Intro to Real Estate Investing

Real estate investors have become a cliché during the past 3-4 years. It seems like everyone you talk to is a real estate investor or knows someone who is. What makes real estate investing so popular? In the past few years you could do no wrong with real estate. With profits in the five and six figure ranges, one profitable real estate deal would exceed most people’s yearly pay.

On Risk and Effort
However with great reward comes great risk. That risk can be mitigated and controlled if you are investing correctly. Unlike paper assets, buying real estate is not a simple process. You cannot just log into your brokerage account and point and click. It also requires additional work, sweat equity or even more money.

How You Make Money
You make money in two ways, cashflow or capital gains. This is the same as buying high yield stocks or buy low and sell high. When it comes down to the math, real estate investing is pretty easy.

For cashflow, buy property in which the rent will cover all your monthly expenses (mortgage, taxes, insurance, management, HOA, maintenance and repairs). For capital gains, buy low enough to resell at a price that covers all your expenses (holding costs, realtor commissions, closing costs and repairs). Purchased correctly you can get both cashflow and capital gains with your investment property.

Up in ARMS – When is it right to use an Adjustable Rate Mortgage?

This article Orginally appeared on
An ARM can be a huge money saver, or a time bomb. Unfortunately, there are a lot of time bombs out there.

In my previous posting, I focused on interest only mortgages and a couple of readers pointed out the risks of these mortgages – well actually, they pointed out the risks of adjustable rate mortgages, which are a different beast entirely (though they often come in the same package).

There are many variations of adjustable rate mortgages. The worst of them are those that allow for negative amortization – meaning the principal on the loan increases over time because your payments are not sufficient to cover the interest on the loan. These loans are evil and should be avoided in almost all cases (the one exception is a reverse mortgage used by some senior citizens to turn the equity of their home into income).

Adjustable rate mortgages have two separate issues that can magnify to either save you lots of money or cost you lots of money. First, they almost always start out with below market rates (either due to marketing discounts or rates bought down through points) which results in effective interest rate increases early in the life of the loan. Second, they vary with interest rates.

When are adjustable rate mortgages a wise choice?

The only ARM I’ve had was on a condo I purchased in 1985. That year conventional mortgages were over 12% – very high from a historical perspective. It was also fairly early in my career and I was still enjoying steady increases in salary (I had a real job back then). It was also a fairly slow time for real-estate – one of the periods of stable or declining prices common in the California real estate market. The combination of high interest rates, increasing income and stagnant property values is the perfect storm for getting an ARM. Over the next ten years or so, the choice turned out to be very wise. The loan was linked to T-Bills that only once during that period exceeded the rate at the start of the loan, and at one point was 4 points lower than that initial value. Most of the years I held the loan my payments actually dropped. Ultimately I paid thousands of dollars less than I would have with a conventional loan.

I honestly don’t know if I was lucky or smart at the time – but I do remember considering the risk and deciding that it was worth the chance.

Unfortunately, most people who use adjustable rate mortgages today are using them for a different reason – to purchase a more expensive home than they can really afford. All of the factors that pointed to use of ARMs in 1985 are different today.

Right now we are at a peak of housing values after a period of rapid increase (not only recent increases, but a major increase in values in the 1999-2001 period). Historically these boom periods are separated by periods of stable or declining prices – periods of a decade or more. So purchasing the most house you can afford in order to get maximum leverage is high risk choice, at least at the moment.

Despite recent rate increases, mortgage rates remain near historic lows. That means that there is a high risk that an adjustable rate mortgage will result in higher payments over time, in some cases dramatic increases.

The final factor to consider is your own income. The recent economic recovery has not resulted in widespread wage increases. With the increased levels of outsourcing and continuing shift of manufacturing to low wage countries, there is no reason to expect wages for most people to grow significantly or even necessarily to keep up with inflation.

