My biggest real estate regret was not buying a two bedroom, two bathroom, double balcony condo with a view of Manhattan’s Chrysler Building in 2001. I was 24 and could have put down 10% on the $760,000 property that is worth over $2,000,000 today. Now I’m almost 40 and no longer have a desire to “grow into my debt” through aggressive hustle. Instead, I’m all about paying down debt and simplifying life.
I’m a huge fan of real estate because you only need to do four things to grow your wealth: 1) come up with a downpayment, 2) pay your mortgage on time, 3) try not to buy at the top of the market, and 4) own your property forever. If you do these four things, I’m confident that thanks to inflation, your net worth will be healthier than if you just rented.
As I just finished refinancing one of my properties, I decided to put together a “progress chart” to see where I stand with this one. A couple folks mentioned $850,000 is still quite a large mortgage. I agree. That’s why I’ve come up with an accelerated pay down plan. I’m all about creating goals, making charts, consulting with others, and tracking my finances to make sure I’m on target. You should do the same. It’s very enlightening.
What I realized from this latest exercise is that perhaps I’m spending too much time trying to build wealth with too many different asset classes. If I just focused on optimizing this one property in my portfolio, there’s a good chance it alone could make me a multi-millionaire!
Why You Should Buy Real Estate
When it comes to building wealth, everybody wants simple. Understanding real estate as an investment is about as simple as it gets.
1) Real estate prices move in 7 – 10 year cycles.
2) There’s a natural tailwind due to inflation.
3) You want to own real assets because money is only a medium of exchange that loses value every day due to inflation.
4) With inflation, rents naturally rise. If you stay a renter, your costs will always go up quicker than a homeowner’s costs, making retirement a little more difficult to manage.
5) Despite inflation, interest rates keep coming down. This is the goldilocks scenario for all real estate investors who get to take advantage by refinancing their mortgages or getting record low mortgage rates for purchase while also raising rents.
6) Humans are undisciplined savers and spenders. Having a mortgage forces you to save because each month you are paying down principal.
7) After you’ve finished paying off your property, if you wish you can add the full value of the property to your net worth. Everybody should make this calculation to see what their minimum net worth will be.
8) Living in your house doesn’t require investment work. Living is just life.
Here’s my progress chart for a property I bought at the end of 2004 for $1,525,000. For the six years prior, I saved and invested 50-75% of my after tax income in order to one day break free from an unsustainable career. The numbers are estimates within 10% of true value/cost.
Housing Chart Analysis
* In 2005, I’ve already been an adult for 10 years. I missed my opportunity to buy a place in Manhattan at age 24. At 26, I finally bought my first property in SF, a 2/2 condo. The place was nice, but I regretted not buying to my maximum potential because I was afraid. Therefore, at age 28, I went all-in and bought a single family home for $1,525,000 by taking out a $1,220,000 mortgage. It was kind of nuts to have over $1,600,000 in debt at such a young age. But I felt bullish about my future, having just received a promotion at my firm. No risk, no reward.
The total cost to own after deductions was about $4,800 including property taxes, insurance and maintenance. Given you can only deduct $1,000,000 in mortgage indebtedness, my goal was to get the mortgage down to $1,000,000 sooner. However, after the $305,000 downpayment, I had practically nothing in the bank so I didn’t make extra principal payments the first five years. Instead, my immediate goals were to work hard at my job so I wouldn’t get fired and to replenish by savings account by saving 70%+ of my after-tax income.
If you take on huge debt, your motivation to work hard will shoot through the roof!
* There is an opportunity cost to sinking $305,000 into a downpayment. In my case, I would have only invested this downpayment money in more conservative asset classes like CDs, treasuries, or muni bonds yielding ~4% at the time. So yes, I could have made about $1,000 a month risk free, but I wanted to swing for the fences while I was still young. I was either going to blow myself up or get rich sooner, rather than later.
Related: Invest In My 401k Or Save For A Downpayment?
* I had two good years of property price appreciation until the financial meltdown chopped off ~22% from the 2007 high. I estimated my property’s value declined to $1,400,000 – $1,450,000 in 2010 because that’s the value I was able to convince the city to agree on to lower my property tax bill for several years. The downturn didn’t feel good, but it didn’t hurt my lifestyle. I still enjoyed living in my place with a fixed payment. I just locked down all superfluous spending. My $6,000 vehicle named Moose was good enough! When you never plan on selling, devaluations don’t hurt as bad. Financial Samurai was born during this time of turmoil.
* By mid-2011 things started to recover. The S&P 500 bounced off its lows and people were interested in buying property again. Interest rates declined, and I refinanced my property before I left my day job in 2012. 2012 was the time I seriously thought about selling my house given I didn’t have a steady W2 income anymore and Facebook had just gone public. Having $1,075,000 in debt just from this house without having a day job was concerning. Still, all I thought about was simplifying life! Thankfully, I didn’t sell because a nice five year bull run ensued. In retrospect, I should have bought more property in 2012.
* In 2015, despite having over $1,000,000 in equity in a property that I valued at $2,300,000 compared to online estimates of $2,800,000, I still couldn’t refinance my 5/1 ARM 2.625% mortgage because I didn’t have two years of freelance income under my belt. I was disappointed, but felt strongly that another opportunity would arise before the fixed rated adjusted in June 2017.
* In 2016, I finally refinanced my mortgage to 2.375%. The cost to own dropped to only around $3,000 a month after deductions (mortgage interest cost of $1,682, property tax of $1,600, $200 for insurance, and $200 for maintenance). Meanwhile, estimated rent for the house now ranges from $8,800 – $10,000. It is a blessing to be able to lower costs through a refinance and raise rents.
* Unfortunately, I now see the real estate market declining for the next two years as global growth softens, private tech/internet company valuations decline, layoffs increase, more new condo inventory fills the market, and a dearth of liquidity events like IPOs keep startup employees illiquid. We’ve risen too fast, too soon. It’s time for some retrenchment.
* After a 5% – 10% correction, SF real estate bouncing back to a reasonable 3% – 5% a year growth rate starting in 2019. The idea is to front-run the thousands of Uber, Airbnb, and Pinterest employees before their IPO lock out periods are up.
* By 2025, I plan to completely pay off the $1,220,000 original mortgage. I’ve always had a goal to pay off this property by age 50. The ongoing cost to own this property will drop to around $2,000 a month post-deductions. $2,000 is still a lot largely due to property taxes, but it’s less than the $10,000 a month it would cost to rent the property. Further, I have the option to sell.
* If I do nothing else, this property alone will make me a small fortune. I’ll need it, because in 10 years, $4 million might be the new $1 million. Sure, there might be a massive earthquake, a fire, or another huge economic collapse between now and 2025 that will destroy my plans. Thank goodness for insurance and risk-free assets. But if I stick to the program, there’s a real possibility that the scenario I’ve created in this chart will come true. Now it’s your turn to create your own scenario.
Update 2018: I decided in mid-2017 that I couldn’t take being a landlord anymore so I sold my SF rental house for $2,740,000, or 30X annual gross rent. I was getting $9,000 a month for the place but when I looked for renters for 45 days, the best two offers I got were for only $7,500. The influx of new construction luxury condominiums is really putting a damper on prices. I ended up using $500,000 of the $1.8 million in proceeds and bought real estate crowdfunded deals in cheaper parts of the country with much higher net rental yields. Managing tenants was too much of a PITA after my son was born in April 2017. I’d much rather make money 100% passively.
Automatic Wealth Building
I’ve made my bet about where real estate prices are going over the next 10 years. Now it’s time to make bets elsewhere for diversification purposes. We are now near the top of the real estate cycle if not past it already in 2018. Unless you plan on using my spray and pray method to take advantage of desperate sellers with low ball offers, bid on stale-fish properties that were originally mispriced, or find a fixer with great upside potential, I do not recommend buying now. Instead, wait until about 2018 when real estate agents and sellers are no longer in denial.
When we are young, time is on our side. But once we hit middle age, time starts becoming our enemy. We lose our enthusiasm and energy the older we get. We need time to ride out the cycles. We need time to build equity. We need time to take advantage of refinancing opportunities. All I want to do as a 39 year old fella is relax! Once we’re past 55, it becomes harder to justify buying a property because we might die before we pay it off.
Save as much as you can, figure out where you want to live for the next 10+ years, and get long inflation by buying at least one property as young as you possibly can. If you don’t invest a single dollar in any other asset class, at least you’ll end up with a fully paid off property within 30 years to provide some financial security. If you can build a diversified net worth, all the better!
Recommendations
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns. Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Less than 5% of the real estate deals shown gets through the Fundrise funnel
Shop around for a mortgage: Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.
Updated for 2019 and beyond.
I did not know the fact that real estate prices move in 7 – 10-year cycles. My parents are planning to buy another house but they haven{t decided what area to choose from. did a great job of explaining how having a mortgage forces you to save because each month you are paying down the principal.
I like what you’ve said here about owning real estate. I love how you said that as long as you have a down payment, pay your mortgage, buy lower on the market, and own the property for a long time, it’s a good choice to buy. My wife and I want to buy our forever-house this year, so we can do all of that!
Hi Sam – any updated thoughts about Bay Area real estate? I’m in the peninsula looking at low end condos. Prices definitely seem to be on the decline for now, Fed keeps raising rates, SALT tax changes may not fully hit until people file next year, and overdue for a recession. Still, a lot of IPOs seem to on the books for next year and you’ve convinced me renting is equivalent to shorting housing (which I don’t want to do). Any thoughts?
My thoughts are that the housing market will continue to soften around the SF Bay Area. Inventory is up 40% YoY and at multi level highs. Stock market is crapping out as well. I’d be patient and really bargain hard.
Winter is the best time to buy real estate.
Also:
Time To Worry About The Housing Market Again
But I have to imagine the IPO of Airbnb and Uber will reignite the market here in 2H2019 or 1H2020 after 6-12 more months of softening. But let’s see what the entire US economy does.
Stories about people making big profits in real estate always amuse me, because they are by far the exception not the norm. Most people are shocked to learn that over the past 100 years, average U.S. home values have barely kept pace with inflation, increasing 3.1% annually. The stock market, on the other hand, has returned an average of over 10% annually during the same time period. On average, real estate doesn’t even come close as an investment.
True, there are pockets where real estate prices get distorted due to large shifts in population due to companies moving in or out of the area, or the region suddenly becoming “trendy” for one nonsensical reason or another. But these are the exceptions, not the norm. They are also the places where real estate bubbles form and pop, often wiping people out. The 2008-2009 real estate crisis was a very localized phenomenon, as most areas of the country were completely unaffected.
I live in one such area, and we watched the 2008-2009 housing crisis unfold with complete bewilderment, much like we watch a natural disaster on the news and think to ourselves, “Good thing we don’t live in an area that experiences (hurricanes / tornados / earthquakes / floods / wildfires / mudslides / etc.)”
Home owners also tend to conveniently “forget” the enormous costs involved in owning a house: Property taxes, maintenance, repairs, mortgage interest, buying & selling costs, remodeling, etc. Plus homes can go out of style over time and thus become out of favor in the market, forcing sellers to unload at bargain prices in order to attract buyers. In many areas of the country you actually LOSE money as a home owner (although typically not as much as you would lose by paying rent).
