The real estate market has been cooling off lately. Many people have made large amounts of money as they have realized double digit returns for the past few years. So will buying a house be one of the best investments a person can make? You might be surprised.
Here is a comparison between buying a house and investing in index and mutual funds. According to the Seattle-PI the average house price in King county, Washington (April, 2006) is $419,500. Let's say that a couple are renting a nice 2 bedroom apartment for $950.00 per month which goes up in rent $50.00 per year. They decide that they want to get into a house because they are tired of paying rent. Here is how the investments stack up.
The numbers for the house buyers:
Down payment: 20% of 419,500=$83,900
Amount owed to the bank: 80% or 419,500=335,600
Buyer closing costs: $5411.54
Seller closing costs: $3325.00
Insurance: $60.00 month
Mortgage rate + home owners insurance @7% 30 year fixed: 2292.75 annualized to $27513.00
Average annual upkeep on the house (repairs, painting, new appliances, etc.)=$2000.00
Average tax rate in the state of Washington=$11.32 per $1,000 of home value=$4749.00
Water and sewer: $100.00 per month or $1200.00 annualized
Garbage: $35.00 per month or $400.00 annualized
Income tax savings based on 20% year tax rate and deducting $7000.00 worth of standard deduction that is lost (This is assuming other things like medical etc. could be deducted)=$5452.00
Average appreciation of house prices between 1990 & 2000 per the US Census Bureau: 51% ($79,100 to $119,600)
The non house buyers investing:
Amount the couple would have to invest if they didn't buy the house (Down payment+closing costs)=$89,311.54
Amount of savings if couple kept renting (Annualized mortgage+maintenance+property tax+water and sewer+garbage-tax savings-rent savings)=Year1 $19,010; Year2 $18,410; Year3 $17,810; Year4 $17,210; Year5 $16,610; Year6 $16,010Year7 $15,410; Year8 $14,810; Year9 $14,210; Year10 $13,610 (This assumes an increase in rent)
With the average rate of return of 10% (some investments would be greater and some would be lower depending on the investment) and adding the yearly savings this is how the investment grows through the years:
1) $117,253 2) $147,388 3) $179,937 4) $215,140 5) $253,264 6) $294,600 7) $339,470 8) $388,227 9) $441,260 10) $498,996
The home owners return:Price of the house at the end of 10 years assuming 51% appreciation: $419,500x1.51=$633,445
Beginning principle: 80% x $419,500=$335,600
Amount owed to the bank (assume 10% paid on principle after 10 years)=$302,040
Amount received from sales of house (House price in 10 years- amount owed to the bank-seller closing costs-real estate agent commission @6%)=$290,073
So how does $290,073 compare to $498,996? Well, sorry folks but the couple that invested in the market did substantially better than the couple who invested in a house. I know, there were a few assumptions. If the couple had invested in the housing market recently, they would have realized substantially superior returns. These calculations didn't even calculate other risks that would be associated with investing in real estate.
If the housing market, stalls or prices start dropping like is prevalent in many markets now, the return would be seriously decreased.
In the ten years from 1990 to 2000, the real estate market increased by 51%. In some areas between 2000 and now, home price have more than doubled. In some areas a partial capitulation of these gains occurred. I think one would be naive to think that the previous rates of appreciation in the last few years will describe the housing market in the near future. Housing prices will vary geographically....It would behoove a person to understand what might be happening in the area where they plan on buying a house. It may even be hard for the real estate market to produce 51% returns in the next decade.
The home owner also risks the possibility of default which would make the investment a loss of the up front money plus the extra money paid to the bank. A person may lose their job or an illness or other malady that might affect their ability to pay their mortgage. This is a real factor to consider.
I am not trying to discourage people from buying real estate. I, however, believe that people must change the way they think about real estate. The primary house should be a luxury or something that a person buys when they have enough money . People should not think of it as an investment. Always be sure that you consider all factors before buying a home and know what you can afford. In some peoples cases, the home could be the riskiest investment they ever made.......With returns far lower than standard investments.
Folks start living within your means
Bibliography:
Seattle PI: http://seattlepi.nwsource.com/local/269290_housing06.html
US Census Bureau: //http://www.census.gov/hhes/www/housing/census/historic/values.html
Sunday, July 15, 2007
Most people are smarter than they think regarding their finances
I am a business owner and a equity trader. The vehicle that I use to trade is options. So many people may be asking, "What the heck are you doing writing a financial planning column? You are a big risk taker going into business and trading of all things options."
Well I do want to say that I am a very conservative trader and I don't take to many risks.......However, this blog will not be about trading it will be about figuring out how we can conduct our financial lives. I have been in business for many years and I have had to live on very little for a long time and I also have had to forgo many of the luxuries and good things that so many people take for granted. I have learned to budget my finances.