In short, if you currently have an ARM, you may well be sitting on a time bomb. I strongly encourage you to look at the historic values for the index on which your ARM is based to get a sense of how it might move. Interest rates during the past 4 or 5 years were generally the lowest in the past 40. Betting that they will go back down is probably a long shot.

The good news is that it may not be too late for you to get out of the trap. Fixed rate loans are still relatively cheap. If your income has increased, now may be the perfect time to refinance into a fixed rate loan and protect yourself from possible rate increases.

Mortgage and interest rate statistics:

Housing booms and busts:

Living in Boxes: China’s Trade Deficit = Affordable Housing Solutions

The rapidly rising U.S. trade deficit with China has caused some US entrepreneurial homebuilders to “think outside the box”. Or rather – think “using the box”.

The Facts

China exported $243 billion worth of goods to the US last year (2005). The US exported only $41.5 billion worth of goods to China, leaving a trade deficit of a staggering -$201.5 billion. (Source: US Census Bureau – Trade in Goods with China)

As a direct result of this disproportionate balance, tens-of-millions of empty cargo containers are amassing on US soil. It’s simply cheaper to stockpile these containers than return them empty to the Far East. The problem has become so rampant, that many residential communities have forced local legislators to relocate this logistical waste to designated container junkyards. But as the trade deficit widens, the problem only increases. Major port communities, particularly in the LA and Long Beach, CA area have also been victims of this “plague”.

Entrepreneurs to the Rescue

Savvy entrepreneurs have discovered a solution to contain this container dilemma.

By recycling the containers into building materials, homebuilders can buy materials to supply affordable housing at a cost of approximately $10 per container. According to home improvement guru Bob Vila, “architects, designers, planners, and homeowners are finding renewed interest in these inter-modal steel building units (ISBUs) as they look for affordable, sustainable housing options for the 21st century.”

Empty containers are useful for both single structures, or as building blocks for larger structures. The units come in 40’ x 8’ x 8’ and 20’ x 8’ x 8’. There are pretty slick ISBU designs, and even architectural competitions.

For more information on building with ISBU’s see

Homebuilder Industry Analysis

Last week the Federal Reserve raised interest rates for the 17th time in a row. This is dire news for the Homebuilder Industry because with every interest rate hike, it gets that much tougher for new home buyers to afford to buy a home. It also introduces an additional negative factor into the equation, in that existing homeowners become worried as to whether they are losing equity in their homes. This may induce them to panic and to put their homes up for sale. These same homeowners, many of whom took out ARMs (Adjustable Rate Mortgages) or “Interest Only” mortgages a few years back, will soon see reality knocking at the door.

Reality will come in the form of higher mortgage payments adjusted to current interest rates. Fortunately, many homeowners have seen their homes appreciate in value significantly over the past 3 years and this signifies higher equity in their homes. As a consequence, some were able to get fixed mortgages, but nevertheless may be concerned about falling house prices in their area, which may induce them to sell as well. With each existing home that goes on the market, it makes it that much harder for the Homebuilder Industry, as existing home sales constitute strong competition.

As an analyst, I like to take theories such as the one presented above and go out and see for myself what is happening on Main Street. Over the past few years I have been driving around the various neighborhoods in the metro Seattle area and have been on the lookout for “For Sale” signs. About three years ago, we were in a “sellers” market and “For Sale” signs were non-existent. This was due to the fact that whenever a home went up for sale, there were a dozen buyers waiting in line to make a bid for it, making the need for a sign superfluous. Exactly the opposite scenario is in place currently. Within a three-mile drive on West Mercer Way on Mercer Island, Washington, the other day, I was able to spot 23 “For Sale” signs. Mercer Island exemplifies a nouveau riche residential area that is located just a few miles from the central Seattle business district. Its residents are good examples for our analysis because they are the type of consumer that the Homebuilder Industry targets when marketing their homes. Perhaps one can argue that this was an isolated event and that it has no bearing on the rest of the country. However, I should mention that I received further verification of this scenario the other day when listening to CNBC commentator Ron Insana. Mr. Insana took a similar drive in Nyack, New York, a suburb of New York City. He reported very similar findings to those that I saw on Mercer Island. Nyack, like Mercer Island, is a key market for the Homebuilder Industry.

