For many people their first goal in real estate is to purchase their own home. While it is most ideal to buy your first home before thinking about investing further in real estate, I believe at times that depends on where you live. The costs to purchase real estate in places like New York, San Francisco, and Los Angeles are often extremely expensive. Furthermore, maintaining the property is expensive as well – property taxes, management fees, HOAs, and etc. For those home buyers it is a huge investment and can take a long time before they can truly take the chance.
Not All Real Estate Prices are the Same
On the other hand, there are other cities in America that have extremely reasonable real estate prices. For example, a single family house in Las Vegas can cost anywhere from 1/4th to 1/6th of what it would have cost in New York. The two properties are the same, but just located in a different area.
Not All Rental Incomes are the Same
Despite the vast difference in the price of real estate, the discrepancy in the rental rates of those two locations are not proportionally different. Just hypothetically, a $600,000 house in New York might net you $2,000 a month in income while a $150,000 house in Las Vegas might net you $1,000 a month. So on one hand, a house in New York might offer you a 4% return while a house in Vegas might get you a 8% return, double the rate of return!
But let’s flip the script for a moment. What if you are a renter instead? If you lived in New York, you will be paying $2,000 to live in a $600,000 house. But in Vegas, you will be paying $1,000 to live in a $150,000 house. Which location is offering a better deal? That’s right. New York. You are paying much less to live in a much higher valued property.
Try to Seek the Highest Returns
So what I’m trying to get at is that you don’t have to buy your primary residence first before thinking about getting into other real estate investments. You should really begin assessing what it costs to live in your neighborhood and whether your neighborhood is good for investment. If where you want to live in does not offer a high return on your investment, you don’t have to buy it first. Instead, you can choose to rent in your neighborhood while using your capital into other investments.
For example, say you have $600,000 in cash to invest in because your rich uncle passed away and you want to live in New York. So you decided to buy a $600,000 house in New York. On one hand, you no longer have to worry about mortgages (but you still have to pay property taxes, insurance, etc), but then you will no longer have a source of income.
You can take another route. You can instead, buy 4 houses in Las Vegas for the same total. Remember, each house can net you about $1,000. So now you have $4,000 monthly income. You, being a diehard Yankees fan, still want to live in the Big Apple. And you can by renting the same $600,000 house for $2,000 a month. But this time, you have an extra monthly income of $2,000 left because you have all these investment properties.
In other words, you can use your capital more efficiently by putting them towards where the return is the highest. You may miss out on being able to say you own your own home. But that is okay. Wouldn’t you rather own something that’d give you a better return?
Additionally, a 20% down on a $600,000 house is $120,000, whereas a 20% down on a $150,000 house is $30,000. Which investment is going to get you started the fastest?
Photo: Arek Olek
{ 19 comments… read them below or add one }
Wise information from the wise one…
Thanks Leo! But I don’t think I can take up that title yet. There are plenty of people in BIggerpockets who are much wiser!
Great post Leon! This makes perfect sense. I’ll be sure to send people back here when they ask this question!
Thanks Brandon! Much appreciated!
Wise words, Leon. I live in California, in a pretty pricey area, and renting is an insanely better deal. I pay less than half of what PITI would be if I were to purchase the townhouse I live in. The rent ratio (on a monthly basis is about) .4%. On the flip side, where I invest in the Midwest (Kansas City) I’m routinely getting a rent ratio of 1-2%.
For a young person like me, I think the biggest caveat to this logic would be to use an FHA loan to acquire and occupy a multifamily property in a high cost area and have tenants that chip away at your mortgage payment. That’s the only way I could justify long-term investing in a market like San Diego.
Thanks Brandon! You are absolutely right. I definitely get what you are talking about as I have a friend who is utilizing the same strategy near San Diego. I’ve always wanted to live in California and my plan is to rent as well!
Good article. I personally wouldn’t care if I ever owned my own personal residence as I don’t take the view that it is an asset.
Thanks Brian! I definitely understand that many people view their personal residence not so much as an asset but as an expense. With that being said, if renting instead of owning can trim a HUGE monthly expense, then wouldn’t that be tempting?
To add to that point, when one rents, they are also not on the hook for property taxes, interest, insurance, maintenance, and capex (although an assumption can be made the tenant is paying those via rent to an extent). When my wife and I were living in CA, we rented a house for around 2k per month that would have easily sold for around 800k. Renting was a no brainer. Out here in TN, it is the exact opposite. It’s almost twice as much to rent as it is to own. Go figure.
Great point! Especially if you were to invest in a high rise condo and you have to pay several hundred of dollars a month in HOA alone, why not just rent?
This post is very wise, I must say! Thanks for sharing! It’s a great reminder for people who wants wise investment. Cheers Leon!
Thanks Bob!
Great article with a philosophy to which I subscribe. We own rentals (furnished vacation rentals and unfurnished homes) and rent our own home. We just renewed our lease and have no plans to buy for ourselves. Our unfurnished rental homes are typically 1/4 to 1/3 the value of the home we rent but the rents paid are 40-50% of our rent plus our landlord pays the Hoa’s, pool service, and gardener. Our market is one where the rents don’t scale in a linear fashion with the house values. Plus by not buying, that gives us one more mortgage to use for a cash flowing property and my husband loves that I don’t have a honey-do list.
Thanks Tricia! It is great to see someone who’s putting that into practice!
I actually have a young couple in one of my rental units that has 8 rental units of their own. They lived at a parents house for the first 2 years of marriage, saved a ton and kept buying rentals. Instead of buying a home they are renting with me in order to save more to buy additional rental units.
It’s a good bet they will be able to retire very early.
Wow Bill. I’m sure they are going to be able to retire really early as well. Great to have tenants like that too don’t you think?
Great and concise intro not only to the owner/occupier/investor question, but also to out of state investing 101.
Cheers!
I like this post because it is mind opening with simple math. And for what it’s worth, I would rather say I own 4 houses than one and that I live in a house where I odn’t have to pay to have anything fixed if it breaks!!
I’m looking into the possibility of selling my place to free up the capital since my city is seeing a definitive upswing.
I think it may be artificial and short lived so I’d like to cash in.
Then use the new cash to get more rentals and fund more of my flipping business.
My wife ultimately wants to buy our own home here again but we can wait for the market to stagnate before doing it again.