Owning a home is a lifestyle choice, and a home should be viewed as a consumption item, not an investment. At least that’s true in the rational 90% of the country that isn’t forced to ride the real estate price rollercoaster.
Does this mean you’ve been renting? After the huge rally in the property market, I sold my SF rental in 2017 for $2.74M after buying it for $1.52M in 2005. I couldn’t believe it. I’ve got a new post about the property market now for 2018: It’s Time To Worry About The Property Market Again
The cost of ownership is often the same or cheaper than renting over time. Hence, that cost is cancelled out. Remember, the return on rent is always -100%. You get a place to live, but same with ownership, so that cancels that benefit out as well.
Don’t forget, you can own and invest in stocks at the same time. Not sure why so many against homeownership don’t believe this to be true.
Sam
I was a lifelong renter until 2011, when my wife and I bought a house together. We moved in a month before my 46th birthday. Prior to that my wife owned her own home. I should add that during my 18 years of renting, only once did a landlord ever raise my rent. This included 5 apartments: 4 in L.A. over a 13-year time-span and one in upstate NY over a 5-year time-span.
I should clarify I’m not against home ownership by any means; I just wanted to point out that it is not the automatic money-making venture that so many make it out to be. SF is a bizarro-world when it comes to real estate, as is most of California (I should know, having lived in the L.A. area for over 13 years.)
Houses appreciate much more slowly in most areas of the country. Our house was built by the previous owners in 1992 at a cost of $219K. They sold it to us in 2011 for $246K… after they had a 2-story addition built. So no, they did not realize a profit on the house. And this is a 2,400 sq ft house in a very desirable upper middle-class area with one of the best school districts in the county. But that’s the way it is most areas of the U.S. that aren’t distorted by large population inflows and outflows and the resulting supply and demand imbalances.
Home owners enjoy total control over their living space and a few other perks that renters don’t get, but it has its drawbacks as well. Where I live, renting can be a much cheaper option, assuming you’re renting a smaller apartment as opposed to a house of the same size. My current property taxes (~$9,000/year) are equal to what I used to pay in rent for a decent-sized 1-bedroom apartment (~$750/month).
Anyway, I just wanted to share my experience so that people don’t think they’re making a mistake if they don’t buy a house. Renting can be a very smart way to keep your expenses fixed while also giving you enormous flexibility in case you ever need to move on short notice.
I completely agree with the benefits of renting. I’m a math guy and I look at the total cost of home ownership and total cost of renting. Over time, I’ve saved and invested an enormous amount of money by renting very cheaply. If you are very disciplined, you can become wealthier by renting very cheaply and investing intelligently. By renting cheaply, you’re throwing less money away per month than the total cost of ownership. This difference when invested intelligently over time turns into enormous amount of money. My rent has only increased one time in the last 7 years. It is still extremely low compared to ownership costs. A house is a risk. Anything can break over time. Property taxes will go up. Maintaining a home is a headache. The biggest problem with housing is the COST to own and maintain the property. It’s far better to reduce living costs to save money, than to try to make more money by buying a house to live in and raising your living costs. I’m able to save over 50% of my income because I rent. It’s far better to look at the biggest costs, than to save pennies here and there. Being a landlord is creating work for yourself. If you buy a rental property, you will have a job to keep the rentals occupied and well maintained. Bad renters will sometimes not pay on time. It’s a big headache. Even with the best renters, there is no guarantee of on time payments. If you are not handy, you will get killed financially. I hate real estate, and every person who works in the business of buying and selling real estate or fixing and maintaining houses. This is my personal opinion. I will rent forever by choice, and I will become rich by renting. Buying a house is similar to picking a stock. You can get lucky and you can pick a good location just as you can pick a good stock. Just because you got rich by owning rental properties doesn’t mean that it is the norm. A lot of people got killed financially by the housing crisis.
Whatever is good for you.
The latest Federal Reserve Consumer Survey data shows that homeowners are 11X wealthier than renters. That has to mean something.
See: The Average Net Worth In America Is Huge!
There’s a very simple explanation for why homeowners are on average much wealthier than renters. Young people or first time buyers who own homes (in high cost areas like parts of the east and west coast) on average have higher incomes and are able to qualify for larger mortgages and are able to save much more compared to young people with lower incomes who cannot qualify for a loan and cannot save much money. I’m emphasizing “young” and “first-time buyers” because past performance in certain housing markets like san francisco are not guaranteed to repeat over the next 30 years. Not everyone lives in a location that will turn out to be a great real estate investment. If you look at the family income statistics of those young people who own houses in a good location, and those young people who rent cheaply, you will find that people who own homes in good locations have higher incomes on average compared to people who rent cheaply. You cannot qualify for a mortgage in a good location as a first time homebuyer, if your income is not high enough. The most expensive homes are only affordable for the wealthiest people. A lot of renters are forced to rent because they can’t realistically afford a house with their low income. Think about the young people who graduated college recently. Most of them will rent for many years before coming up with the down payment to buy a house. A higher income allows you to save and invest more money, whether that’s in the form of home equity or stocks. A lower income doesn’t allow you to save much money and often makes it difficult to buy a house. Looking at the average wealth of homeowners can be very misleading because some very wealthy billionaires own homes and many many students and recent college graduates who have very low income are renters. Going forward, I strongly believe that your income has the biggest impact on your wealth potential, not your choice of owning or renting. My net worth is among the highest for my age and income, and I have never bought a house in my life. Doing the math, if I bought an average priced home in a good location at the bottom of the housing market after the financial crisis, my net worth would be lower today.
Hi Sam,
I am glad I ran into this article. My husband and I are looking into buying a 2 bedroom 1 bath condo in SF. But we are worried that the market is right at it’s peak and we will need to wait out any upcoming downturn after buying. You predicted 2017/2018 the market would soften. How do you feel now that we are in November 2017? From a “buyer’s” perspective, the market is still pretty competitive but sellers pricing strategies seem to be less effective than before. Should we continue renting, saving and keep our nice cushion every month? Or should we max out our budget and buy now?
Hi, my husband and I trying to decide whether to rent or buy. We live in Orange County, and the most we can afford is a 2 bedroom condo for 440k or under. We have a one year old and another on the way. We have been getting a lot of pressure to buy from many of our family members, who have made a lot of money in the southern CA housing market. However, I am skeptical about paying so much for so little space. If we rent, we’ll probably pay 2000/month. If we buy, with a 10% down payment, we will be paying 2600-2700/month. What would you suggest doing? Thanks!
Kristina
It’s hard for me to get excited about buying California real estate right now. I just sold one of my rental houses in San Francisco because the prices are crazy in terms of annual gross rent.
Graduations on your second kid. How do you think about the cost of housing versus the cost of raising children?
I would stay patient and try and go bargain-hunting for misprice listings or listings that have been on the market for a long time. I would not be overbearing and chasing hot deals.
See:
https://www.financialsamurai.com/why-i-sold-my-rental-home/
https://www.financialsamurai.com/real-estate-investing-rule-rent-luxury-buy-utility/
Hi Sam,
I bought a multifamily in 2010 when prices in South Florida were still very low from the recession. The price of the property has gone up by 130%, and rents are very high in the area. I don’t owe anything on it. It seems like I should just leave it alone, but a part of me wonders if we are approaching a bubble and if I should sell now while prices are high. I have not invested in stocks or anything else and wonder if I should diversify. If I do sell, where should I keep the money until I decide to buy again ( theoretically if prices come down again) . Any suggestions?
Sam, what are the areas similar to GGH you believe offer value in SF? I’ve heard Shipyard and excelsior but wanted your thoughts on upcoming area for 2018 to buy.
Outer Sunset
Parkside
South City
Are good value
20yrs old. 36k salary:20k in expenses. 16k left over each year. Have been with my girlfriend for 7 years now. Wondering your opinion on if it is worth it to buy a 300k townhown in Raleigh, NC to add to my folio and rent it out after 3-5 yrs. Either that or just rent until I’m ready to settle down in 10+ years from now.
Can you explain why you used an ARM ? I feel like that could get you in trouble if interest rates go up.
Sure. See this post: 5/1 ARM Over 30-Year Fixed All Day Long
And
How Much Can My ARM Go Up After The Fixed Rate Period Is Over
What would you recommend for low to moderate income earners? I’m currently 24 yrs old with about 20k in cash and 20k in stock/bonds investment. I earn about 30k a year but would eventually like to purchase a property with the ultimate goal of eventually renting it out. I live in Oakland and have been contemplating possible buying a property in Sacramento, hopefully in the 150k < less range. Any advice is greatly appreciated!
Hi, I have been following your blog for a while. It’s very helpful! I am 23 now and looking for buying a house in South Bay for my primary residence as well as renting it out potentially. I am now debating if I should buy a condo(actual condo, on the 1st floor of a building) in Santa Clara which would cost me $3000/month to operate(including property tax, mortgage, utility, insurance…) or should I buy a townhouse in Sunnyvale which cost me $4500/month. Both would be 3B2B ish and would generate $2600-$3000/month if I rent two rooms out. I am just wondering should I invest for cash flow or appreciation, and there is a concern that condo would not appreciate as much as townhouse.
Hard to say Angela without knowing more specifics. At age 23, have you already saved up for the 20% or more down payment? If so, then you probably can afford to buy a larger place and grow into it with your type of income and savings.
But the market is finally slowing in the bay area, and will probably continue to slow until Uber or Airbnb goes public.
I am a 31 y.o. and would be first time property buyer. I saw you eluded to waiting till end of 2017 early 2018 to buy a property. Do you think it’s a bad time buy right now? I am not in the SF market I am in Las Vegas. Things seem a bit high for here as well. I will probably stay here for another 3-5 years at minimum. Buy soon in next 3-6 months or wait it out for a while?
If you can find a good deal now (still winter) where you can rent it out for a positive cash flow after putting 20% down from the get go, and plan to live it int for 5+ years, then you may be OK. But Vegas is back to peak prices again.
The unknown is how much the 10-year yield goes up and whether Trump’s policies are helpful.
I’m personally waiting for a 10% correction in SF, NYC, Honolulu, and investing in middle America for better returns via RealtyShares. Non-coastal real estate is much more attractive now with higher returns.
See: Should I Buy A Home In A Rising Interest Rate Environment?
Great post Sam. It’s surprising to me that a Facebook IPO changes the market that much. Seems that if you’re not in the club, you’re gonna be left out of the party for quite a while. I really have no option to purchase a property in San Francisco given the savings that I have. I’ve only become really aggressive about saving recently. I started looking at purchasing a rental property somewhere else that I could afford just so I can some skin in the game. I pulled data from Zillow in order to search for properties which could give me the highest yield for my investment. Per your recommendation I created a blog on my own and wrote a post about find the best rental properties using the Zillow Research data. askadatascientist.com/2017/01/10/real-estate-investment-hacks-using-price-to-rent-ratios/
I am 100% with you. However, not only is is smart to buy your own home and use that as a way to build wealth….