The scenario I have just outlined is part of what a qualitative analyst does. A qualitative analyst masters his trade, in part, by studying the works of Philip Fisher (the father of Qualitative Analysis) whose masterpiece, Common Stocks and Uncommon Profits, is a must-read for anyone who is serious about investing. It is a road map of things to look for on “Main Street” which signify just how good a company, its management or the Industry as a whole, is performing. Fisher analysis also works well with macro-economic analysis when trying to predict how the economy will affect a particular industry.

By contrast, quantitative analysis is not instructive in analyzing the Homebuilders at the present time. Quantitative analysis was brought to the forefront in 1934 by Benjamin Graham in his masterpiece Security Analysis which he wrote with David Dodd. Prior to Graham’s work, those who analyzed companies in a quantitative fashion were statisticians and later, were called Security Analysts. A quantitative analyst “crunches the numbers” or analyzes companies in a bottom-up approach by analyzing its financials. Value is then assigned by analyzing each company in an industry, comparing companies with each other within an industry, and then forming a conclusion on the Industry as a whole. This value analysis is micro-economic in nature, and is the basis of Value Investing.

Now it is important to explain why quantitative analysis is not useful in analyzing the Homebuilders. Listed below are the eleven major players in the Homebuilder Industry that are worth noting.

Beazer Homes USA BZH $45.20 $10.46 4.32 23%
Centex Corp. CTX $47.48 $9.67 4.91 23%
Horton D.R. DHI $23.40 $5.03 4.65 23%
Hovnanian Enterpr. ‘A’ HOV $28.65 $7.09 4.04 19%
KB Home KBH $44.09 $10.54 4.18 24%
Lennar Corp. LEN $43.13 $8.60 5.02 21%
M.D.C. Holdings MDC $51.48 $11.24 4.58 21%
Pulte Homes PHM $27.23 $5.65 4.82 19%
Ryland Group RYL $43.04 $9.67 4.45 27%
Standard Pacific Corp. SPF $25.01 $6.51 3.84 20%
Toll Brothers TOL $26.05 $5.15 5.06 22%

SP = Stock Market Price
PE = Price to Earnings Ratio = SP/DEPS
DEPS = Diluted Earnings Per share
ROE = Return on Equity = DEPS/Shareholders Equity

If we were to view the foregoing table solely from a quantitative point of view, these results would be considered excellent. Indeed, as a group, the Homebuilder Industry’s results are superior to any other industry out of the 440 main industries that the federal government tracks for its Standard Industrial Classification (SIC 440) tables. In 2004, I wrote an article and concluded by saying that the Homebuilders as a group should be considered a superior investment and I actually picked it as my “Industry of the Year.” I was justified in saying so because the companies in the foregoing list skyrocketed in value and made some amazing gains.

However, despite the fact that the quantitative figures (“quants”) are excellent, the qualitative analysis is quite dire. Companies in the Homebuilder Industry are required to deal with increased commodity prices (raw materials), increased competition (existing home sellers), and a customer base that is rapidly getting priced out of the market (over-leveraged consumers). On top of this, the Federal Reserve is still uncertain as to whether it will raise interest rates again, and this produces way too much uncertainty to have any confidence in the Homebuilders as a safe investment. Moreover, if the real estate market gets flooded with existing homes, then envision the opposite scenario of what occurred in 2003-2004, and instead of a seller’s market, we will enter a buyer’s market. If this turns out to be the case, then home values will drop sharply and the equity that was accumulated will slowly erode. If the Federal Reserve continues to raise rates, then this process will be accelerated.

