Buying real estate property doesn't make financial sense

Orange County, California
Buying & Selling Real Estate
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Buying real estate property doesn't make financial sense

Rich Chen
Homeowner · Burbank, CA · Member since 2020 · 24 posts · 5 votes

Just a simple math:

Let's say I buy a home for a million dollars, with 20% down and 30-year term

    interest rate = 5% 
    +
    property tax = 1%
    +
    maintenance = 1%
    -------------------------------------------------
    = Total 7% annual costs of owning a house 

Now, during the 30 years of owning the house

    Average homes in American appreciate 5% annually
    - 
    Inflation runs 3% annually
    ----------------------------------------------------------
    = 2% gain annually


Those are just rough numbers. In real life, of course interest rates and inflations are much higher. For the sake of this exercise, let's keep it simple. 

Also don't forgot there is tax on capital gain for over $500,000 when house is sold, andclosing costs typical goes around 5%-6%.

So unless home appreciates A LOT, it doesn't seem to make sense to own a property as long as you are paying mortgage with interest, unless one can pay it all back in much shorter term (10 years or less). The only upside I see is that family get to live in it for "free". 

Even the house is fully paid off, the 1% property tax + 1% maintenance offsets 2% annual gain. It only about makes even. At current rate of inflation (7% roughly), it loses money owning real estate properties.

In 30 years, one would be paying over 1 million dollars for just interest and tax, let alone other costs such as maintenance. 

Calculator link: https://www.mortgagecalculator.org/?q=cy8pc-1KW

Am I missing anything?

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JD MartinBusiness Member
Moderator
Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
2y
Quote from @Rich Chen:

Just a simple math:

Let's say I buy a home for a million dollars, with 20% down and 30-year term

    interest rate = 5% 
    +
    property tax = 1%
    +
    maintenance = 1%
    -------------------------------------------------
    = Total 7% annual costs of owning a house 

Now, during the 30 years of owning the house

    Average homes in American appreciate 5% annually
    - 
    Inflation runs 3% annually
    ----------------------------------------------------------
    = 2% gain annually


Those are just rough numbers. In real life, of course interest rates and inflations are much higher. For the sake of this exercise, let's keep it simple. 

Also don't forgot there is tax on capital gain for over $500,000 when house is sold, andclosing costs typical goes around 5%-6%.

So unless home appreciates A LOT, it doesn't seem to make sense to own a property as long as you are paying mortgage with interest, unless one can pay it all back in much shorter term (10 years or less). The only upside I see is that family get to live in it for "free". 

Even the house is fully paid off, the 1% property tax + 1% maintenance offsets 2% annual gain. It only about makes even. At current rate of inflation (7% roughly), it loses money owning real estate properties.

In 30 years, one would be paying over 1 million dollars for just interest and tax, let alone other costs such as maintenance. 

Calculator link: https://www.mortgagecalculator.org/?q=cy8pc-1KW

Am I missing anything?

 Yes, you are missing a lot unless your choice is between buying a home and living in a van by the river, in your parent's basement or under the overpass. 

You have to live somewhere. If you buy a house in 2024 on a 30 year note, you've essentially locked your "rent" payment in for 30 years. In 2054, when your note is set to expire, you will still be making payments based on 2024 dollars while all of your fellow renters will be paying rent in 2054 dollars. 

So forget about thinking of it as a "return"; instead, think of it as a hedge against expenditures. Whatever you make in terms of appreciation and tax benefits is just the icing on the cake. Just go to a calculator and compare it. If you make a couple of assumptions - i.e. rent in any given market is somewhere around 25%-30% cheaper than the cost of a monthly mortgage payment - you can find out pretty fast what's better for you. I just ran a quick one using your figures on NerdWallet, and by year 30 you've spent $1.9 million on rent and $2.0 million on the purchase, but the house (using your 5% appreciation figure) is now worth $4.3 million. That's a $2.3 million "profit". Even if we use a more modest 2% (inflation) appreciation model, you end up with $1.9 million, which is a $100k "loss" versus a $1.9 million loss.

