Is residential real estate always a great investment? We will be exploring some essential factors you should consider before purchasing your next property by focusing on five key considerations during our analysis:
- Price
- Location
- Time Horizon
- Interest Rates
- Renting Alternatives
Price
Price is the most important factor when deciding whether to invest or not. We typically see long, steady price increases in real estate over time. With this in mind, it is important not to pay too much during what is known as a “hot” period.
“Hot” periods are typically when buying activity is historically very strong and it appears that buyers are “buying at any price.” These periods of euphoric optimism have typically led to astronomical home values that typically don’t hold in the short term.
Signs of “Hot” Periods
- Buying a house for 10-30% above the offering price
- Waiving inspections
- Buying the house sight unseen
These are all typical indications that it is heavily a sellers’ market and prices may likely be stretched. Instead, we recommend considering how much you can afford, and waiting for a normalized market to go ahead with the investment to mitigate buying at historically high levels.
Location
Location, Location, Location! Where a property is located is commonly known to be one of the most important factors in its value and future appreciation. It is crucial to buy in a highly desired area or an area that you strongly believe will continue improving to capture the benefit of strong future increases in value.
On the other hand, if you currently hold a property or are considering a property in an area with deteriorating demographics and worsening trends, we typically suggest either selling or holding off on the purchase.
Time Horizon
Although it is very difficult to know exactly how long you will be holding on to the property, it is important to make some conservative assumptions to make sure buying is the right decision. Since transaction fees for buying and selling are high (5-10% of the purchase price), we highly recommend holding on to a property for a minimum of five years to avoid triggering taxation or excess fees. The ideal situation would be to buy and hold forever to minimize transaction costs and defer taxation, though that’s not always realistic. If on the other hand you can’t see yourself holding on to the property for at least five years, it may be more prudent to rent and have the flexibility of moving at your discretion.
Interest Rates
Interest rates have a big impact on your monthly payment and are an important consideration before making an investment. Since interest rates are a big factor of your monthly payment, specifically in the first years, it is important to secure great terms and refinance when it makes sense.
When interest rates are at historic lows, we highly suggest locking in a fixed rate mortgage to take advantage of the favorable financing terms. On the other hand, when interest rates are on the high end, it may be prudent to consider how that can affect your monthly payments and if the investment still makes financial sense. Although interest rates are an important consideration, the fact that you can refinance in the future makes it less of a concern long term.
Renting Alternatives
Lastly, it is important to consider the cost of renting a house rather than buying. There is a great sense of pride and accomplishment when you own your house, and many people won’t even consider any other option for that reason. However, we recommend renting for those who plan on holding the property for less than five years, as short-term price volatility and transaction costs typically hinder the return potential. Secondly, when home prices and mortgages are priced substantially above their rental equivalent, we highly recommend renting over buying.
The below graph charts historical home prices compared to their rental equivalents to point to periods where it may be more prudent to rent. The periods where the line is higher, the more it makes sense to rent, since the cost of purchasing a home is proportionally much higher than the rental equivalent, and vice versa.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.