As if I have not already painted a picture imbued with sufficient foreboding, there is more. I am concerned that if this pattern were to continue or to accelerate, it could negatively affect the US economy as a whole, for the following reason. Over the past few years, consumers have felt very rich because they have made large equity gains in their homes, with some areas of the country experiencing 100%+ gains. These increases have created a wealth effect that has permitted the same consumers to borrow off this equity, particularly since banks and mortgage lenders have flooded the market with opportunities for second mortgages, home improvement loans, and credit card offers. So now we have consumers who have exploited the strong equity in their homes in order to buy cars, furniture, take trips, or renovate their homes, if not to buy a second home. When lending money, creditors based their decisions on the accumulated equity in the applicant’s home.

If we were to have a few more rate hikes by the Federal Reserve, then the pressures on homeowners will increase and they may panic. When those ARM loans get adjusted to current interest rates, we may see nationwide sticker shock. This will force many to put their homes up for sale immediately in order to avoid bankruptcy. If the number of homes put up for sale grows to the point where there are not enough buyers to purchase them, then the lender community will be forced to start foreclosing on those who can not make their mortgage payments. When this starts to happen, then banks and financial institutions will be required to take what would have been their profits and set that money aside for “reserves for bad loans.” Consumers will begin loading up their credit cards in order to pay their loans and the credit card industry will start to have problems as well. Consumer spending will be anticipated to dry up and other industries such as the retail industry will suffer. Companies that supply these industries will also be forced to slow down operations and thus a spiral effect will take place in the economy. Housing is the backbone of the wealth effect and when people become concerned that they will not be able to pay their bills, then consumer spending all but stops.

In conclusion, it is important that the Federal Reserve stop raising interest rates. With every rate hike comes further increase in the probability of personal bankruptcy or worse, the risk of a recession. Recessions are ugly beasts and everyone suffers. For those interested in the extent of damage caused by a recession to the Real Estate Industry, look at the years 1989-1991. Any way you look at it, the Homebuilder Industry is a dangerous place to invest unless interest rates were to be reduced.

Note: Peter George Psaras is not an Investment Advisor and nothing mentioned above can be construed as investment advice. All Research is written and produced as an information source only, and is not a solicitation to buy or sell securities. Investing in securities is speculative and carries a high degree of risk. All information contained in this research should be independently verified. Investors are reminded to perform their own due diligence with respect to any investment decision. Factual material is obtained from sources believed to be reliable, but Peter George Psaras is not responsible for any errors or omissions. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.

Realtors: Ouch

Some people are saying that you can track the real estate market by how many new realtors there are signing up. “When everyone thinks they will get rich selling real estate,” they say, “that is when the market will fall.”

Charles Turbiville has some advice for people wanting to get into the real estate game now, but you might want to reconsider. Charles has some scathing words for what he sees as a typical realtor:

Companies like [Redfin and Igglo] will expose the Real Estate Agency Industry as the “we know that you are stupid, and that buying a house is scary so we will drive you around town and hold your hand at closing and give you a dozen business card with my ugly face on them to hand out to you friends because all I care about is marketing myself, not selling your home. Actually if you never sell your home, that is fine, because I will take every potential buyer that I talk out of buying your house to a dozen other houses in the neighborhood and maybe I can list their house too, and do the same thing to them, and pass out a thousand more butt-ugly business cards to all of their potential buyers in the process and maybe we can sell your house before the listing expires, because ‘you’ve got to list to last'” business that it is.

Normally, I wouldn’t pay too much mind to a statement like this. It sounds like the typical rant of a dissatisfied customer. But then, Charles isn’t a disgruntled home seller; he used to be a realtor himself.

If Housing Prices Stopped Rising

According to the latest stats, American home prices are still on the rise – in most major markets across the nation.

The National Association of Realtors published a median increase of 4.2% from 1/06 to 4/06. Compare this figure to the published 16.6% last year.

Although prices appear to be leveling off, many economists don’t predict a sour turn for the worst. If housing prices were to weaken, logically the fed would cut rates. This is clearly not happening with rates at a 4 year high (currently 6.7%). A clear indicator that the housing market is still strong. And it would take a serious and unexpected shock to our economy to change that. Year on year, aggregate average US home prices have not fallen since the Great Depression.