Of course there's lots of other factors - can you stay there for 30 years? Will you totally remodel the house a dozen times? ETC - but bottom line, if you are stable geographically you will end up far, far ahead if you buy a house, and even more so if that house is reasonably priced & valued relative to rentals in that area. 

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Skyline Properties
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  • Ko KashiwagiPro Member
    Lender · Los Angeles, CA · Member since 2022 · 967 posts · 445 votes
    2y

    Hi Rich,

    Yes, if you assume you are buying a property all cash and rely completely on appreciation, this makes sense. However, the return on an investment in real estate is usually calculated from the perspective of ROI and Cash-on-Cash return, which is based on the cash flow on the deal. Buying real estate with financing allows leverage and provides a positive return on cash when the rent is higher than the expenses.

    What about the gains from the cash flow? The depreciation tax benefits?

    310-848-9776
    0Reply
  • Rich Chen
    OP
    Homeowner · Burbank, CA · Member since 2020 · 24 posts · 5 votes
    2y

    Let's say one just wanted to live in a house and start a family, and then what's the point of owning from financial perspective? Equity will take time to build.

    By the time one has paid off the loan, the house would worth, say, 2 million dollars after 30 years. With the interest and tax occurred at 1 million total, and 1 million principle paid, the ROI is ZERO.

    0Reply
  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    2y
    Quote from @Rich Chen:

    Just a simple math:

    Let's say I buy a home for a million dollars, with 20% down and 30-year term

        interest rate = 5% 
        +
        property tax = 1%
        +
        maintenance = 1%
        -------------------------------------------------
        = Total 7% annual costs of owning a house 

    Now, during the 30 years of owning the house

        Average homes in American appreciate 5% annually
        - 
        Inflation runs 3% annually
        ----------------------------------------------------------
        = 2% gain annually


    Those are just rough numbers. In real life, of course interest rates and inflations are much higher. For the sake of this exercise, let's keep it simple. 

    Also don't forgot there is tax on capital gain for over $500,000 when house is sold, andclosing costs typical goes around 5%-6%.

    So unless home appreciates A LOT, it doesn't seem to make sense to own a property as long as you are paying mortgage with interest, unless one can pay it all back in much shorter term (10 years or less). The only upside I see is that family get to live in it for "free". 

    Even the house is fully paid off, the 1% property tax + 1% maintenance offsets 2% annual gain. It only about makes even. At current rate of inflation (7% roughly), it loses money owning real estate properties.

    In 30 years, one would be paying over 1 million dollars for just interest and tax, let alone other costs such as maintenance. 

    Calculator link: https://www.mortgagecalculator.org/?q=cy8pc-1KW

    Am I missing anything?

     Yes, you are missing a lot unless your choice is between buying a home and living in a van by the river, in your parent's basement or under the overpass. 

    You have to live somewhere. If you buy a house in 2024 on a 30 year note, you've essentially locked your "rent" payment in for 30 years. In 2054, when your note is set to expire, you will still be making payments based on 2024 dollars while all of your fellow renters will be paying rent in 2054 dollars. 

    So forget about thinking of it as a "return"; instead, think of it as a hedge against expenditures. Whatever you make in terms of appreciation and tax benefits is just the icing on the cake. Just go to a calculator and compare it. If you make a couple of assumptions - i.e. rent in any given market is somewhere around 25%-30% cheaper than the cost of a monthly mortgage payment - you can find out pretty fast what's better for you. I just ran a quick one using your figures on NerdWallet, and by year 30 you've spent $1.9 million on rent and $2.0 million on the purchase, but the house (using your 5% appreciation figure) is now worth $4.3 million. That's a $2.3 million "profit". Even if we use a more modest 2% (inflation) appreciation model, you end up with $1.9 million, which is a $100k "loss" versus a $1.9 million loss.