Our finances are dictated by our wants and needs. We have to conduct our financial lives accordingly......If we do not have the income to meet our wants and needs we have to change part of the equation. We have to change either our income or our wants. We also have to distinguish between our wants and needs. It is easier to change our wants than it is to change our income.
Many times we think that a want is actually a need.
This brings up some very big fallacies and misconceptions that many people have. I have seen many people talk about giving up a cup of coffee a day or giving up a luxury to either create savings or to balance the budget. This is not going to do it. The major misconceptions stem from how we are socialized. We are socialized to believe that the buying a home is the best way to get to financial freedom. We also develop an idea that our vehicle is the extension or ourselves so we must have the nicest vehicle possible. Well folks, the house and the car consume the most money in our budgets.
We will address the widest misconception that a house is a investment......It is actually a luxury. Now please don't get me wrong, I am not saying don't go out and buy a house. In fact many people have Phenomenally increased their net worth by owning a house. The problem, however, is that many people get way beyond their budgets by buying a house. I contend that a house should be a luxury that a person buys when they have enough money. I will also say that the best way to save for retirement will be to pay off the house. The vehicle goes without saying (One has to buy a vehicle that they can afford not want).
This blog is going to consist of the following subjects:
1) I will discuss how to make a financial plan and how to balance it so that a person can meet their needs and save.
2) I will compare the investment of home ownership to other investment vehicles. I will also talk about the biggest misconception in that a house is not an investment but a luxury.
3) I will talk about the dangers of credit and credit cards and how to wisely use the credit that has been extended to us.
4) I will do some case studies.....Some will be real (names will be changed) and some will be fictional. This will give us a good view of how other people's financial problems can be resolved.
5) We will look at how to balance our budgets using excel (tm) or just a pad with columns.
6) How to save for retirement.
There will be some other subjects but I won't discuss how to trade or invest in stocks, equities, derivatives, commodities, etc. I do have other blogs for these purposes.
The bottom line, though, will be to teach people how to make their own decisions regarding their finances. It is really common sense and most people are smart enough to do it themselves. There are many guru's out there that are going to tell you what to do......You know what, you should make your own decisions. Understanding how to make these decisions will give you the ability to direct yourself to financial freedom.
Well I do want to say that I am a very conservative trader and I don't take to many risks.......However, this blog will not be about trading it will be about figuring out how we can conduct our financial lives. I have been in business for many years and I have had to live on very little for a long time and I also have had to forgo many of the luxuries and good things that so many people take for granted. I have learned to budget my finances.
Our finances are dictated by our wants and needs. We have to conduct our financial lives accordingly......If we do not have the income to meet our wants and needs we have to change part of the equation. We have to change either our income or our wants. We also have to distinguish between our wants and needs. It is easier to change our wants than it is to change our income.
Many times we think that a want is actually a need.
This brings up some very big fallacies and misconceptions that many people have. I have seen many people talk about giving up a cup of coffee a day or giving up a luxury to either create savings or to balance the budget. This is not going to do it. The major misconceptions stem from how we are socialized. We are socialized to believe that the buying a home is the best way to get to financial freedom. We also develop an idea that our vehicle is the extension or ourselves so we must have the nicest vehicle possible. Well folks, the house and the car consume the most money in our budgets.
We will address the widest misconception that a house is a investment......It is actually a luxury. Now please don't get me wrong, I am not saying don't go out and buy a house. In fact many people have Phenomenally increased their net worth by owning a house. The problem, however, is that many people get way beyond their budgets by buying a house. I contend that a house should be a luxury that a person buys when they have enough money. I will also say that the best way to save for retirement will be to pay off the house. The vehicle goes without saying (One has to buy a vehicle that they can afford not want).
This blog is going to consist of the following subjects:
1) I will discuss how to make a financial plan and how to balance it so that a person can meet their needs and save.
2) I will compare the investment of home ownership to other investment vehicles. I will also talk about the biggest misconception in that a house is not an investment but a luxury.
3) I will talk about the dangers of credit and credit cards and how to wisely use the credit that has been extended to us.
4) I will do some case studies.....Some will be real (names will be changed) and some will be fictional. This will give us a good view of how other people's financial problems can be resolved.
5) We will look at how to balance our budgets using excel (tm) or just a pad with columns.
6) How to save for retirement.
There will be some other subjects but I won't discuss how to trade or invest in stocks, equities, derivatives, commodities, etc. I do have other blogs for these purposes.
The bottom line, though, will be to teach people how to make their own decisions regarding their finances. It is really common sense and most people are smart enough to do it themselves. There are many guru's out there that are going to tell you what to do......You know what, you should make your own decisions. Understanding how to make these decisions will give you the ability to direct yourself to financial freedom.
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