So what does this “slower” growth mean to the economy as a whole? And why should I care about housing prices, if I currently am not a homeowner?

The housing market is a powerful motor which drives an economy. Homeowners “feel” richer, and that drives consumer spending. If housing prices stopped rising at these sharp rates, and only increased moderately from year to year (or remain stagnant), this has the potential to create a serious dent in the economy as a whole.

Even the non-homeowners like myself will surely be affected. And I’m a little bit worried.

My first blog entry, and my 2 cents.

How Much Should You Spend on a Home?

In my previous article, Misconception: Renting is for Suckers, I wrote that there comes a point when it makes more sense to rent an apartment than buy a home. For myself, I have a rule of thumb that for every $1 dollar I spend in rent a month I can afford to buy up to $125 in property. Right now I pay $1000 in rent, so using my rule I shouldn’t spend more than $125,000 on a home. This created a surprising amount of controversy; some exclaiming me a heretic, and some accusing me of house-hating. For those of you who wanted to know where that number came from, wait no longer — and I’ve put together a calculator for you to figure out how much you should spend on a home.

But wait… Isn’t buying always better?

For those who view buying a home as an investment, there comes a point when it makes more sense to rent than buy. There are many expenses involved in owning a home that need to be weighed against the cost of renting, such as property taxes, maintenance, repairs, and major expenses such as a new roof or appliances. If you pay too much for a house, your expenses will be greater than your current rent. In essence, your house would be costing you more money!

There are three major benefits of home ownership: equity, reduced taxes and appreciation. These benefits are great, but they run out at some point and don’t automatically make buying a better option. The question is when is buying the better option? What we need to do is figure out at what point the costs and benefits of home ownership become equal or less than renting.

So how much should I pay?

In my last article I wrote that my rule of thumb is for every dollar of rent I spend, I can buy up to $125 in property. That means with my $1,000/mn rent, I should buy a home that costs no more than $125,000. That’s unfortunate for me because it’s nearly impossible to find anything habitable for that price in Northern NJ where I live. Therefore for me renting is the better choice.

But the ratio is different for everyone because it is affected by a number of variables and from what I’ve seen the ratio typically ranges between 100:1 and 190:1. The factors that impact the ratio the most are:

  • How much you can spend as down payment. Larger down payment; higher ratio.
  • How many itemized deductions you have. More itemized deductions; higher ratio.
  • How much property taxes are in your area. Lower property taxes; higher ratio.
  • What the current interest rates are. Lower interest rates; higher ratio.

I’ve built a calculator in Excel for you to use that will tell you the most you should spend on a house. You simply open the file, enter in a few variables and use Goal Seek to figure out how much you should spend on a house. You can also look into help to buy a house.

You can also use a mortgage rate calculator to determine your total mortgage payment based on interest and loan amount.

Download the Maximum Home Price Calculator
Plus: Help with Goal Seek

Take a few minutes to download and play with the calculator. If you have questions please post a comment here or email me at chris {at} investorgeeks * com, and I’ll get back to you as soon as I can.

Why tax benefits are overhyped

In my previous article I wrote that tax deductions were flakey, and therefore I didn’t include them in my calculations. That was probably too hasty and I have now included them in my calculator. Tax deductions can result in real savings, but because of the Standard Deduction the benefit you receive from your mortgage and property taxes will vary based on how many other deductions you have in a given year.

When you look at the tax benefits of owning a home you have to look at the extra tax benefit you receive above and beyond the Standard Deduction because you can’t take it if you itemize your expenses. Think of the Standard Deduction as a hole. If you want to save a pile of money, you first have to fill the hole. The more deductions you have, the smaller the hole will be when you include your potential home deductions.

If you cannot itemize any other deductions other than mortgage interest, the standard deduction ($5,000 for single filers) will in essence be deducted from your mortgage interest. So if you’re single and you can deduct $6,000 in mortgage interest and $3,000 in property taxes, you’ll be able to itemize $9,000. But the tricky part is that it’s only going to reduce your taxable income by $4,000 because your standard deduction is now gone. The more deductions you can itemize, the more your taxes will be reduced when you buy a home.