…But if you buy rental properties you can see this same thing happen but on a much grander scale. The difference is that you have your tenants pay your mortgage for you! And, if you buy right, you can earn a positive cash flow from your rentals (what is leftover after you pay your mortgage and other expenses). Imagine having 100 rental units, and 100 tenants paying your mortgages for you! It’s like having 100 people putting money into a savings account for you every month. There are so many benefits of real estate… it’s no wonder 90% of millionaires are created through real estate.
I think the above comment is from a spam bot.
I agree man! Hopefully Financial Samurai will see my actual post haha:)
Hello Financial Samurai,
My name is Marcel Jara and I am 19 years old. I recently moved out of my parents house to move closer to school NC State. Through seeing the struggle that my mom went through in my earlier years I made it into an inspiration and motivation for myself to insure my financial future so that neither I nor my children in the future would have to go through the same difficult situations that I did. I am a Human Biology student but have always had a focus towards money and financial independence. I made my first investment to my future when I was in 10th grade with money that I worked hard for and had accumulated overtime by putting 1,000 in my first roth IRA account. Ever since that day I have been saving the majority of my minimal income and investing it as efficiently and effectively as possible. I make 11 an hour working at my parents food truck. Seeing my Dad 55, working countless hours on his business made it clear to me that I did not want to spend the rest of my life working especially at his age although I know that 55 if not old at all but I know that i want to reach financial independence sooner. I have been focused on saving and investing as much as my finances allow me to even if it is just 20$. This has allowed me to have now about 5,000 dollars in investments distributed through Acorns, Betterment, Robinhood, Stash Invest, Roth IRA and today for the first time I invested 1,000 into Fund Rise ereit. I have made each deposit with a lot of hard work and I know that almost everyone deters me from investing my money especially at this age and also considering that I have only a couple hundred dollars in my bank account while still having to pay for my rent and all expenses but what I have pushed myself to do is to deposit about 500$ a month with the little money I have. I have been smart with my money by rarely ever eating out or doing other things that almost everyone my age is doing and wasting their money on. I know you are an extremely busy individual and that your time is way more valuable then spending time mentoring me but that is what I would like to ask. I would like more information on what I should be doing with such a low income while investing and what you recommend would be the best way to invest my money in a way that I can truly build that residual income. I have always been focused to start as early as I can investing because I know the power of compounding although I just have 5,000 invested now I know if I stick to it I can reach financial security in the long run but I want to educate myself more on how I can get financial security with a smaller time horizon such as in the next 10 years because I end goal is to reach financial independence by 30 which is a big aspiration but I know with the right tools and mentoring I can reach it and help others do the same as you have been doing:) Thank you very much for your time!
Hi, it sounds like your attitude to saving / learning and investing is strong for a 19 year old. My advice would be to continue reading and learning as much as you can. Knowledge truly is power. You can focus on improving your professional skills which may improve your earning capacity. You would also be wise to improve your financial literacy. Please consider the following two books: Rich Dad Poor Dad (Robert Kiyosaki) & The Richest Man in Babylon (George Samuel Clason). If you haven’t read these books already, they will propel you to the next step. At your age, the most powerful force in the world (compounding) can truly be harnessed. Best of luck on your journey.
My husband and I were thinking about buying our first home in San Francisco this winter. I am 27 and we currently rent an apartment and do not own any properties. I know you mentioned that we are near the top of the cycle right now, but you also mentioned that we should buy as young as possible. What are your thoughts on us buying this winter, or waiting another year or two and betting that prices will come down?
Hi Lindsay,
Winter is always the best time to buy real estate IMO. The reason being is that it’s the holidays and the weather is the worst. You’re really motivated if you can’t wait 3 months to list in Spring.
If you can find a deal where the cost to own is less than the cost to buy after your downpayment, and you plan to own it for at LEAST 5 years, if not 10+ years, if not forever, then buying this winter is probably going to be OK in the long run.
I think there will be more deals to be had in the winter of 2017/2018. But of course, I could be wrong. You should look to buy in the winter BEFORE Uber and/or AirBnb go public. There will be lots of money being converted from stock to cash to real estate 6 months after the lockup period is over. Get ahead of that wave.
Best of luck! And also, check out this article for where I think are the best values and upside in SF today.
Sam
Hello Financial Samurai,
I have thoroughly enjoyed reading your article. My parents own quite a lot number of real estates in Mongolia, an Asian country situated between China and Russia. I myself intend to continue my parents business and I was wondering if you have any advice for me.
Hi Sam,
Thank you for this site. This is exactly what I need lately. I started working late in life (grad school takes up so many years) and landed myself back in the SF Bay Area with a relatively ok job, but now I’m torn between saving up for downpayment for maxing out my 401K since my current company has a bad match (6 year vesting period). I’m 30 years old and predicting the market 30 years later seems a lot riskier than waiting out a year or 2 to buy a condo instead of renting….
And would you say 20% downpayment is ok or do you advocate more? Do you have any recommendations on how much mortgage to take on?
Hi Andy,
Thanks for visiting and sharing my site.
The SF Bay Area real estate market is cooling. And I really believe it will continue to cool for the next 1-2 years until Uber or Airbnb go public. Hence, there is NO RUSH to buy now. I’d look in the winter of 2017/2018 to take advantage of desperate sellers.
See these articles that answers your questions!
https://www.financialsamurai.com/invest-in-my-401k-or-save-for-a-house-downpayment/
https://www.financialsamurai.com/the-ideal-mortgage-amount-is-1-million-dollars/
Sam, I’m a little confused by this article. On one hand you stated to invest in real estate as young as possible. On the other hand, you stated to avoid real estate until a market correction in ~2018. So should we buy in now or wait?
Also, I’ve seen you show charts for historical and projected real estate prices nationally and in SF. Where can I find the like for my city – New Orleans?
Some great stuff on this site. Thanks for sharing all your knowledge!
Nikhil,
If you can find a great deal from a motivated seller and if you’ve calculated all your numbers and plan to stay put for at least 5 years, if not 10 years, then you should buy. In 10, 20, 30+ years, I don’t think you’ll look back and regret having bought.
Just know that we are closer to the top of the real estate cycle than the bottom. For NO, there should be tons of data online!
Sam
Thanks a lot Sam! Another question if you don’t mind. What do you think of as the point at which to leave a nice corporate job to work on your startup idea full time? How do you know when it’s time? I struggle to progress it as a lot of my energy and time go into my full time job but it of course provides a certain security and an independence from living with your parents.
Hi Sam,
My fiancee and I are new readers and big fans of your site.
We are also struggling with the decision to buy a place now or hold off until next year or even 2018. Our home market (San Diego) has been appreciating at what seems to be an unsustainable rate, particularly in our price range (around $600 to $700k). We are in our early 30s, combined make about $250k, and our monthly rent is $2k. Finding a good return elsewhere with the money we’re saving by renting seems to be quite tough at the moment. We’d be committed to living in anything we bought for 7 to 10 years.
Any thoughts on whether to sit tight and keep saving or to pull the trigger if we find something we like, even if it we don’t utilize your spray and pray method?
Thanks in advance for any advice and for all of your great content!
David
With a $250K income and only $2K a month in rent, I don’t see any rush to buy. Spend time talking to the realtors about the target price range you are looking for to get more color.
I’m a buyer now if you can find a great deal from a motivated seller. But I plan to find a great deal from a motivated seller in 2017/2018 b/c I need to save more cash and I know the market is cooling. 7-10 years is really the minimum you should own the property. The longer you can own, the more buying will make sense.
GL!
Sam
I purchased my house about 2 years ago here in SLC, UT. It’s appreciated roughly 20-25% already. The housing market continues to be hot here (UT home prices to increase an avg. of 5% in 2016) as local businesses grow and expand as well as out-of-state businesses moving here to take advantage of UT’s favorable tax breaks, not to mention the standard of living here is a lot less than larger cities across the US which means these businesses don’t have to pay its employees as much here as they would in say NYC or SF.
Having said that, I do feel that the market will slow down over the next few years as you mentioned and I’m debating what to do:
1. Sell my house. It’s hard not to want to sell considering the 20-25% gain (less realtor fees + taxes). Do I sell now and rent for a couple of years until the market has a correction then buy another house?
2. Hold onto my house. Is it better to hold onto this house long term and eventually turn it into a rental? It’s a 4 bed/2 bath house in a great location and should make a great rental. The only issue I forsee is the fact that it’s an older home and things will eventually need to be replaced or upgraded. There are no sprinklers so I know renters won’t take great care of the yard, etc.
What are your thoughts Sam? Does anyone else have any advice for me?
Check these posts out:
https://www.financialsamurai.com/property-sellers-go-on-strike-dont-sell-your-home-if-you-dont-have-to/
https://www.financialsamurai.com/invest-in-real-estate-for-capital-appreciation-rental-income-or-lifestyle/
I did some calculations on two properties I own in Cupertino and San Francisco. The Cupertino property was valued at $20,000 when the original owner purchased back in 1959 (I bought from him about 10 yrs ago). The San Francisco property was valued at $36,000 in 1971. Based on current market value, the Cupertino property appreciated at 8.1% annually, while the San Francisco property appreciated at 7.9% annually. From 1959 to present, S&P 500 rate of return was 6.5% annually, not counting dividends.
If you were to pay all cash for properties, S&P 500 outperforms even Bay Area real estate when factoring in dividends, and this doesn’t account for maintenance and property taxes on the property. It’s due to your leverage ratios that make owning real estate in the Bay Area the big winner.
Real estate is local. I think for much of the country, real estate appreciation just exceeds the inflation rate. Over the past several decades, homes have gotten much bigger, so $/sq ft may not even be keeping up with inflation for much of the country.
Most people are very comfortable with leverage for real estate ownership but would never consider such leverage ratios for investing in the stock market, rightly so.
Good calculations! I would take a 7% to 8% annual compounded game any day. This shows the power of compound interest and inflation. The question is: how much did you pay for the Cupertino and San Francisco properties and how much are you renting them out for ?
I find owning property to be much more relaxing during downturns than owning stocks. It doesn’t feel good to lose money in the stock market and receive no utility from your money. At least with owning a house, you can still live your life and enjoy your property while the market is falling apart.
I know 3 Asian families in California.
One owns a piece of land in Palo Alto that is so big that Facebook tried to buy it from them to build their campus. They refused to sell.
The other 2 families in southern California have enough rental properties to generate 7 figure incomes each other. One of them own 120 rental houses.
They all started with just above average wealth. But over 30 years, with some luck and hard work, they achieved unbelievable wealth.
I calculated with 12-15% annual returns you can achieve that crazy money. That kind of return is attained by being lucky (in California), optimization (networking, knowing the banks and contractors so you always get the cheapest property), careful but also consistent reinvestment with moderate leverage.
Insane.
Amazing. My neighbor, who is ~66 and drives a beat up service truck owns about 30 properties in SF as well. That equates to a $25M+ portfolio and he still works hard everyday building and maintaining. He’s gifted his son and daughter each $1.2 – $1.6M houses as a result. (Inspiration for this post: A Massive Generational Wealth Transfer Is Why Everything Will Be OK)
So the question is, if an immigrant who speaks poor English and doesn’t have any advantages can build this type of wealth, why don’t more people who already live here and have all the advantages in the world?
