Buying a home can be a daunting task, especially if it’s your first time. Deciding if it’s a good investment or not can be more complicated. Much depends on a variety of factors including the intent of the investment, your time horizon, liquidity and other factors.
“In general, if you’re buying for the long term, then market cycles matter less as compared to buying for a quick fix and flip,” says Sahil Gupta, co-founder of Patch Homes, a home equity finance company in San Francisco.
Many millennials and Generation Zers are making the leap. In a March report, the National Association of Realtors said 34 percent — the largest share of all home buyers — are 36 years and younger, and a whopping 66 percent were first-time home buyers in 2016.
[See: 10 Long-Term Investing Strategies That Work.]
Unlike a mutual fund, you can’t buy real estate and passively let it grow.
Consider your real estate strategy. Start by asking yourself if this is just “a goal” or if you are trying to build wealth, says Scott Tucker, CEO and founder of Be Financially Fit in San Diego.
If you are looking at housing as a long-term investment for capital appreciation, look to generate 13 to 15 percent returns annually, Gupta says, or have cash-flow linked properties that generate 6 to 8 percent per year. If you do a short-term fix and flip investment make sure it can generate returns.
Weigh other potential upsides such as the tax benefits of having mortgage deductions, diversifying your wealth base, generating income or long-term capital appreciation for your money and hedging yourself against inflation, as home prices move with inflation, Gupta says.
Keep in mind, many people overspend on a home and then rationalize that decision by saying “it’s an investment,” when it is more of a want than a need, says Rosemary Frank, a financial advisor at Rosemary Frank Financial in Brentwood, Tennessee.
Go for the long term. Think at least 5 to 10 years, says Michael Griffin lecturer of accounting and finance at the University of Massachusetts Dartmouth. But ideally, make it at least seven.
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“The problem with real estate is that the real money is made over long periods of time and most of us aren’t that patient,” says David Waldrop, president of Bridgeview Capital Advisors in El Dorado Hills, California. “If you buy a home and count on selling it in five years to turn a profit, you might be disappointed.”
Most experts say real estate is only a good investment if you plan on maintaining or improving the property. It probably isn’t a good investment if property values aren’t increasing, which can vary depending on where the home is purchased, or if you plan a short-term stay, Griffin says.
Do a quick litmus test. Kerri Moriarty, head of company development at Cinch Financial in Boston, says, “If you sold it today, could you get more than you paid for it?”
Then, she says, ask yourself if you do home improvements, does it improve the resale value by at least a factor of 1.5?
Look at real estate comparables to see what people are paying for similar properties in the area. Measure your potential purchase against homes of a similar size, condition, age and style that recently sold in your neighborhood. See how your potential purchase compares to the condition of other homes.
Buying in a good location always makes it better, says Bruce Ailion, a Realtor and attorney for ReMax Town & Country in Marietta, Georgia, but always buy the best location you can afford. Then make sure to use caution when the market is overheated or peaking.
Ultimately, compare the net cost of home ownership to the net cost of renting, given price assumptions. “If you net more by owning then you should own,” Ailion says.
Weigh potential changes to tax law. Historically real estate has been a tax-advantaged asset, thanks to being able to deduct mortgage interest, state and local property taxes and closing costs, which have typically made owning more affordable than renting, Ailion says.
“But this may change,” he says.
Much depends on President Donald Trump, who has proposed a change that would double the standard deduction for individuals that many in the real estate industry say would marginalize the mortgage interest deduction by removing the tax benefits of owning a home and discourage potential buyers.
Shop around for the right loan. The type of loan depends on the type of borrower you are, your risk tolerance and the length of time you will be in a home, Ailion says.
“The majority of people choose a fixed rate 30-year mortgage regardless of whether this is the best loan for them financially,” he says.
For example, the Federal Housing Administration guarantees a portion of a loan to help first-time buyers who typically have less than perfect credit. The U.S. Department of Housing and Urban Development has the Good Neighbor Next Door program which offers law enforcement officers, pre-kindergarten through 12th grade teachers, firefighters and emergency medical technicians homes at a 50 percent discount off the list price, if they live on the single-family home property for 36 months as their sole residence.
HUD also has highly discounted “dollar homes” for low- to moderate-income families who want to purchase previously foreclosed homes. Similarly, the U.S. Department of Agriculture has helps low to moderate income families purchase single-family homes in a rural area by providing a 90 percent loan guarantee to approved lenders.
“With rates still historically low, potential homeowners should be looking at fixed-rate loans and if they can afford the higher monthly payments, the 15-year fixed payment loan looks good,” Griffin says. “And I wouldn’t be too quick to pay it off. Take advantage of the leverage and the cheap money.”
Military members should consider getting a 30-year loan through the U.S. Department of Veteran Affairs that is locked into a low-interest rate, says Tucker, an Army veteran and author of the book, “From Deployment to Dollars.”
Military members can also use the tax-free basic allowance for housing to help pay for a mortgage. The U.S.-based allowance is determined by a service member’s geographic duty location, pay grade and dependency status.
[Read: Your Home Is a Better Investment Than Bonds.]
“It’s like having the government buy your house and you get to keep any profits,” Tucker says.
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When Is Buying a Home a Good Investment? originally appeared on usnews.com
