Why buy real estate

In this post you will learn

  • The main reasons why you should consider buying real estate
  • The best trick to gaining wealth is to buy a rental property

I started reading the Economist around 2000. Back then, there was an article or two about the housing bubble (mostly in the UK) and I became a big fan of that theory. However, it was really early and although I was somewhat right, I was wrong for about 8 years. This is when I realize I can't keep long-held belief and always try to question myself. I changed my mind a lot and here are the facts about the cases.

Negatives:

  • You have to pay taxes. When you think about it, it is the only investment in the world that you need to pay taxes on the capital (not on the gains). This means if you do the math, with a 2% tax you will pay the whole asset in taxes after XX years.
  • Single-family house do not appreciate in value. It requires a lot of "sweat equity" to maintain it, etc. If you're not handy person, you should rent otherwise maintenance costs will be very high
  • You need to stay there at least 5 years to recoup some of your investment. Transactional costs for real estate is very high (up to 6-7% of total cost). The seller usually pay this fee.

Positives:

  • Mortgage interest deduction: You get Mortgage interest deduction. This is very interesting, especially if you are a high income earner 1.
  • You get taxes deducted.
  • 30 years loan: In the US, you can get a loan for 30years. When you think about it, this is quite insane. I currently have a loan at 3.75% for 30years. For example, in most other countries this would be impossible. We should thank all the foreign investors eager to pile on US debt.
  • Inflation: Assume you lock for 30 years, then the price of your mortgage will stay the same. You can see this as an hedge on inflation (or shorting inflation). You are basically locking in your rent forever. There will always be inflation and the very long-term value of money is always 0. I'm not saying you should be a gold bug, but investing in productive assets is always better than keeping cash.
  • Building an asset: You have an asset that can generate income. If you live in the single family house, that doesn't apply. But if you buy rental property then this will help you build assets pretty quickly. You can also live in a high-cost city and buy a place and get roommates. Of course there is a lifestyle decision to make here, but getting 2000$ in income per month with minors annoyances is definitely worth it in my opinion. Besides, if everyone would do it, then there would no economic advantage in doing it.
  • Non-recourse loan: If you live in california, your loan is non-recourse 2 3. This is true for those 12 states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington. This means, that if for some reason your house (and land) gets washed away in the ocean you can always decide to walk away. You could have a 1M$ in your bank account but there will be nothing the lender can do to take that money. You would only lose the downpayment, all the money you payed in capital and a dent in your credit score for 7 years. But you won't be on the hook for the extra 700k$ in mortgage left you need to pay. This only applies to the original loan (and does not work if you re-finance). This is the reason you should opt for a 30years or 15 years loan to start with and hope you get a good rate.

  • You can depreciate the asset: This is a fabulous tax-break for generating wealth. This only applies for rental income, but for example if you own a condo in NYC and share it with 2 roommates (that are paying you), then you can claim depreciation for their parts. Of course, you need income to offset that depreciation, but if you make less than 75000, then you can offset this depreciation against your salary income.

Although the US is supposedly a capitalist country, there are so many "subsidies" for home ownership.
If you're just starting out, then you should look to buy a rental income property. This can have many forms. Either a small complex in a nice location. It could be a condo with multiple rooms that you can rent out. Or even a house close to a major cities where you believe you can easily get (good quality) roommates. Roommates are more easy to find in high cost areas because people are already use to the idea. Back when I was living in Canada, only students had roommates since rent were so cheap. Therefore, do your homeworks about the market before making a purchasing decision.

Even Arnold Schwarzenegger started this way