Wednesday, November 4, 2009

Your Home is not an ATM and 7 Reasons Why You Should Weigh Your Options Before Investing in Real Estate

Over the past couple of years, America has been wracked with financial pain and many of the basic tenets of investment and wealth-building have been upended.

Although real estate has brought some handsome returns, it’s important to point out that real estate has also ruined many property owners who rue the day they tiptoed into “the market”.

Inspired by an article, “Real Estate Price Plunge Makes U.S. Homeownership a Perilous Path” we’ve outlined a few principles that every buyer should consider before signing on the dotted line:

  1. A home is shelter. When you purchase a house, condo, duplex, manufactured home or mansion – you are buying a roof over your head. It may indeed be the best investment you ever made -- or the worst. The great American Dream of homeownership has turned into the biggest nightmare for many recent homebuyers.
  2. A home is not an ATM. In recent years, homeowners were able to get Home Equity Lines of Credit (HELOC) and could “tap” their equity, open the spigot, and pay for vacations, remodels, and college educations. HELOCs are now much harder to obtain, and the days of home as cash machine are probably long behind us.
  3. Past trends are no indications of future performance. Read your mutual fund literature and you’ll find a similar disclosure. The following is the breakdown of annual price appreciation over various decades: 40s – 6.2%, 50s – 15%, 60’s – 4.3%, 70’s – 13%, 80’s – 6.8%, 90’s – 5.1%, 00’s – 2.5%. It’s anyone’s guess where real estate values will head in the future.
  4. Tax rules change and so may the tax benefits of homeownership. Although the mortgage interest tax deduction is the sacred cow of the American tax system and has been preserved through generations thick and thin, there’s no guarantee it will continue in the future. Ditto for the deduction of property tax.
  5. Real estate belongs in the “risky” pool of your investments. Just because it is real property and it is tangible doesn’t mean its value can’t vaporize just like that great Internet incubator stock you picked in 2000. Although it probably won’t run to zero, many California homeowners have seen the value of their “investment” plunge by 50% or even more.
  6. Renting can be cheaper and less of a headache than owning. In much of central Los Angeles, it’s much cheaper to rent a house or condo than to purchase the same. And when your roof is leaking one rainy night during the monsoon season, you may wish you could just call your landlord to handle the problem.
  7. You might get lucky and real estate might make you rich. “If you buy a home in Beverly Hills or an apartment on Manhattan’s Upper East Side, over the next five and even 10 years you are going to do very well,” said one quoted consultant. You might build wealth by buying a home – but go into the proposition with eyes wide open.
There are many compelling arguments why you should own a home or invest in real estate, but it’s important to consider the downside and the risks before you – like many Americans – get burned.