To see just how much your current itemized deductions affect your price ratio take a look at the following table.

Downpayment Taxes Deductions Price Ratio
$ 20,000 2.5% $ 0 118:1
$ 20,000 2.5% $ 2,500 125:1
$ 20,000 2.5% $ 5,000 132:1

In this case, the difference between having no itemized deductions and expenses equal to the standard deduction meant a ratio increase of 12%. Even with a higher down payment and lower taxes, maximizing your deductible expenses could increase the price ratio by 5-10%.

My calculator has built-in support for tax benefits so it does the work for you. Simply enter in the standard deduction that applies to you and how many deductions you can itemize this year, and it will do the rest.

I still won’t bet the farm on appreciation

Many people criticized my last article that I didn’t take appreciation into account, but I’m okay with that. I’ve built appreciation into the calculator if you’d like to include it in your analysis, but I like to sleep well at night, so I want my house to be financially sound on a cash flow basis first so that bull markets are even sweeter. Using leverage may mean huge returns but it can also mean devastating losses. The market right now is in a very weird spot, and it could keep going up or it could fall precipitously. With all bets off on the direction of the market, I’ll err on the conservative side.

You should buy a home… Eventually!!

The reaction to my previous article uncovered something that I had already suspected: people have strongly-held beliefs about home buying. Let me assuage those people now. A home is a place to live, and if you feel strongly about buying a home because you’re looking to start a family or settle down for 10+ years, then I encourage you to buy a home.

However, for those of us who are still young and will likely not keep our next home for more than a few years, then I encourage you to look at buying a home as an investment. And just like any investment, there is an element of timing. The motto is not "buy high, sell low" and likewise we should not buy when home prices are overvalued.

Home buying should be for everyone, but that doesn’t mean it has to happen today. If the numbers work for you then make the leap cause you are leaving money on the table by renting. Otherwise, sit back and relax as your landlord mows your lawn for you and you wait for the right time to buy. The more you can stash away in the bank now, the bigger your down payment will eventually be and the more you can afford to pay for a home.

Wrapping it Up

Buying a home isn’t always the best option. There comes a point when home ownership will actually cost you more money than renting. Given my circumstances I can spend up to $125,000 on a home — unfortunately even condos in my market cost more than that and so for now renting is the best option for me. The amount is different for everyone based on how much they can afford for a down payment, what property taxes are like in their market, and others. Using the Maximum Home Price Calculator you can quickly and easily figure out how much you should be spending on a home and if renting is the best option for you.

Misconception: Renting is for Suckers. Chris Welch. InvestorGeeks.
Publication 530: Tax Information for First-Time Homeowners. IRS.
Your Home as a Tax Shelter. NOLO.
Is It Better to Buy or Rent? David Leonhardt. New York Times.

Misconception: Renting is for Suckers

You’ve heard all the reasons that people want to stop renting. “I don’t want to waste my money.” Heck, you may have even said them yourself. Many of my friends are reaching that point in their lives where they’re considering buying a home. However it’s unfortunate that so many choose to buy over rent, especially in this expensive market, because many well-intentioned people are buying homes that are actually damaging their finances.

Despite the fact that many people disagree with me that the real estate market is going to deflate, there is a rule of thumb that I use that should give you an idea about how much you should spend on a home even if the market is in a slump.

For every $100 you spend in rent a month, you’d be better off buying up to $12,500 in property instead.

For example, I live in Northern New Jersey, and currently pay $1,000/mn for my 1 bedroom apartment. I would be better of financially if I were to buy a condo that cost up to $125,000. The only problem is that where I live, there’s nothing habitable that I can buy for under $125,000, and if I spend much more than that, it’ll actually cost me more money to buy than rent!!! Unfortunately this is a problem shared by my friends in major cities around the country.

