments:

  • I think real estate has its place in an investment portfolio, but in specific situation. Good for diversification.

  • e.g.: You live in a country where you can’t invest in the stock market and can only buy real estate.

  • e.g.: You have $1mm sitting doing nothing. Invest 80% stock market and %20 real estate ($200k).

  • e.g.: You have $300k doing nothing. Invest $150k stock market and $150k real estate.

SimplifeLifeBalancing.

Franky Yea
Previous

Frugal life.
Next

Remote work