    Of course there's lots of other factors - can you stay there for 30 years? Will you totally remodel the house a dozen times? ETC - but bottom line, if you are stable geographically you will end up far, far ahead if you buy a house, and even more so if that house is reasonably priced & valued relative to rentals in that area. 

    Podcast Guest on Show #243
    Skyline Properties
    View Page
    4Reply
  • Rich Chen
    OP
    Homeowner · Burbank, CA · Member since 2020 · 24 posts · 5 votes
    2y

    You are right, it would be $4.3 milion after 30 yrs. My appreciation estimate is wrong. Yes, factoring in inflation 2%, the profit is -$100,000. 

    Adding the maintenance roughly 1-2% annual costs, 30 years would probably cost around $400,000. So now the total profit is -$500,000 after 30 years of owning the house. Not so good. 

    In my view, tax benefits are almost negligible ($10,000 max annual deductible), the tax on capital gain in $2.8 million would be around $850,000 (federal + state tax), total profit is -$1,350,000. 

    Yes, renting is much worse, I'm in agreement with you. But still, why would anyone want to invest on sth that destined to loseas much as $1.3 million after 30 years of investment??

    0Reply
  • Glen Wiley
    Investor · Richmond, VA · Member since 2023 · 459 posts · 474 votes
    2y

    Your primary residence is a liability, not an asset (it does not generate income), compared to an income property which is an asset not a liability.

    A few things you are missing:

    1. You need to compare owning to renting similar properties. Typically, over the long term it is more expensive to rent the SAME property compared to buying since there is no equity in the house if you rent it. You have to live somewhere.

    2. Taxes: If you use your primary residence as inheritance to your kids, the cost basis gets reset so the capital gains taxes are zeroed out.

    3. Unless it is your last home, buying another primary residence and using the previous one as a rental is a great way to build wealth through operating income properties.

    4. You have a lot more freedom to make changes to the house if you own it.

    5. You are not at the mercy of the landlord if you own the house - when the landlord decides to do something else with the property you might have to move.

    2Reply
  • Rich Chen
    OP
    Homeowner · Burbank, CA · Member since 2020 · 24 posts · 5 votes
    2y

    Appreciation for the advice. It appears logical not to sell the primary residence once it's fully paid off, considering the associated taxes and fees. Instead, leveraging it to invest in rental properties seems more advantageous. However, I remain skeptical about purchasing property as a primary residence being a sound investment. From my perspective, homeownership primarily serves as a hedge against inflation. It represents a passive investment option for individuals seeking to save money beyond traditional savings accounts, without delving into more complex investment strategies.

    0Reply
  • Glen Wiley
    Investor · Richmond, VA · Member since 2023 · 459 posts · 474 votes
    2y

    The question of whether owning a primary home is a sound investment, if you ignore lifestyle issues, can be true. Robert Kiyosaki has talked about renting a primary instead of owning because the primary can be considered a liability (it typically doesn't generate cash flow).

    The challenge here is that in reality you can't ignore the lifestyle issues - money is a means to an end, not an end in itself.

    0Reply
  • Jeremy Alessi
    Member since 2024 · 1 post · 0 votes
    2y
    Quote from @Rich Chen:

    Let's say one just wanted to live in a house and start a family, and then what's the point of owning from financial perspective? Equity will take time to build.

    By the time one has paid off the loan, the house would worth, say, 2 million dollars after 30 years. With the interest and tax occurred at 1 million total, and 1 million principle paid, the ROI is ZERO.


     If you live in it that is not the investment. The metrics for the investment come when someone else lives in your investment and pays all the expenses plus a cash flow you are comfortable with. Also the $500,000 rule is for those of you living in California which makes much of work profit the state. Looking for advantages tax states would do better. Also, Jim Napier’s model which is how I found this thread is talking about buying notes at a discount to yield, not property. There is immense amount of wealth to be found in that as long as you time values of money are arbitraged in your favor. 

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