“5) Despite inflation, interest rates keep coming down. This is the goldilocks scenario for all real estate investors who get to take advantage by refinancing their mortgages or getting record low mortgage rates for purchase while also raising rents.”
In 1980 mortgage rates were approximately 16 percent. We’ve been on this lowering of interest rate wagon since then. Median House Price in L.A. County was 99k and the cost to own the home after 30 years with interest 393k. Imagine that! Ok so I have the opportunity to pay off 99k faster to avoid paying the full interest over 30 years, right?
Fast forward to today Median Home price in LA County is somewhere around 460k. Cost to own the home after 30 years with roughly 3.5 percent is approx 617k. Wow! You’d have paid more in interest in 1980 than you would’ve today. What a bargain most would say…
So this leads me to my logical conclusion that the interest is built into the principal of the home and there is no opportunity to pay the mortgage off in a reasonable amount of time. 20 percent used to be needed when the principal-to-Total Cost Over 30 Years ratio was lower. Today, principal is high since interest is built in which is why you see 3 percent down payments as the norm today.
I wonder how many buyers are priced out (Based on Household Incomes) of these markets due to interest rates being low. I would suspect a lot (with my thesis that interest is built into the principal).
All-in-all I feel like the federal reserve is doing everything in its power to inflate away the 2008 debacle. I wouldn’t be surprised to see lower mortgage rates going forward. FHA loans are allowing people to leverage up to 625k in los angeles area. I see this as the floor since these loans are easy to qualify for as long as your income is in the proper range.
Should I count on -16 percent mortgage rates going forward to get the same investment gains? I am investing what I can into stocks. I am waiting for the next crash to jump into the RE market. Making slightly more than median household income in Los Angeles isn’t what I thought it would be. I couldn’t imagine raising a family living in a 1 bedroom apartment for 2k a month. I am saving 60 percent of my income and my net worth is on track with your models, but Real Estate is so far out of reach today for me without sacrificing my retirement accounts being maxed out.
I look forward to a future article from you telling us that the bottom is in so I can get started off on the right foot.
I hope other people realize that interest rates have been going down for 35 years. I write this over and over again.
Have you ever been long property? I believe the next “bottom” will be in the winter of 2017/2018. My chart above is my forecast for coastal cities of properties you actually want to buy.
Interest rates will stay low for longer. This is structural now.
Are you sure the zillow “zestimiante” reflects the real value of your property Rob. A more accurate estimate could be found by consulting with relators. Also if your more interested in a greater return try flipping houses or specing houses. To generate a significant return in rentals you would need atlas 4 million whereas if you invest 2 million into flipping houses or building you would be looking at around 300-500k a year
Yes, in fact I’d say Zillow is more accurate than the realtor’s I’ve worked with, including on my last property in that market that I tried to sell with two realtors before realizing zillow was right and converting it to a rental. Zillow is also very accurate for rental prices in my market as well. The market those 3 properties are in has been very stable (not much appreciation, if any) so perhaps that’s why its been accurate, but it’s also been very accurate based on selling prices in my neighborhood just outside of Charlotte the last 6 months and what the appraisal came up on my 15 yr refi 2 months ago.
I don’t have time or knowledge to buy fixer uppers. I work a corporate job that works me about 60 hrs a week on average – which pays well. Also, in my area I don’t think you’d be able to generate as good of returns on flipping/spec homes as you would in markets like California and some other hot real estate markets. And the market can crush you on the downside with those types of investments. Rentals will nearly always have at least some ROI.
Assuming 50% leverage, you can generate about 14-18% NOI returns on rentals in my market if you manage them yourself and not counting property appreciation. Unlevered is around 7-10% NOI excluding appreciation.
I find Zillow to be extremely INACCURATE. See: https://www.financialsamurai.com/you-cant-trust-zillow-and-its-estimates/
Properties that are sold are dressed to the 9s. They are remodeled, staged, cleaned, and in the best condition possible. That sales price is then used for all other comps.
Discounts need to be used. Zillow has this property at $2.8M. I’d be lucky to get $2.5M, and more likely $2.3M b/c my place hasn’t been remodeled in a while.
I also made a huge mistake not purchasing property when I was young (like 26). We looked at a crap-shack in 1998 that was selling for $110,000 in the SF Valley (can’t get ANYTHING for this price anymore). I thought it was a dump and we didn’t think we’d qualify for it any way (I think we would have qualified looking back now). Fast forward (or not so fast forward), and we are in the process of purchasing a manufactured home in a community. This is a mixture of buying and renting all at the same time (I’d love to hear your thoughts on this!) We’re buying the home, which is very reasonable compared to the current market (and NEW!) and renting the land it will be sitting on. Our plan is to live in the home for at least 15 – 20 years, by then the home will be paid off and we’ll only be paying insurance, property tax, and land lease.
Could you have torn down the crap-shack in 1998 or remodeled? I always try and buy property that has expansion or remodeling opportunities where buyers don’t want to bother doing the work. I’ve finished building a master bathroom in my house. Now I’m building a ~280 sqft deck off my master bedroom over the next two months. Fun! And it should make the house more livable and valuable.
I feel mixed on renting land and owning a house. Land is what is most valuable. The whole idea is not to be beholden to anybody when you own your own house. But, just do the math on the price discounts of such homes and the benefits. Do the math on rent versus buy and all that stuff.
At the end of the day, we rent everything anyway since we all die.
I’m curious to see your deck – the build process and final product!
As for our manufactured home, we’ve crunched the numbers and over time it will be a better option than renting forever. Ultimately, it will allow us to live in a much nicer place and at a lower cost as we head towards retirement. We also have the option to move the house once it’s paid off (but this might not make sense financially – reselling it would be the better option.)
Fantastic advice (I actually might just take it because I have ~$30000 saved up in the bank and I’ve recently graduated college). But before I take the drive into real estate, do you have any recommended books or websites that you recommend to study up on it? I do want to invest but only when I understand it and would like to hear any recommendations :)
Yes. Read this for free: https://www.financialsamurai.com/category/real-estate/
You’ll see the good and the bad.
Wow fantastic way to archive. Thanks!
Thank you for your excellent post Sam. How do you feel about the Greater Los Angeles market? Do you think it will also face a downward trend in the next 2-3 years?
Shelley, I suspect the trend to be softer for LA just like SF, NYC, Miami, and other coastal cities that attract domestic and international buyers.
My experience with real estate hasn’t been great so far unfortunately. These first 3 are from a growing area in the Southeast with just under 300k people in the city and a MSA of around 1 million.
First purchase – 2005 – 2k sq ft townhome – 3 bd, 3 ba for $155k in a quickly growing area of Town. Sold in 2009 for 133k. After realtor comm, concession to buyer of $1.5k and other closing cost, and repairs to close, I lost over 30k. This townhome is estimated at ~140k today per Zillow.
As soon as I sold that townhome in 2009, I simultaneously bought a 3bd, 2 ba 1437 sq ft SFM in the best school district in the county and really for probably > 100 miles for $155k just on the edge of town. That house is currently valued at $157k per Zillow. I converted this to a rental in 2013 and currently make around $150/mo cash after a 10% maintenance reserve managing myself. However, if I was to sell it now, after realtor fees and the like, I would lose money on this home. Should be able to refinance this within the next year and increase the cash to around $350/mo. Plan on making this a LT rental.
In 2013, I bought a 4bd, 4ba 3040 sq ft home in a posh part of town for $355k. Zillow estimate for this is $361k. This is currently being rented for roughly cash flow breakeven with a 7% maintenance expense managing myself. Plan on making this a LT rental.
In fact, outside of the “super metro” cores, most of the country’s housing is still below 2005 levels (Florida is still mostly way below 2005-07) not even adjusted for inflation. With the average median household income of around $55k/yr, it also is likely to limit your mobility with making a Home Purchase as most won’t be able to cover 2 payments both from a DTI or if the tenants stop paying or trash the place. My household income is around $275k/yr (90% me, 10% wife) so no big deal for me today but definitely would have been 5-10 yrs ago. Don’t get me wrong – I think owning real estate should always be a part of a diversified portfolio, but leverage goes both ways – amplifies gains AND losses. San Fran, NYC, etc remind me a lot of Japan’s housing prices – especially Tokyo’s – until the 1980s.
Thanks for sharing your history Rob. What locations in Florida are you buying in? I have friends who are telling me Miami has done very well over the past 6 years. Is this not true?
I take the view that SF is undervalued as a rising international city. Nowhere can you find ocean view properties for less than $1,000/sqft for major cities.
I think NYC has a HUGE international demand curve from Asia and Europe, making prices there astronomically high and sticky.
Perhaps all the major US cities turn into Tokyo one day. But I don’t think that day is here for the next 20+ years.
I’ve bought property in the Carolinas – not in Florida – just familiar with the market due to family and friends. Carolinas didn’t go nuts in the mid 2000s, didn’t drop as much in the recession and haven’t rebounded as much, either.
Miami has done well the last 6 years but is still way below 2005-2007 levels:
https://us.spindices.com/indices/real-estate/sp-case-shiller-fl-miami-home-price-index
Looking at the 20 cities Case-Shiller covers, the following are still below 2005-2007 levels
Atlanta
Chicago
Cleveland
Detroit
LA
Las Vegas
Miami
Minneapolis
NYC
Phoenix
San Diego
Tampa
Washington, DC
Most of the rest, including SF (which indicates your property has significantly outperformed), are basically right at 2005-2007 levels or just barely over. Denver and Dallas are the two exceptions.
So in the last 10 years, 13 out of the largest 20 markets are still down and I believe they’ve rebounded better than second tier markets and all rural areas.
I’m not quite as optimistic that housing will go higher from here unless median household income goes up but given that I have quite a bit of my net worth tied to real estate, I’m hoping my pessimism is unfounded.
Gotcha. Yes, buying near the top or the top makes returns difficult. And we are right now near the top.
One of the main points of this article is simply this: within 30 years, no matter what happens, you will have a paid off asset that can help with financial security. You can live in it for less than renting, sell it, or rent it out. You won’t even feel much pain throughout the years b/c the payments are automatic. Get this asset out of the way, and utilize your extra money to invest elsewhere.
Well one I bought at the bottom of housing in 2009. But at least the one I bought last year in Charlotte area is up 10% in a year or so based on zillow and refi appraisal.
If you hold it for 30 years (or anything close to that long), it definitely makes sense. Most people only own their home for 6-9 years, though (trading up, moving, etc), and adding in buy/selling costs, and sometimes expensive repairs, and renting can make sense for people around middle income levels since most won’t qualify for a second housing mortgage on another property with just $55k/yr in median household income if they get a good job offer in another city and happen to be upside down or just don’t want to take a loss. People on this site I’m sure probably are at least 2x that for household income and probably able to hold as rentals if they move. Just depends on risk tolerance.
https://www.creditsesame.com/blog/how-long-are-americans-staying-in-their-homes/ (slightly old article but shows holding periods for real estate from 2003-2011)
As soon as the commission cost come down to a more reasonable fixed rate, flat rate, or 2%, the real estate industry will see a ton more transactions. Before then, we should all be incentivize never to sell our properties. Why lose out on 5% and pay taxes? It is a wealth killer.
