I love investing in real estate, and it’s one of the main reasons I was able to become a millionaire. But I’ve learned that buying a single-family home to live in isn’t always a great investment.
I realized this in 2003, when I was newly married with a newborn, and bought my dream home in Los Angeles. But as time went on, I didn’t see a return on the money or time I put into my home. So I sold it and used the capital to buy some rental properties. So my family became tenants again.
Don’t get me wrong: I still support homeownership. Today, I own three houses, two of which I rent and the third is my primary residence. But at the end of the day, for many people, owning a home takes money out of their pockets.
Here’s why I think buying a home is not a good investment, especially right now with rising inflation and high home prices:
1. Costs eat profits
Let’s say you bought a house for $100,000 and put a down payment of $5,000. Then 10 years later, he sells the house for $200,000.
Looks like he nailed it: He turned $5,000 into $100,000, after paying off his mortgage. But he forgot to calculate the cost incurred to own that house:
- 10 years interest at 6% each year: $60,000
- 10 years of property taxes at 2% each year: $20,000
- 6% real estate fees: $6,000
Total cost before maintenance: $86,000
That leaves you with a net return of $14,000 (or 14%) of that $100,000. For 10 years, your investment returned 1.4% per year and we don’t even include the cost of the roof, plumbing, painting and other maintenance fees.
A good rule of thumb to keep in mind is that you’ll spend about 1% of your home’s purchase price on maintenance each year, but those fees can be more expensive in times of high inflation.
Advice: Don’t buy a house expecting to make a real profit. Instead, only buy when you have enough income, whether passive or active, to fund the cost of the mortgage, property taxes, and maintenance.
2. No cash flow makes you dependent on the market
True real estate investments give you monthly passive income, or cash flow, after all mortgage payments, property taxes, and maintenance.
When your home doesn’t provide monthly cash flow, its value is always tied to having a buyer who is qualified to buy and who likes your home. You pay to live in it while you wait for maybe make a profit
Hard times often benefit rental property values and hurt single-family homeowners. When I’m going to sell a rental property, I just need to find someone who wants to make a profit, and that’s not hard to do.
Advice: Buy only when you find a trophy property that is selling below its value, you can pay cash and you are 99% sure there is a profitable exit due to the surrounding market.
3. Limited tax benefits compared to commercial real estate
For example, you are limited in the amount of interest you can pay off on your home and are only allowed a tax exemption on a $250,000 gain on the sale of a single-family home every two years..
But when you move from investing in your home to investing in income-generating real estate, tax benefits skyrocket.
While rental income is taxable, there are certain expenses you can deduct on your tax return, including mortgage interest, property taxes, operating expenses, depreciation, and repairs.
Advice: To earn passive income from real estate, invest in tax-friendly rental properties.