Okay, you’re skeptical. I know it and I don’t blame you. So I’m going to prove to you right now, why my rule of thumb works.

The Proof is in the PITI

The great thing about a home is that you get to build equity. It’s like your home becomes this great big piggy bank and with every mortgage payment you’re saving more money. But, this privilege is not free. Unless you can pay for the entire cost of your house in cash, which is rare, banks offer loans to help individuals purchase the properties in exchange for interest.

Like rent money, mortgage interest is essentially “wasted.” It goes neither to improving the property nor to building equity. It’s simply a fee for the privilege of living in your house. And in addition to interest, you’re also required to pay property taxes and insurance every month as well. All these payments are known as the PITI payment, which stands for Principle, Interest, Taxes and Insurance, and is a single payment you pay to your bank, who then distributes your money to the government and insurance company.

Houses also have additional expenses, such as lawn care, maintenance, and big ticket expenses like a new roof, new appliances, or a new furnace. As renters we don’t have to worry about any of these expenses because most leases include them as part of your rent, meaning no extra money out of your pocket when the freezer stops freezing, and someone will install it for you! A responsible homeowner should set aside some money every month to pay for these expenses when they eventually occur (and they always do).

So there are a lot of extra expenses that are essentially wasted when you buy a home. Wasted in the sense that they don’t build equity, which aside from taxes and appreciation is the only real advantage to owning a home.

So let’s compare renting and buying

Buying a home should not be about what you can afford. It should be about wasting as little money as possible. For example, let’s say you can afford to pay $1,200/mn for a condo, but rents in your area are only $800/mn for a nice 1-bedroom. You’d actually be building more assets if you rented, and saved the extra $400/mn in a mutual fund.

So again, how do you determine when you should rent and when you should buy? When the combined home expenses, interest, taxes, and insurance equals your rent, that’s the point when you can and should buy a home.

I’ve run all kinds of numbers to prove out my theory, and when I look at it 125:1 seems to be the ratio I keep coming up with. If I pay more than that (especially as I near the $1400 level), I would actually be spending more money on my home than if I were renting. Of course this number isn’t totally exact, and unforseen situations can arise so, I’ve also built a comfortable cushion in this ratio to cover the wide range of circumstances.

This ratio is different for each person based on variables such as how much they can afford as a downpayment and local property taxes. For more information on how I calculated this ratio and a calculator to determine your ratio, see my article How much should you spend on a home?

What about taxes, appreciation and multi-families?

Look, I like being appreciated just like the next guy, but this rule of thumb takes into account two assumptions. First, we can’t take into account taxes or price appreciation. With few exceptions, a home purchase should first make financial sense without taking appreciation into account, so that no matter what the price of your home does, you won’t be perched precariously over a financial disaster.

Because personal mortgage interest is deductible on your taxes, your overall tax burden is minimized at the end of the year. Because most of the interest in a mortgage is paid at the beginning of loan, your first year you would receive the greatest benefit. For a typical mortgage on a $125,000 house at today’s interest rates, you’d be spending about $7,400 on interest for the first year (it drops to $7300 in year 2). Of the deductible amount, the standard deduction may chop off a good hunk of that right away, so you’d be saving maybe an extra $1,200 on your taxes, and that’s for only the first year! The longer you have a mortgage the less you pay in interest a year, and the more inflation will eat away at your deduction. In either case, I don’t believe you should spend more money to have a bigger deduction.

In terms of appreciation, I think most people agree that the real estate market is going to slow. I personally believe that we’re going to experience serious price drops in major metropolitan areas, such as here in New Jersey. Renting is just too attractive an option for consumers, and the rents are too low for investors. If the prices of housing at the very least stagnate, we’ll see appreciation of less than 5% for the next few years, if not longer. That being the case, you’d be better off buying a mutual fund making 8 to 12%, even if you’d be affected by long-term capital gains taxes. Unless the real estate market is red hot in your area and you want to flip your property, don’t rely too much on appreciation.