I am 23, work in commercial banking, and live in Napa. Housing prices are about equal to SF, as I couldn’t even qualify for a rent to own property last week. Should I save up and buy RE in 2018 (yes the market will turn over soon) or should I risk my money fortune hunting in stocks.
Yes, same all you can for the next two or three years. Napa is definitely seeing a downward decline and pricing. The first properties that go are those second homes and vacation properties. I definitely would not buy enough for right now. Worst case scenario you have a ton of liquid money in two or three years.
Appreciate the real data and total cost of ownership numbers. Makes me glad I stayed in the valley and didn’t move to SF.
Rent vs buy will always be a personal decision. But I agree. In today’s manipulated markets, real estate is one of the few ways individuals can assume some control over their investments.
It’s not just the hot money out of China that’s causing the real estate surge. Real estate has a value that goes beyond numbers and his you deep in your soul in a way no other investment can.
Like sex, love, and parenting, if you’ve never tried it, you will never understand.
I live in Manhattan in prime real estate location. My rent is $4,200 in a 1br that would retail for $1,500,000 or so.
Quick math means $8k a month all in mortgage, tax, condo fees (latter two are not too high under $1k each).
I can’t figure out why I would buy given I can just build “equity” by pocketing the $3,800 difference no?
Household income $400k. Two salaries. Late 30s no kid. Been in NY for 10 years. Not sure where we will be next 10.
Apartment hard to rent (no AirBnb allowed or short leases and high move in and out fees).
Should I NOT buy? Have 20% down payment in cash but not much more at all. Buy/Hold/Rent???
To me the difference in monthly when owning rather than renting is staggering and any help appreciated from Sam or other readers.
One thing you have to ask yourself is why or what were the reasons why you didn’t buy 10 years ago, five years ago and three years ago. Only you will know the answer. For me? I didn’t buy into thousand and one because I was afraid after the.com bubble burst and I was uncertain about my job future.
$4200 a month in rent is cheap if the place really is worth $1.5 million. $4200 is exactly what I am renting out one of my places for and I would be extremely lucky to get 1.2 million, more like 1.1 million.
When you are at these expensive valuation levels, the key variable is your duration of stay and your forecast of principal appreciation. I think we are past the market top and are in a two-year downward trajectory, so I would keep on renting if I were you if you’re looking to buy at that level.
There is a risk of course that the 1.5 million will cost 1.6 million or 1.7 million when it’s time for you to buy. But as you said, if you’re saving the difference and investing in making money, maybe it doesn’t really matter because you’ll still be able to afford it. I would personally should to buy a two bedroom two bathroom condo for more flexibility and upside.
Excellent response, very appreciated.
I didn’t buy 10 years ago b/c I started working late, 5 years ago because I was starting to make decent money but had no savings, and 3 years ago because I felt like what was in my price range would be too restrictive a few years after (i.e. would buy a small 1br and be unsatisfied) and due to new job (in)security.
My income is also 3x now what it was 3 years ago, and I expect it to stabilize now, so I feel like I am getting financially ready. I save a little bit over $100k a year after taxes and retirement.
$4,200 is cheap, and I negotiated decent price increases over next 2 years as well, so my risk is hedged. The place might be worth more…a couple of similar units recently sold for $1.6-1.9m a few stories above mine. I’d buy mine at $1.5m.
Normally in NY a $1m 1br will yield $3.2k or so rent.
What I think is making a big difference in high price vs. low rent where I live are a few intangibles (location and view) that are highly valued by a buyer but may not for renters. In addition, there are a lot of condo fees to move in and out which limits turnover.
Or we just got plain lucky. Other similar units rent at $4,500+
Principal appreciation where I live will be modest. I figure 6% a year. I agree on the downward trajectory. Commercial real estate here is showing lots of vacancies. And it’s starting for residential real estate…I want to be ready.
I am not sure if my apartment value will drop (I doubt) but I think it may stabilize while I keep saving, at least that’s the plan. Just very confused about such a gap vs owning / renting.
I save the rest in 55 equities / 45 muni bond etf.
A 2br in my building is more like $3-5m (they’re 1300 sqft+) so that’s out of the question for now. In less desirable locations (but still good ones) a typical 2br will be close to $2m these days.
Typical 1br run from $800k-$1.9m Thanks again Sam! Your blog is my #1 personal finance / financial freedom read. I got inspired since reading and my saving rate is now ~55% of after-tax take home.
Wow…. $3-5M for 1,300+ sqft is muy expensivo! Why do you think the media always harps upon SF being so much more expensive when it is clear that Manhattan blows SF out of the water? You can get 1,300-1,500 sqft 2/2s in SF in great locations for $1.3 – $1.9M. Damn, maybe the 1,300 sqft 2/2, double balcony place at 22 East and Madison w/ a view of the chrysler building is actually worth $2M from the $760,000 I could have bought it for?!
Related: How Do People Afford To Live Comfortably In Expensive Cities Like NYC On Less Than Six Figures?
I’m glad I’ve helped motivate you to save and get on the path to financial freedom. It’s so worth it not to have to work after a while and do your own thing. Take full advantage of your opportunity now, as you never know how long it will last.
BTW, here’s something else to think about. Let’s say you want to buy a $1.7M place. If it inflates by 4%, you’ve got to make $68,000 on your salary just to keep up. Your $400K combined income is great, but that means you need to grow your salary by 17%. Possible? Of course. But long term sustainable, difficult unless you are on track for partner/MD mega millionaire status.
Interestingly, I am almost in the exact same situation as Mark. I’m starting to look for properties again but I am paying $5,300 for a 1 bdrm. Just got married. If we buy, we would like to buy for a potential family, ideally 2 bdrm 2 bath with office, which is going to be in the $2.5-$3m range. It’s hard for me to imagine going from $5k per month to $12-15k per month. On the other hand, I don’t want to buy a 1 bdrm 1 bath, because we know we will not be happy with the space and I don’t want to spend money and time moving, only to then move again in 2-3 yrs. The other issue is psychological, nearing 40, I am breaking $1m, but I grew up with very little and it is hard for me to fathom that I could ever buy a $2.5m apt and am always concerned that my businesses will crash.
The good news is that instead of sitting on multiple downpayments worth of cash, I have been steadily investing in commercial real estate around the country. Mark, you may want to consider this as an option – basically I’m geoarbritraging by investing in markets with 7% cap rates, for ex, and paying my rent with that money (I still pay the difference as I have only put $500k in those strategies). Currently, I have stopped doing this because I see Manhattan prices dropping fast and I want to be there and ready if asks start hitting my bids.
Anyways, good luck out there! I love Manhattan, but I really wish I didn’t!
“If you take on huge debt, your motivation to work hard will shoot through the roof!”
This has rung very true for me. Very similar to procrastination, you will be much more productive when you only have 1 day before a deadline.
I do feel your real estate articles are somewhat outliers due to the nature of the SF housing market. You yourself are also an outlier because you’re able to afford a 1.5 million home with a down payment of 300k at a young age. Despite that, I agree with all your sentiments in buying as early as possible and holding for as long as possible. Perhaps the risk of declining home and neighborhood value over time and the importance of always keeping a high cash reserve should be highlighted!
Hi John, my hope is that readers can ignore the actual dollar value of the property and focus on another salient points in the article. But I also understand that it is hard to ignore.
I should have use the other property as an example to make it more relatable or less distracting to more people, but I just finished refinancing this property so I wanted to make an update on this one specifically. I already wrote post about the other property as entirely in 2015.
Everything is relative, so I’m just using my own example living expenses San Francisco. I’m sure a $5000,000 property and net worth would be great for someone living in a place where the median house price might only be $300,000 for example.
Thanks for reading!
Wow, what a great post. I’m much more on the Warren Buffett, Robert Shiller, Ramit Sethi, James Altucher individual homes that you live in are not a great investment. WAY different than what most people say. But this is the most intelligent and nuanced defense of buying I’ve seen. Made me rethink things a little. So, we aren’t quite at the $1.3M net worth or so for the above average couple our age per FS but we are close and VERY liquid as it’s all stocks, savings, mutual funds, and 401(k)s (though of course we’d never steal from our 401(k)).
We live in the DC area which really, really, really is closer to the post-peak, things are about to fall down hard for DC than even SF or Chicago. People are in denial. If we decide we are going to live here another 10 years, pretty unlikely, will save some of our cash for housing rather than just stock investing.
I also believe everyone should buy property for lifestyle first. And after you’re bored or want a new lifestyle, but another property and rent out your first. You know everything about your first property as a result, and know that if you enjoyed living there, other people will too. Also, you are hedged against a downturn b/c you’ve built up more equity and enjoyed life in it.
I’m familiar w/ the DC area b/c I went to high school in NOVA. I spent time looking around McLean, VA online and there seems to be a boatload of high end properties just sitting. Save aggressively now and look towards 2017/2018/2019 instead. A $1.3M is great! Don’t let a post by me tell you otherwise :)
Sam,
This is my first Comment in your website, but I am an avid reader. What are your thoughts on seller financing instead of going through a traditional lender?
This works on both sides of the sale. If you buy with seller financing, you can negotiate terms that are better than what you can get from a bank. When you sell, you can sell with a lease to buy option and hence avoid the tax penalty of one big sale on a given tax year.
Ofcourse this all works assuming you don’t have a “due at sale” close in your current mortgage agreement.
Thanks,
Faisal
I love seller financing, if you can find a seller who will do that. But I’ve yet to find one b/c a seller generally wants to simplify life and remove risk from their books. Keeping a relationship with you for years doesn’t do that.
But, I wouldn’t mind doing a lease to own as a seller. The buyer essentially rents from me at a slightly higher price, of which the extra money goes to paying down their buy cost. But I like to hold on for as long as possible. Most do not. Most just want to sell completely.
Sam,
If you live in your property and rent out would it not be better to sell (and not rent), utilize Sec 221 for a tax free profit of $500K (per couple). When you live in the property and rent it out you are only relying on cash flow. Appreciation on the property does not matter because of taxes (which even if you defer with 1031) need to be eventually paid.
So if cash flow is the primary driver, why not Midwest where cash flow is better than SF?
Hi John, check out: https://www.financialsamurai.com/tax-free-profits-for-home-sale-250000-500000/
I won’t get much benefit. I actually believe SF is one of the most undervalued international cities in the world. I’ve been everywhere, and most recently Paris again, and it makes SF feel like the Midwest. As soon as we can get better public transportation, I strongly believe over the next 20-30 years SF will be a big winner. Midwest, not so much.
I saw how Singapore changed from being very cheap in the 1990s to now one of the most expensive places in Asia, all in a span of 10 years. It was NUTS!
In SF, you can buy PANORAMIC ocean view properties for only $900/sqft. That’s unheard of. We’d be talking $2,000+/sqft in Mumbai, Singapore, Hong Kong, Manhattan, etc.
