Thread on Owning A Home
This is one of the biggest discussions that personal finance twitter gets into...and 99% of people are approaching it the wrong way.
A home is a financial tradeoff, like a lot of other things. Let's look at it from a financial standpoint:
This is one of the biggest discussions that personal finance twitter gets into...and 99% of people are approaching it the wrong way.
A home is a financial tradeoff, like a lot of other things. Let's look at it from a financial standpoint:
1. We will assume that you need a place to live and that you will pay for it. If your parents are paying for your place, then you can skip this thread 😂
2. All real estate can produce cash flow by being rented out. We need to think about this as buyers and sellers, renters and owners.
The most important concept is the rental yield (also called cap rate) of a property. Simply, this is the rent divided by the market value/price.
The most important concept is the rental yield (also called cap rate) of a property. Simply, this is the rent divided by the market value/price.
3. If you are buying an investment property, then obviously you want the cap rate to be very high.
The higher it is, then the more you can borrow, and after repaying your mortgage costs, you have more left over.
You want a yield >10% (maybe >8% in markets w 0% interest rate)
The higher it is, then the more you can borrow, and after repaying your mortgage costs, you have more left over.
You want a yield >10% (maybe >8% in markets w 0% interest rate)
4. Let's do some round number math
purchase price: 100k. Rental yield 10% for rent of $10k/year or $830/month.
w/20% down, a 30yr fixed mortgage is $359/month.
Let's round outgoings to $600/month for taxes,etc.
You are clearing $230/month, or $2750 per year.
Not bad!
purchase price: 100k. Rental yield 10% for rent of $10k/year or $830/month.
w/20% down, a 30yr fixed mortgage is $359/month.
Let's round outgoings to $600/month for taxes,etc.
You are clearing $230/month, or $2750 per year.
Not bad!
5. Your 20k is earning $2750 in cash flow, or 13.8% per year plus principal paydown, etc. You are doing well with your money.
Even if you have to put down 30%, you are still doing 10% returns in cash, plus upside, etc.
Even if you have to put down 30%, you are still doing 10% returns in cash, plus upside, etc.
6. As an investor, you can see why high cap rates are good and how you want to lever up to buy them, especially when interest rates are low.
This is how you build cash flow, equity (paying down principal), and net worth.
Only take on debt to buy assets like rentals
This is how you build cash flow, equity (paying down principal), and net worth.
Only take on debt to buy assets like rentals
7. If you run the analysis, you'll also see that it usually makes sense to RENT the place where you want to live. Why?
- rental yields on the place you want to live are usually lower
- the rental yield on your house is lower than what you would invest in
- why tie up the cash?
- rental yields on the place you want to live are usually lower
- the rental yield on your house is lower than what you would invest in
- why tie up the cash?
8. In big cities, in nice neighborhoods, and with single family houses, you usually find that rental yields are lower. It can be 4-5% typically. in Manhattan, it's 2.5%.
Those are times when you RENT, rather than buy, and happily....Let's check the math again
Those are times when you RENT, rather than buy, and happily....Let's check the math again
9. On our theoretical 100k place, the mortgage payments on a 30 year were $4380 per year, or 4.4% of the property value. Adding in taxes, maintenance, etc, then it could be 7.2% of the value of the property.
A 5% rental yield, you are saving >2% of the property value every year
A 5% rental yield, you are saving >2% of the property value every year
10. At a 2.5% rental yield, you are saving 4.7% of the property value per year.
Basically, you are getting the same lifestyle for MUCH cheaper.
Now, you may not own it, but if you are investing the excess cash, then you are probably earning appreciation and cash flow somewhere
Basically, you are getting the same lifestyle for MUCH cheaper.
Now, you may not own it, but if you are investing the excess cash, then you are probably earning appreciation and cash flow somewhere
11. Even if the rental yield on the home is insanely high, like >12% and you WANT to own it instead of rent it...don't jump in yet.
Instead, make sure you pass 3 tests for yourself
Instead, make sure you pass 3 tests for yourself
12. First test: Can I pay 100% cash? If so, then it's OK. You have enough liquid wealth to do so.
Second test: Am I certain to move on in a couple years? In that case, it's OK, you can think of it as two years rent and than an investment
Second test: Am I certain to move on in a couple years? In that case, it's OK, you can think of it as two years rent and than an investment
13. Third test: Does the cash flow from my investments cover 2x my planned mortgage payments? In that case, you can buy the house with a mortgage, because you are financially secure enough to take some personal debt, and you know that the house was cheap on a major metric.
14. But...are you sure that you couldn't just buy the house and rent it out and rent another :) ?
Seriously, be very focused on investing well, rather than owning a house. The dream house comes AFTER financial independence when it's a luxury spending, not BEFORE.
Seriously, be very focused on investing well, rather than owning a house. The dream house comes AFTER financial independence when it's a luxury spending, not BEFORE.
15. Also: house hacking. There are cases where rental yields are high and you can buy a 3 or 4BR house, or a duplex/triplex, and that will cover the mortgage 100% or more.
In that case, do it! You are getting the same benefit, a cheap property with cash flow...and a place to live
In that case, do it! You are getting the same benefit, a cheap property with cash flow...and a place to live
16. What are your thoughts on renting and buying? What did I miss?