[NOTE] Home price appreciation is magnified by leverage. If housing prices increase 5% and you only put 5% down, you’ve doubled your money your first year on paper. With a mutual fund, though, a 10% return is always 10% no matter how much you invest. In real estate taking control of a property for less than its value is known as leverage, and can lead to serious returns in booming markets. However housing prices are softening in many areas, and selling your home with a real estate agent can cost as much 6% of the value of your home, eating away at your sale price. For Sale By Owner (FSBO – “Fiz’ bow”) will help you avoid those costs, but in a buyer’s market can also lead to a significantly lower sale price. Is it possible to make a lot of money with price appreciation in the next 5 years? Of course. But don’t bank on it unless it’s a sure thing.

Additionally, this discussion only makes sense if you’re talking about buying a single family home (house/condo). When you throw multi-family into the mix, the discussion gets more complicated, so since the vast majority of people start off with a one-family we’ll use that as our basis. Becoming a landlord can be very financially rewarding and hopefully more people will choose that as an option to first-time home ownership.

Wrapping it up

If you take away anything from this article, I hope it’s the fact that there are many expenses involved in owning a home, especially when you’re just starting out and are struggling to afford a place to live. While it may be easy to think that home ownership is a way out of the rent trap, consider how much money (and don’t forget time) you’d actually be wasting every month just to own your home.

Unfortunately in most major cities these days, buying property is so darned expensive it doesn’t make sense for many of us to own until we get married and start families. But how bad is that really? Sure you have to deal with your neighbors, but renting means that someone else worries about your leaky faucet and broken washer, and that kind of good night’s rest is truly money in the bank.

Don’t get me wrong. I think homeownership is a wonderful thing, but think long and hard about the decision before you make the leap. Unless you can find a cheap condo somewhere or live in a market that hasn’t had the kind of price runups we’ve seen in the past 10 years, I think it makes more sense to start saving for your downpayment in a diversified mutual fund, and wait for prices to stabalize.

FAQ on Deducting Mortgage Interest.

Buying a Financial Calculator

Tools are designed to help their users do their tasks more efficiently and crunching numbers is no exception. I’ve been humming along with Excel and my trusty scientific calculator just fine, but as I’m getting more involved with calculations such as discounting I’ve decided it may be worth the time to pick up a financial calculator that has many of these formulas built-in.

I ended up buying the HP 10BII, which is among the most popular financial calculators out there. It’s very reasonably priced, has training modules on the HP web site, contains advanced functions such as IRR and NPV, and has a user-friendly keypad. For $30-40, this is a must have for anyone in finance or real estate.

HP 10bII Financial Calculator on Amazon (please support us with your purchase!)
Calculator Comparison from

The Importance of a Mentor

Becoming wealthy is a full-time job. Successful entrepreneurs have worked for years to build a deep knowledge base in areas as diverse as sales, marketing, accounting, stock investing, real estate investing, leadership, team building and personal finance. For someone who is still laying his foundation, finding a mentor can help him avoid potholes he otherwise would not have seen, and is an invaluable asset as both a friend and a counselor.

A mentor is someone who has already done what you have set out to do. Whether that means becoming a successful stock investor, or real estate mogul, your mentor is an expert and is willing to share his experiences. Just as professional baseball players have pitching coaches and managers have leadership coaches, so should budding entrepreneurs have a mentor that can help steer them down the right path.

While mentors or coaches can be found in various fields for a fee, it is vitally important that your mentor is actively involved in their field, and truly wants you to succeed. Financial planners and stock brokers can work for a commission, and may not actively invest in the products they sell you. Therefore these would be poor mentors. While their professional opinions may be extremely valuable, they may not always have your best interests in mind.

Unfortunately, finding a mentor can be easier said than done, but networking is likely the best way to find someone you can trust. So join an investment club or networking group; talk to family members and friends. Those that keep their eyes open will eventually find someone who not only shares their passion for the field but also is interested in spending time with someone just starting out.