Last updated on 26 de March de 2023
Buying your main home could be the most important financial decision in your life. While such decision tends to be emotional, we discuss why your main home can also be a very good investment for the long term.
Content
- Introduction
- Is it possible to achieve a Risk-free and Tax-free 8% Return?
- Assumptions for an 8% Annual Return
- Calculations
- Conclusions
Introduction
Before digging into the question of whether the main home is a good investment or not, we need to remember that the macroeconomic situation can be unstable. We never know what is going to happen in the short term. But this analysis tries to provide you with a framework so that you can assess if buying a main home can be a good investment for you.
At the same time, buying a home tends to require greater financial stability than renting. We both need savings for a down payment and are taking on a significant amount of debt. Therefore, good personal finances and a steady income are usually a requirement.
This is one of the main reasons why people buy their first home when they are in their late 20s or 30s and not sooner. Time allows them to grow their income, save money and mature.
Is it possible to achieve a Risk-free and Tax-free 8% Return?
As you can imagine, the answer is yes. In my base scenario, the purchase of a main home implies getting a 8% annual return on our money. And that return is pretty much risk-free and tax-free.
The low level of risk of this investment is because its dividends are guaranteed. When you buy a property for you to live in it, we receive a dividend in the form of free rent. We no longer have to pay rent to a landlord. You get to live rent-free by buying the home and paying all expenses associated with that ownership.
And while the value of your property does fluctuate, the value of that dividend does not. It is in guaranteed that you will be able to live in that house.
When it comes to taxes, in most countries we do not have to pay any income taxes from imputed rent. The value of those dividends in the form of free rent are tax-free. Property taxes are simply part of the costs associated with owning that real estate. From an investment standpoint, the fruits of our investment are not taxable.
Assumptions for an 8% Annual Return
Let us discuss what assumptions I have used to determine that the purchase of a main residence can result in an 8% annual return in a base case scenario.
In this example, we will buy a property for $250,000 whose monthly rent costs $1,500.
All assumptions:
- Purchase Price: $250,000
- Rental cost: $1,500 per month
- 20% down payment: $50,000
- Other closing costs: $10,000
- Total initial investment: $60,000
- 30-year mortgage at a 6% interest rate: $200,000
- Monthly mortgage payment: $1,304
- Property Taxes: $1,000 (increasing every year in line with inflation)
- Other ownership costs: $1,000 (increasing every year in line with inflation)
- Rental price also increasing every year in line with inflation
- Property value increasing in the long term in line with inflation
- Annual depreciation: we will assume that the property depreciated by 1% every year
The last point accounts for big renovations and expenses which may have to be done in a couple of decades. We need to factor that in to have a comprehensive analysis.
For our inflation assumption, we will use a 3% rate. This will seem high to some people and low for many people. In any case, I believe 3% is a conservative assumption. A higher inflation rate will usually translate into a stronger case for buying our main home.
Calculations
For our calculations, we have looked at how much money we had to put in initially. After that, we made a comparison between renting and owning that place
To begin with, we had to make an initial investment of $60,000 in order to pay for the down payments and all closing costs.
We have assumed that the monthly rental cost is $1,5000 ($18,000 annually) and increases each year by 3%. We do not consider other expenses that tenants may be exposed to, such as moving costs.
The mortgage payment is $1,304 per month ($18,148 annually). These payments are not going to change in the next 30 years. But ownership of that home will be associated with other costs, such as taxes, depreciation and other expenses. These add up to $4,500 every year, increasing in line with inflation.
Note that, initially, renting is cheaper than owning from a cash flow perspective. However, from year 9, owning implies lower monthly expenses. And, both initially as well as later on, a portion of our mortgage payments goes toward debt repayment. Whereas rent payments never lead to owning an asset free and clear.
Finally, we assume that the value of the home in 30 years will be $606,816, after we have assumed property prices will rise 3% every year on average in the long term.
If we annualize the return on the our purchase over 30 years with an IRR calculation, we will see that our initial investment of $60,000 will have compounded at a rate of 8.23% every year. This is thanks to both the appreciation of the property as well as the savings of owning relative to renting.
Conclusions
There are some conclusions we can draw from this analysis. This will help us analyze if the main home can be a good investment for us:
- Buying requires a significant initial investment. This should help us realize how important it is to save when we are young with the goal of owning a property. It illustrates how helpful it can be for young people to receive help from their parents to buy their first property. It is not just money, but money invested at an 8% tax-free, risk-free rate.
- Over the life of the mortgage, monthly outlays will be very similar between owning and renting. Initially, renting might be cheaper. Later on, owning will be cheaper.
- At the end of 30 years, by having bout the property, we will own it free and clear. This will give us the option to live completely rent and mortgage-free, or rent it out and generate very strong income.
Therefore, realize that an investment that yields 8% per year, every year, with hardly any risk and without having to pay taxes is one of the best you can do in your life.
If the assumptions we used are met, and they are indeed very conservative, buying a main home is not only a good investment, but a very good one. A higher inflation rate in the future, a lower purchase price, or a higher monthly rent would lead to an even higher return.
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