In the last eight years, I have purchased three real estate properties in the Bay Area. I believe owning properties is a great way to generate wealth and I bought my first one in 2010. While the willingness to buy depends on many factors, it is important to understand the pros and cons when it comes to a purchase decision. Personally I’m a huge fan of home ownership. Whether it is for primary residence or investment, there is a set of advantages and disadvantages that one should carefully consider before jumping in. In this article, I’ll go over the common pros and cons of buying. They are not meant to be exhaustive nor do they apply to all markets or situations. They’re simply rule of thumbs that people can start with.
The points mentioned are especially true for US real estate markets in expensive areas (coastal cities and towns). I’ll use simplified examples below to dive deeper into the points.
Key Benefits of Owning a Real Estate Property
Interest Payments Are Tax Deductible
Depending on your personal income level, price of your house, and market you’re in, mortgage interest and property tax on primary residence are generally tax deductible. If you hold a mid to high income job, chances are you’re paying massive amount of taxes on your paycheck if you have nothing to offset them. Purchasing a primary residence and deducting against mortgage interest is a popular vehicle to reduce tax obligations. But be sure to consult a tax advisor first whether this is for you.
Security of Owning a Home
Many people get displaced when rent rises or the landlord no longer wants to rent. Owning the physical asset yourself means where you live is no longer at the discretion of others.
Fixed mortgage is Advantageous
If you take out a 30-year fixed rate mortgage (most popular option), you know exactly how much you need to pay for the next 360 months. The beauty of this is inflation rate will work in your favor and decreases the actual cost of borrowing as time progresses. Hypothetically speaking, if you’re paying $2,000 a month on a 30-year fixed mortgage at 4.5% interest rate, with average annual inflation of 3%, effectively it only costs $1,500 in 10 years.
Appreciation Generates Wealth
Bay Area housing price growth has been doubling every few years with occasional dips from major recessions. This is also true for coastal cities like New York, Seattle, Austin, etc. Many who have purchased 20 years ago have seen the nominal price of their house appreciated 3x (example here). Some argued investing for appreciation is speculation, but when you have a chart like that, why would you bet otherwise?
Rental Opportunity and House Hacking
Since you own the physical asset, if you decide to not live there you can rent it out. Growth in rent has tightly tracked house appreciation this side of the country. Coupled with the point above that future inflation will make mortgage payment incredibly affordable, the growth in rent will substantially increase your future cash flow. Better yet, you can still rent out part of your place even if you live there. This is referred to as house hacking and AirBnB is a common platform for achieving that.
Freedom to Do Whatever
Finally, you just have more freedom being the owner. I’ve seen leases where landlords require no hanging pictures on wall, no nailing or drilling holes, limited use of laundry machines after dark, etc. If you own your place, you’re free to do whatever you like as long as it’s not affecting your neighbors.
Challenges with Purchasing a Property
Downpayment is Hefty
Buying a property requires a sizable downpayment and coming up with the money is challenging. This is especially true in expensive areas, 20% downpayment on a home priced at the median in San Francisco means $320K. For most this means a lifetime of savings. For others putting all eggs in one basket feels risky.
Lifestyle Becomes Less Mobile
You can’t easily move to the hip neighborhood 3 blocks down the block because now you’re planted to a specific location. Technically it’s possible but imagine the amount of logistical nightmare just for that.
Asset is Illiquid
The asset is illiquid. No matter how much a house has appreciated, you can’t buy food with the equity until you sell the house. For many, this creates a house rich cash poor situation.
It is a hassle to deal with plumbing issues and roof leaks, not to mention a billion other responsibilities that come with home ownership. You can no longer just call up your landlord and have problems fixed, you have to figure out how to fix the problems.
Economic Downturn Exposes More Risk
When the economy turns bad and you lose your job, it’s likely you may no longer be able to sustain the mortgage payment. This leads to foreclosure of the house or forced to sell at an unfavorable price at a distressed market.
Financially Tied Down for the Next Many Years
If you take out a thirty year mortgage, you’re owing someone money for a good portion of your life. Many people may not be comfortable with the idea of that.
I’ve laid out the common arguments for and against buying a house. I hope this provides a sense of why one should seriously consider owning vs renting. Notice I did not offer opinion on how to address the cons even though I’m a fan of home ownership. They will be discussed in future blog posts.