Where do you live and what are the prices/rents doing out there? Do you invest in real estate?
Sam,
I was born in Mumbai and now live in the East Bay. Since you are on a strike to sell, the appreciation price does not matter. Assuming you have 1M now to invest in buying a rental; would you still buy in SF or buy in the Midwest where you would get more cash on cash rental income?
My point is cities like Mumbai, SF, NYC have great appreciation but return lower cash on cash rental income.
SF has a huge homeless problem so comparing it to HK or Paris is not fair. Also it is dependent on only the Tech industry and we know what happened to Detroit after 30 years. Diversification is always helpful over the long run
If there is any industry which I think will continue to evolve and survive, it’s tech.
Hi John,
If you are not thinking of selling, price does not matter in the sense that you won’t lose any money if prices go down.
However, if prices go up, prices do matter, as you can use your capital gain to borrow more money for your next Real Estate purchase, without selling.
I’m hesitant to advise young kids to invest in real estate primarily because of the experience my husband had. His parents encouraged him to buy a condo in 2007, without doing much due diligence on rental prices in the area because “it always makes sense to buy.” As a result, we’ve had basically zero price appreciation and the monthly mortgage/taxes/HOA is still higher than what one could rent the unit for. I ran the numbers and if we sold today we still haven’t hit the break even horizon compared to if we had rented the whole time. Yes, you say “never sell” but many will need the capital in their current home to get into their next one.
I think that real estate can be a great investment but it doesn’t work out for everyone and it’s not the end all be all of investments. Your capital is all tied up, there’s lots of isometric risk, your investment profile is probably not properly diversified, and it inhibits mobility (yes, you say you can just rent the place out but many cannot cover all their home costs with the cash flow from rent, or must hire a property management company, which hurts the bottom line. This can psychologically discourage one from moving).
I believe it’s an equally good strategy to rent and put your savings in the market. You say humans are bad savers, but if one has saved up the 20% down payment for a home then clearly he/she is not terrible at saving! Just my two cents.
Sorry about your situation. Where did you buy? And do you have other investments as well?
It really is a much more difficult result if one buys at the top of the market or close of the top of the market. Do you think if you would’ve bought in 2010 to 2012 you would have a different opinion? Also, is one or both of you looking to leave right now but feel like you cannot do to the house?
Her rent prices going for nowadays for a property like yours compared to the all in monthly costs after deductions?
Well I hope you’re wrong, as we just went under contract yesterday for our first home. There was not a lot of choice in our timing, as we are moving for a new job (MI -> NJ). And, with young children that we don’t want to move more than we have too, a rental was not considered.
I figured the housing market would move sideways for another 3-5 yrs and not necessarily go negative. Either way, we will be there for 7, 10, or infinite years depending on how my job works out. Hopefully, we at least break even, if we decide to leave. The people we are buying from are probably losing money, as they have been there for less than 3 years and are selling for 1.2% above what they purchased. They are moving for a new job as well.
I really hope I am wrong, but I am out there researching new listings, existing listings, and expected inventory every single week. It is very clear to me the high-end is slowing down and price cuts are much more common now. Everything gets compressed from the top to the bottom. But if you can live there for 10+ years You will probably be fine. Just don’t so with commission rates at 5% or greater. It is such a rip off.
I have long considered buying rental property and came close a few times. I am trying to figure out what to do. I have a net worth of $1.65 mm (56% in my primary residence, 43% in the stock market and 1% in cash). I am 100% debt free, including no mortgage. My income is $475,000/year gross ($333,000 net). About $93,000 of my income goes into various retirements accounts and deferred comp. My expenses are $80,000/year. I have $160,000/year left that I am trying to decide what to do with. I am considering either buying a set amount of S&P500 each month for life and let it ride or plowing it into high yield account for cash to buy property down the road. If I put $5,000 of the $13,333 I have left in cash per month, that means I will be effectively plowing 45% of my net income annually into the stock market. Is this too much? It’s nice to have cash on the sidelines to pounce when opportunities present themselves but it is an unproductive asset.
Age is a big factor. How old are you and what is your risk tolerance?
Having a 1% risk free cushion is way too low at the top of the market IMO. I’d shoot for 10-15%. See: Recommended Net Worth Allocation By Age
Also, depending on your age, your net worth can be considered good or not so good at 3.5X your gross annual income. Try to shoot for 20X before it’s all and said and done. See: Net Worth Targets By Age And Income. It is good that your expenses are only $80,000 a year though.
I am 33. I have a 1% cash position because I have a HELOC with access to money at any time. No good?
The cash position is actually from a HELOC you are paying interest on? I don’t think that’s the right way to go about the cash position b/c the HELOC can be recalled as they were during the downturn, so it’s not really your money.
Given you have a large income and savings rate, I recommend you just build real cash, and do so aggressively as everything turns for the worse.
You make nice bank. What is your profession?
Out of curiosity, are you a business owner? I’m hoping to get to a similar position in a couple years, but the last two I’ve been paying an effective tax rate of nearly 50% working for the man in California and it’s really been eating into my ability to save. How are you able to get your tax rate so low, especially with no mortgage?
Sam — I know you’ve written about it in your posts on becoming a travel blogger, but would really love a more in depth post on avoiding the tax man in California!
I agree with you that the global markets (in most asset classes) are definitely going to be soft for the next bit. I desperately want to change my living situation in 2017 away from crappy roommates, but waiting until 2018 would give me more time to save an even bigger down payment and emergency fund. I’ll be 34 then, still time to get a small mortgage and pay it down before early retirement.
Thanks for showing us your thoughts on these markets. You are one helluva smart guy.
Thanks for yet another insightful post. I assume that you anticipate this upcoming softness will impact other housing markets? What are your thoughts regarding the NYC market over the next 2-3 years and do you think there will be much of a difference weakness wise between the single family and multi family space? Lastly, would your thesis to wait on the side change if one is currently renting (short) or do you think it would still be prudent to be patient over the next few years before becoming a buyer? Thanks again for all of your posts and constant guidance.
I think NYC will have the same trend of softness for the next 2-3 years. The high end of NYC is already very soft. It all compresses downward and then eventually bounces like an accordion. Be extremely picky right now.
Dear Sam
I always find your articles informative, but I think three of the resons you give for investing in real estate are specious.
3) You want to own real assets because money is only a medium of exchange that loses value every day due to inflation.
No, the alternative to investing in real estate is investing in financial assets, with income and capital gains, not just money. Financial assets also tend to rise with inflation.
4) With inflation, rents naturally rise. If you stay a renter, your costs will always go up quicker than a homeowner’s costs, making retirement a little more difficult to manage.
What are your grounds for saying rents rise faster than a homeowner’s costs?
5) Despite inflation, interest rates keep coming down. This is the goldilocks scenario for all real estate investors who get to take advantage by refinancing their mortgages or getting record low mortgage rates for purchase while also raising rents.
No. Rates keeps coming down because inflation is nowhere to be seen. Rest assured if indlation ever revives, rates will rise too.
The fact is, if you want to make rational investment choices, you must always compare the costs of renting with buying. Or the likely returns on real estate vs other assets. By all means, throw the psychological benefit of owning into the mix. But at least start with monetary costs and benefits.
And don’t delude yourself with errors like, ‘Paying rent is throwing money down the toilet’. Then what is paying interest to a bank? You either rent a property directly, or rent money from a bank to buy the property.
The other error is, ‘I own my house, so I save on rent and don’t have to pay the bank either.’ But your capital is tied up in the house. What could you make on it if you put it to work in the financial markets? And would that cover the rent you would then have to pay?
If I’m not mistaken, you have made these points yourself in earlier articles.
Kind regards, Roger
1) Agree. Real estate is only one of several asset classes I believe are worth investing in. This post tries to show what if one only focused on real estate. Check out: Recommended Net Worth Allocation By Age. Real estate makes up about 40% of my net worth, which I’m trying to reduce by growing my other assets and paying down debt.
2) Check out the columns Rent and Cost To Own in the chart since 2005. These are true numbers within 10% b/c in 2005 those were the exact numbers. The same for 2016 since I just refinanced and am now receiving $9,000 a month in rent. Mortgage payments are fixed, and have actually gone down for anybody who has taken the initiative to refinance over the past 30 years. At one point my mortgage was ~$6,500. Now It’s $3,300. When your mortgage payment declines by 45% and the rent rises by 80%, you create HUGE economic gains over time.
3) This is the curmudgeon, and a good one for homeowners. If you look at everything from tuition, to food, to cars, to rents, everything has gone up and continues to go up way more than reported CPI of ~2%. Just look at the prices you paid 10 years ago and compare. The rent prices (showing inflation) in my chart are real. I’m thankful the bond market is getting bid up to keep interest rates low. I may write a post on this more to explain. If inflation does pick up drastically, homeowners will be pumped because their payments are fixed yet their real asset will also inflate drastically because real estate is part of inflation. You can also read: Should I Buy A Home In A Rising Interest Rate Environment?
4) I never said rent is throwing money down the toilet. You gain utility from rent. It’s just the RETURN on rent is always -100% every month b/c you don’t have the OPTION to sell the place you are renting in the future. The return from owning a home is also not a guarantee. Look at my chart of the DOWNS. But when you own a home, you have the OPTION to sell and the OPTION to rent it out. Having more options brings about more freedom.
Tell me about yourself Roger. I’d love to know your experience so I can get a better idea of where you are coming from. What is your net worth makeup currently and what stage are you at in your financial life? I’m always looking to gain more perspectives, especially from those who’ve had good and bad experiences and who are later stage in their financial life. I definitely have blind spots that need illuminating, and the community helps me do that.
I hope this posts shows that despite the ups and downs, real estate can build wealth over time in a relatively simple manner. Real estate has been pretty automatic once the refi or tenants are found, which is why I spend a lot more time trying to build an online business and invest in other asset classes. Thx! Sam
Sam, let me ask you…Do you really own the house if you pay a mortgage, pay property taxes (forever going up and sometimes more than inflation), commissions to buy, renovations coming in the beginning of the purchase and most likely when you sell the home, and continued maintenance forever? Sam, also one has to ask themselves—How much is freedom worth? When you rent, you have the freedom to go anywhere you like…Want to live near a good school district because the child is older? Bingo, let’s rent a place in that district and when the child gets older, just maybe we will decide to relocate to a cheaper area—Freedom. Think about all those home “owners” in 2007 who are still underwater almost ten years later, think about the ones that lost their jobs and still “own” this illiquid asset.
Sam, I think that this is a truly individual choice that someone has to make, but financial freedom blows owning a home any day. When one is Financial free, He/She can feel the sense of a new home any time and any where they want. I have owned and rented, now with some financial assets growing in a dividend growth portfolio, I’d rather have the freedom of going anywhere I want and not have to worry about a broken pipe, all I have to worry about is paying my rent to my landlord, who will have a hard time raising rents, when my credit score is 800 and I am a great tenant who pays on time, He will DO ANYTHING to keep me, ah the power of renting…lol.
Thanks
Joe S.
