Read this before going to your next open house. For many people, their home will be the biggest purchase they ever make. Considering this, it is no surprise they may see it as an investment. If you are one of these people, I have bad news. You may want to sit down for this. Your home is not an investment.
While buying real estate has commonalities regardless of the type of real estate, the process of buying a home and buying an investment are different. If you don’t know which of the two you are doing you are leaving the door open for buyer’s remorse.
To save you the heartache, here are some timeless tips on buying a home vs an investment property that hold true regardless of what year it is, if it’s a recession, booming market, seller’s market or buyer’s market.
Should You Buy a Home vs. an Investment?
This is not a discussion about renting vs. buying but rather what to do once you have decided you want to own and invest in real estate. For most people this will start with the purchase of an owner-occupant property. This property can be a home, an investment or both depending on your long-term intention.
If you are buying an investment, your primary long-term intention is to make a profit from owning the property. If you are buying a home, your primary long-term intention is to have a place to call your own. It will be where you reside until some life event, such as a growing family, requires you to uproot and move.
Which one should you buy? First consider which goal is most important to you. If you have already started searching, which goal has been guiding you so far? If there is a mismatch then the next few tips should help realign your search with your goals.
Investment Property buying process
What is the first thing you think of when deciding to buy an investment property? Maybe the type of property you will buy or how much of a return you will make from your investment.
If you are buying an investment property you have to consider these two things or you will be overwhelmed by the number of properties you could purchase. This will also set the standard that lets you know if you have been successful.
Next you will consider the market. When buying an investment property, you have more flexibility when choosing a market. You will also be looking at different factors when selecting the neighborhood to buy an investment property in.
“If you are buying an investment property you have to consider these two things or you will be overwhelmed”
You may find yourself drawn to buying your first property out-of-state because the returns are more appealing or the barrier to entry is lower. The property would ideally be easy to manage. This means you may forgo amenities you would want for yourself such as a pool or a hot tub.
Once you have found a property, how do you decide what price to offer? As an investor, you make your offer based on the numbers. You have a target return you want to earn. You analyze the financials of the property and make assumptions about its future performance. After this analysis you come to a valuation needed to achieve your target return. That’s your max offer price. Simple right?
Financing will depend on the size of the property and if you intend to occupy any part of it.
Home-buying process : Finding the right home
What is the first thing you thought about when you started your home buying search? Was it how much you can afford to buy, monthly payment, the type of house you wanted, or where you wanted to live?
Immediately you can see how the process of buying a house is different than buying an investment property. You’re thinking about how much you will spend monthly rather than how much you will make.
A good investment should be making you money not costing you money. Guess what that means about your home that you are paying a mortgage on every month?
If you didn’t think about the cost factor first maybe you thought about where you wanted to live. The neighborhood you buy your home in may be limited based on your job, where you want to raise your kids, reasonable commute times or proximity to friends and family. People without any of these commitments may have more flexibility.
You are thinking mainly about yourself and the people you will be living with, when you are deciding to purchase a home. With an investment property you will be thinking of the needs of an end user other than yourself, such as a tenant.
When you find the home you want, if there is stiff competition will you over bid? If so, how will you know when you have bid too high? As a home-buyer you will likely bid as high as the home is worth to you.
Because of the highly emotional nature of home-buying it is easy to get carried away. How high you are willing to bid may only be limited by how much you can afford. If you love the home enough you may even pay far more than it will appraise for.
Financing here has more options for low down payments as lenders consider owner-occupant loans lower risk.
Returns on an Investment property
You’ve already read about the 6 ways real estate investing pays or benefits of multifamily. Creating this many streams of income from one investment makes for desirable returns. Investment property owners are given tax write offs for costs to maintain, operate and own the property.
In addition to tax write offs, there is monthly cash-flow. If this is what you are looking for, guess what; you’re not looking for a home you are looking for an investment.
Once you buy an investment property and stabilize it, ideally it will pay for itself. That initial capital investment will be the basis for calculating your overall return.
How much profit do you make from owning a home?
Owners of real estate are fortunate that the value of real estate increases with time. Owning a home long enough and maintaining it will allow you to see some of this appreciation.
If you buy in an up and coming neighborhood you may be able to maximize appreciation, typically as a secondary goal. If this is your plan A you are speculating. If this is your plan B, you’re buying a home not an investment.
When you decide you want to move you may rent the house out and turn it into an investment. But, if your home has gone up in value, it is likely the surrounding homes have too. You may have to sell your home to be able to afford to buy a new one or move to somewhere more affordable.
You will also be investing a lot of time into the home to maintain it, likely more than a rental as you may want more expensive or higher end finishes or custom work done. There will also be interest and taxes that must be paid.
Every month you are paying money out but no income is coming in. Yes, you get the money back on sale. That is a “return of your money” not a “return on your money”. It’s cashing out a savings account.
There is also inflation to account for. So, your home value must rise faster than the rate of inflation and the interest payments you are making.
When you factor this in, you may realize the “profit” you thought you made on your home is not as high. But that’s ok, as it was not your primary goal anyhow.
”… you get the money back on sale. That is a “return of your money” not a “return on your money”. It’s cashing out a savings account.”
Are you buying a home or an investment?
If you though you were buying a home but now realize what you are looking for is an investment then you should shift gears, adjust your search criteria and buy an investment. And vice versa.
Now don’t get me wrong. I’m not saying you should not buy a home. I’m just saying you should be aware of what you are buying and have the appropriate mindset. If you want to turn a home into an investment down the line, you have to start off thinking of it as an investment.
If you want to invest in real estate and also buy a home, consider buying a home and then investing funds into a joint venture or syndication. This will allow you to buy a second property in less time than it would take to save for a second down-payment.
Buying a home is an emotional decision. Buying an investment is a logical decision. The home that makes you happiest may not make you rich, but with an investment property if you made no profit it will have been a waste. Buy the home you want not the one you think you should want.