Joe, I don’t think we own anything really, since we all die in the end. We are simply temporary renters of whatever we have. During the time we have on Earth, it’s a good idea to minimize expenses and maximize income.
Homeownership is an individual choice. I’ve stated my case, and people are free to agree or disagree. Just run your own numbers and see how things have turned out.
I’m not sure why you think homeownership restricts freedom. I’ve traveled for seven weeks so far in 6 months and own multiple properties. I don’t need to go to work because my rental income pays for all my living expenses. Real estate income helped give me the confidence to take a leap of faith in 2012 to do something entrepreneurial.
Landlords really appreciate tenants. Tenants are our clients. We need tenants to build our wealth, which is why your landlord is trying to get you to stay. Sure there will be homeowners who bought more than they could afford, and are under water. Hopefully most are way above water as the data shows. Some even own property where prices are 30% higher than in 2007 (see chart in post). Don’t you think there are many equity investors who lost their shirts in the downturn too?
Do you think I’m not free? If so, please elaborate as there sometimes a kink in how I see my life and how others see my life. I think this would be a great reflection post and I can write a new update on these two posts:
What Does Early Retirement Feel Like?
What’s It Like To Be Financially Independent?
Please share with us your latest situation. Always great to have new perspective!
Thx
Sam, thanks for the reply as always.
In my experience, a dividend growth portfolio strategy seems to be performing better as an investment than owning a home, in my honest opinion, I would rather rent in a great area than own a home in that area, jeez if I were able to get a lease agreement for 10 years indexed at inflation or at 2.5% increase annually I would take it and take my down payment and invest it in my portfolio, and continue to contribute the max in my 401K, HSA, and Roth IRA, while enjoying living in a low tax bracket because of my contributions.
Sam, again this is my opinion, but I think you have done a great job creating a Real estate empire, my empire relies on stocks investing in the greatest dividend growth companies in the world that have continued paying increasing dividends year after year.
Sincerely,
Joe
I like having a dividend portfolio as well, and I do have one if you check on my passive income post. The issue with me is that I’m not spending the income that I’m generating, therefore I do not gain any satisfaction or utility out of a dividend income portfolio since I am already retired. But I do gain satisfaction living in a house that I enjoy or simply driving by one of my rentals and going to the backyard and picking 100 plums like I just did the other day from my tree.
If I was still working, the dividend portfolio might be relatively more attractive, but still not as attractive as real estate for me.
I certainly hope people can at least get neutral inflation by taking care of their living arrangement, and then building a significant dividend income portfolio along with anything else they like.
Hi Sam, what are your thoughts on the advantages of directly buying a property vs investing the same money in a REIT index?
I like to directly buy a property b/c I want to own 100% of a real asset eventually. There’s tax advantages, and 100% control to rehab, find tenants, refinance, etc. You have no control when you invest in a REIT index. You could leverage up to buy a REIT index like a physical property. REIT index is liquid and has tax advantages too. Just can’t live in your REIT or gain any utility. It’s just using money for more money. I prefer buying property to enjoy for years and then rent it out.
I’d rather buy stocks and equity index funds than REITs and have physical RE make up that portion of my net worth.
Immigrants to the US who want to move back to their home country don’t necessarily want to invest in real estate in the US as it would complicate things when they decide to move back home. That’s a common excuse I’ve seen in tech areas. I bought my 2/2 condo at 23 and it’s now up just over 50% since I bought it. The rental cap in place doesn’t really allow for renting it easily, so I will sell when we want to move sadly, but it’s quite possible we will stay here for a long time. I’m glad I bought when I did – it gives us an affordable place to live in the city instead of getting pushed further out to save money on rent.
On another end of the spectrum, a good discussion would be about if you should make the minimums on your mortgage, or pay it off ASAP. And, if it is better to rent / invest as opposed to putting your wealth into a property (logic being that stocks tend to have better returns than property net of all financial costs / benefits of owning a home) assuming you have the discipline to save money on your own without the “forced savings” aspect of mortgages.
Would love to hear your thoughts on these.
Check out:
Pay Down Debt Or Invest? Implement FS-DAIR
Why I’m Paying Off My Mortgage Early And Why You Should Too
Sam are you sure that there isn’t a bubble in San Francisco real estate? I plugged those numbers into excel and that’s almost a 20% annualized return, which is eerily similar to the 16% annual return of Vanguard’s technology ETF over this period. If Shiller at Yale is right and home prices go up at the rate of inflation long term, then you could be looking at a serious correction coming in the first big market drop. I might sell my San Fran real estate and buy EM, oil, and european stocks or something like that
Check out the chart and the conclusion of the post regarding returns and thoughts on the market. Are you talking about 20% cash on cash return? I expected A decline in prices over the next two years.
Related: The Cheapest International City In The World: San Francisco
Hey Sam,
My wife and I (both 28) make a combined income of $250k/pa after taxes and we are about $450k liquid. One third of that is in the markets while the rest is in cold, hard cash rotting away at a nice 3% pa.
We are thinking of buying our first home in a good location – either a $1.6m (900sqft, 3 bedder) or a $1.3m (2 bedder) condo. Interest rates are around 2.5%.
1) Which can we afford?
2) Would you recommend liquidating everything we have in the markets and using it all as the downpayment?
May I ask where you are looking where there are 900sqft 3 bedroom homes for $1.6M?
If your 250K after tax income is pretty secure, and you want to be where you want to buy for 10+ years, then I’d buy and enjoy your money/house. Just don’t go crazy bidding b/c the market is at its peak now.
What a cute baby you were. The article is good too. My children would like to buy instead of rent but they have student loan debt and need to get that paid down a bit before they can make the leap to home ownership or to landlord.
Great post and some great comments/discussion! Great picture too :)
The rental market in Sacramento has been on fire recently as well. Another year of raising rent feels great! haha Right now I am contemplating buying another rental with a business partner if we can find a good deal.
Also wondering what is going to happen to Sacramento home prices–not that it matters too much if you have a NEVER SELL mentality like you mentioned, which I am 100% in agreement with you! Even though the property value is falling through the floor, rents were pretty much untouched during the 2008 crisis (here is a graph for you visual people:
Part of me agrees price will fall with the global slowdown, but part of me wonders if more people are leaving San Fran to live in Sacramento and driving the prices up. Any thoughts on a potential SF exodus?
Nice details on rents staying sticky while prices dropped 50% in Sac! I experienced the same thing in SF (flat rents due to one year min leases and tenants staying 2-4 years). It’s ironic b/c when the housing market falls, more people seem to want to rent, keeping rent prices high until things really start falling apart.
There has to be some migration out of the SF Bay Area to other cities, pushing up prices. But during downturns, it always seems worse outside of the most expensive areas. I would really be cautious right now and only look for stalefish desperate sellers.
Good point about Sac being much less insulated to downturns! Thanks for your insights! No shame in sitting on cash and trying to lowball desperate sellers this winter, I guess.
I bought my first house at 22 and an investment foreclosure house at 25 (which I still own.) We plan on downsizing and moving in to that next year (after getting the same tenant of 24 years out!) I was born in to a family who bought investment properties so I do thank my parents and older brothers for encouraging me to start young! We currently own 5 properties and just had an investor contact us about an 8-unit apartment complex we own. We are in a great position (since it wasn’t even listed for sale) to make a decision about selling if the price is right! But we know that holding long term is key to real wealth too!
Appreciate the real estate insights. I’ve been searching for a great deal on my first rental property in the MD/DC area but have not seen one. Maybe it’s the local market, but I agree with you the market has recovered too fast since the downturn. I also feel that is the case since many of my peers are talking about buying big houses.
My goal is to find a great deal on a rental property in a good area that I can hold on to for a long time.
In my opinion real estate is probably the easiest way to build wealth. I’ve been trying to purchase some investment properties for awhile now but no luck. I’ve but offers in on 4-5 homes over the last 2 years and have been outbid on every singe one. Personally I feel the market has become extremely competitive and inflated over the past 2-3 years; At least in my local market (Chicagoland). Do you still see this as a current buying opportunity in the near-term?
Check out the chart.
I’ve made my bet about where real estate prices are going over the next 10 years. Now it’s time to make bets elsewhere for diversification purposes. We are now near the top of the real estate cycle. Unless you plan on using my spray and pray method to take advantage of desperate sellers with low ball offers or find a fixer with great upside potential, I do not recommend buying now. Instead, wait until about 2018 when real estate agents and sellers are no longer in denial.
I was wondering about those estimated future growth rate numbers.
They’re very specific. How did you come up with those numbers?
The numbers come from the Financial Samurai Institute Of Housing & Economic Development think tank.
Do you see numbers where you disagree? If so, I’d love to know which numbers and why. Thanks
I don’t disagree with the numbers.
Very specific numbers probably indicate a very specific methodology. I was just wondering what it was.
If you had been just eyeball-guessing, then you would probably have used more round and smooth numbers (10%, 5%, -5%).
Did you take historical averages over the last cycle, and apply a multiplier?
Thanks.
Cool. I’m just kidding around. What I’ve done is analyze the market comparables, input my own price estimates, cross check them with historical rises and falls, and compare to long term interest rates to get the numbers.
I combine the micro (I’m on the ground, looking, asking, talking) with the macro. Then of course there are different segments of the housing market that will perform differently e.g. >$3M SFH, <$2M SFH, <$800K condos, etc.
I think real estate can be an attractive option, but there are definitely risks and downsides.
It can definitely restrict mobility. Transaction costs are very high (upwards of 6% of home value for a seller) and there are markets where the rent:mortgage ratio is bonkers and doesn’t even have you breaking even (here is looking at you Vancouver).
Relying on so much leverage like you advocate can backfire big time if you end up having invested in a future Detroit or during a bubble. SF has risen back to ’07 prices plus some but let’s remember that is not the case for all markets.
Plus when people calculate how much they “earned” on their property, they often conveniently ignore the capital, time, and stress they spent on maintenance and renovation.
All that said, I do think for many people in many markets, home ownership can be a good and potentially profitable hedge against rising rents if you plan to stay long term. But it is far from fool proof.
May I ask whether you own or rent? And if you own, when did you buy?
My chart highlights the ups and DOWNs in the cycle. And even with the downs, things have been fine so long as you enjoy your property, pay your mortgage, and live your life.
There is no “fool proof” investment. If you want fool proof, buy CDs or hold cash that is subject to inflation. Maybe I need to make this clear in the post.
Why do you think real estate restricts mobility when you can just rent it out? You can even do short term rentals like Airbnb, which is now worth over $25B as it become a popular option.
Don’t forget that the return on rent is -100% every single month. There is no ability to sell at the end of the rental period. Renting is a guaranteed loss versus owning is a potential loss. But real estate is also a potential money maker too.
I bought last year and live in a market where it seems like my hedge against rising rents will probably work out. My opinion is not that this was a terrible move for me personally, but ymmv.
Perhaps “fool proof” is the wrong word. My point is that it is not a given that RE should be preferable to other, more passive active classes such as stocks and bonds, especially if the purchaser is not in a favorable market and lacks a competitive advantage (e.g. contractor skills to cut maintenance costs).
I think RE can reduce mobility if PITI + maintenance exceeds rents. Most people with average salaries could not handle a negative cashflow on a rental property (even if they are building up equity).
Further there are markets where rents do not exceed ITI + maintenance (non recuperable costs). In these cases, buyers are actually paying more out of pocket in non-principle expenses than if they had been renting. That turns into a double whammy if home values are stagnant or decline since their purchase. Such a buyer would be losing money as well as paper value every month keeping that property as a rental.
That seems to be the case in Manhattan, where the monthly carrying costs are often already at 50% of rent.
Another point in favor of starting young is it sets you up to make a second major move in your financial career. The first 10 years of a real estate purchase builds equity. The next ten years offers a lot of options. You can trade up into larger, more expensive properties, or refinance and keep buying. You can use the excess rental income to pay off principal and retire. I am struggling with whqt step to make next.
Couldn’t agree more. When i was 20, i bought 5 buildings in 5 years during the no doc loan years with a bunch of liar loans. Just by virtue of paying mortgages with rents, and handling some maintenance issues over the course of 10 years, I have net worth that would surprise the hell out of anyone who doesn’t know me. Inflation is a beast to anyone who dabbles in real estate and is never mentioned as a factor in favor of buying real estate
I’ll take that juicy 5x inflation thanks to leverage! Feels great being on the right side on inflation. Totally agree people don’t talk about inflation and leverage enough–it’s what makes real estate a great investment. Without leverage, real estate is meh for younger people, in my humble aggressive young-investor opinion.
Wow I love your table! It has so many fascinating insights. I wish my parents taught me about real estate when I was younger. I felt very intimidated by the idea of buying property until my late 20s/early 30s. Now I am facinated by real estate and love following the housing market and going to open houses. Excellent points in this post and what a cute pic!
I was hesitant, nervous, and scared before jumping head first in 2003 as well. Then I realized, there was nothing to be scared of if you ran the numbers, had a 10%+ cash buffer after a 20% downpayment and just lived your life. Every time I drive by the 2003 2/2 condo I bought, I feel pride that I took a risk and have held it for so long. Now that it’s entirely paid off, it feels like a nice piece of the retirement puzzle.
What do you mean by a “10%+ cash buffer” and how did you arrive at that number?
I agree so wholeheartedly with this post. I own a rental house and a duplex, but I wish I had gotten in the game much younger. I’m a couple years older than you, but you’re much better off financially than I am so I’m not ready to simplify just yet.
I’m still planning on buying another 2-3 duplexes before I quit the 9-5 in 2025. By then I’ll have my residence and the rental house paid off. The extra money coming in from the rental house will help me pay off the duplex faster. Then I’ll do the same to get the others paid off as quick as possible as well.
I’m not too concerned about the appreciation, but where I’m at rents are reasonable but continue to go up every year (while my fixed mortgage payment stays the same). Hard to beat it!
— Jim
Sounds like a GREAT plan Jim! Having your primary residence AND your rental house paid off when you engineer your layoff (never quit) in 2025 is perfect. You will be completely cruising in life, I promise you that!
Thanks, Sam – I hope so! If I can play it right, I also plan to utilize some of the concepts from your book as well (although my situation is extremely unique).
— Jim
I agree with a lot of what you say, but some of it seems like it only applies to the SF Bay Area. Rent of $9000/month for a two bed, two bath condo is mind boggling.
Our house has been a great investment for us, which we are going to try to cash out of soon. Hopefully we can sell before the downturn.
It’s $9,000 for a single family house with four bedrooms, 3.5 baths actually. The 2/2 condo was a different property I bought in 2003 at the bottom end of my purchasing power b/c I was nervous. Then after I bought, I realized there was nothing really to be nervous about. All I was doing was paying my mortgage and living.
I moved to the San Francisco Bay Area in 2010 when the market was down. And I witnessed how the market went crazy since then. I have friends who bought when the market was low in 2012 and now their real estate investment value has doubled. I have been debating if I should invest my money in real estate for a while, and I think I will keep my money in the stock market for now.
My stock investment has been doing well. My investment gain can’t keep up with the Bay Area real estate, but it is close. If I decide to sell some positions to buy real estate now, I will get hit with a big tax bill given my current tax bracket. Also I am not certain if I want to stay in the Bay Area in the long run (given the high cost of living and state income tax). If I buy real estate now and sell it in a few years, it might not be worth the hassle, especially given the transaction cost.
Indeed. Ah how nice it would have been to triple down in 2011-2012! I remember those times clearly b/c I was engineering my layoff and finally left.
I really think it’s important to have a NEVER SELL mentality. Hold on no matter what after you’ve run the worst case scenario numbers when you bought. Things come back, as you see in this chart. The general trend is up and to the right.
But there is definitely something to be said w/ being liquid. No reason why you can relocate to a much cheaper place in the country. There are so many awesome places that are so much cheaper!
I agree. I do like the fact that my investments are liquid and I can manage it wherever I want. But if I ever want to invest in real estate, I will invest in the Bay Area for sure. Bay Area real estate is definitely not the norm in terms of investment return. Yes it does go through cycles, just like the rest of the country. But every time the Bay Area real estate goes down, it only goes down a little. When it comes back, it goes up much higher. Like you said, for now we have Uber, Airbnb and Pinterest waiting in line to IPO. Even after this current tech boom goes away, I think there still will be a strong demand for real estate here because people want to live here and it is a good place to start a business.
Hi Sam,
Very timely insight for me as I’ve been pondering purchasing a small investment property.
My dilemma is should I acquire one near home (easy to manage and longer term tenants) or 1-2 hrs away at a beach/lake (harder to manage w/short-term tenants, but can use it myself too as a weekend getaway spot). Any thoughts?
Near home for sure. You don’t want your rental property to be a bear on your lifestyle. Then that would be counter intuitive.
Only when you have money to burn should you consider a vacation/weekend getaway/airbnb style rental property to manage.
But before you do, I’d burn a $1 bill and see how it makes you feel first!
“Burn $1 and see how it feels” while federally illegal, its great advice…. i never thought of burning money to get a deeper understanding of ones reaction/relationship towards losing money….
Just don’t tell the government after the burning.
Alternatively, make a paper airplane and through the $1 out the window.
I should tell that to one my teenagers who tends to earn a lot and spend a lot :)
We are struggling with this same question now: to buy or to rent. Thanks Sam for outlining your thoughts here.
The reason we are considering renting is because we can continue to maximize our pre-tax investments, have a comfortable cash buffer, and work on our student loans.
Making a push to buy is also a little uncertain because I don’t think we plan to live in Chicago forever.
As you said, the market typically comes in 7-10 year cycles, so our current plan is save, save, save…and if the market starts to come down, we might be much more inclined to move cash into a property.
The biggest determinant is probably length of stay. If you can’t see yourself in Chicago for 10+ years, then definitely DO NOT buy given where we are in the cycle. Happily rent and invest the difference.
I will tell you though that it feels amazing to buy your own place once you do. It is a priceless feeling of being the king of your castle (so long as you pay your mortgage :O)).
Hey Financial Samurai,
What are your thoughts on multi-family units? Specifically 2-4 units but if you have other opinions on higher unit counts i’d be interested to hear as well. Any reason you pick single family over multi-family?
Thanks,
A
I used to regret not buying a two unit building with 2 bedrooms. I could have lived more efficiently in one and rented out the other.
But then I realized later on that the math / returns are pretty similar due to efficient markets. Let’s say this property is worth $2.2 and can rent out for $9,000. That’s pretty much the same as buying two, $1.1M condos, both of which would probably rent out for ~$4,500. And I know this b/c I have a 2/2 condo which I rent out for $4,200 that is worth $1 – $1.2.
The upside of just having a more valuable SFH is that there’s only ONE set of tenants, kitchen, electric bill, yard, etc to deal w/. Less turnover theoretically too.
I like to live in my properties for 2-10 years and then rent them out.
Hope that helps. Are you planning on buying multi-family properties? Efficient markets depend on robust markets. You just seek a different renter base for different properties. Just make sure you are not OVER BUYING in your city/neighborhood. Stay in the median or bottom 50%.
See: Are There Really People Who Spend Over $100,000 On Rent?
Buying a rental property was on my radar but i had not decided if i was going with multi-family or SFH. While there would be more turnover theoretically since you have more units. I also thought of the other end which meant losing 1 tenant wouldn’t be the end of the world since you should have others still paying rent.
Your last point makes more sense now. I was originally wondering how buying a home and renting it right away could be less than the rental amount in SF. Living in it for 2-10 years definitely helps as the rents rise.
Lastly, when you say stay in the median or bottom 50%, are you only referring to the price of the property?
A
Try to buy property for lifestyle first. Otherwise, property turns into uninspiring money, and that’s no fun. You want to ENJOY your wealth. If you can find utility in your wealth and potentially make money at the same time, that is a huge win.
I see. That is a new way to look at it. I currently have a place that has appreciated and follows your idea of buying the property for lifestyle. I was thinking more along the lines of increasing passive income and buying another property strictly for rental income.
A
In our area, multi-family does better in the cash flow area (which is what I’m chasing after). However, a big point to remember is that if things go bad, you can sell a single family to anyone. A multi-family, however, is limited basically to investors.
— Jim
The potential resale clients is a very good point.
What I think is an advantage for multi-units is that you have several tenants, which means that if one units stays vacant for any amount of time, at least part of the mortgage is covered with the other one(s).
Of course we all strive to have our properties fully rented, but potential vacancy is a factor to be accounted for.
Also, properties for lifestyle is a good way to do it, but it still limits you to where you want to live. We do not really diversify in terms of type of investments, however we diversify in location for our real estate (different states from where we live and even different countries, thus minimizing risks in case of any catastrophy in one of the locations). So we also buy units in places we might never live in, not just from the lifestyle point of view.
Ann,
May I ask why buying property for lifestyle limits where you want to live? I always buy property where I want to live and then live in it. That’s the whole point of me buying the property in the first place. I bought in the Golden Gate Heights area of SF because I wanted peace and quiet and the ocean views, for example.
Thanks,
Sam
Hi Sam,
Sorry no :) I meant it limits you to buy in the areas that you want to live in, not that you are limited to live in some places… I am not sure I am saying things correctly, forgive me for that as I am not a native speaker…
So while I do think that buying where you live or want to live is a good way, I wouldn’t do that exclusively personally. I do like to buy where I live for all the reasons you mention. But I also like to buy where there is better predictable growth – as far as predictions can be right. But you’d likely agree that someone living in Detroit is better off buying in SF maybe or somewhere similar, if purely for investment purposes. We live in Canberra, Australia and it is never a hot Real Estate market – goes up and down a little, that’s all. However buying in Brisbane, Sydney or Melbourne at the right moment of the cycle, will much more likely bring us better returns, more quickly. We went once to inspect a unit in Brisbane before buying it (having done all other due diligence), and now we have a property manager taking very good care of it, no calls ever about a leaky toilet etc. The expected growth of that market (and the “lack” of trouble in the middle of the night) really outweighs paying the property manager as compared to the expected growth where we live. Mind you, we do perform a thorough due diligence before buying anywhere.