Home might be where your heart is, but it isn’t necessarily where your money grows. With interest rates set to increase and salaries in many households stagnant, renting is still the better financial option for many Americans. With American home ownership in a steady decline, according to the U.S. Census Bureau, many households are in the market for the passive asset that is home ownership.
[Related: To Buy or To Rent? That is the Question]
In fact, homeownership is a long-term play and, for most families, true wealth only materializes when they’ve accumulated sufficient equity or when the mortgage is nearly paid off. Renters have an array of alternative strategies for building wealth, but doing so requires an extra dose of self-discipline to save money in the absence of a mortgage that converts an essential cost of living to an asset.
Even so, many Americans view a mortgage as a forced savings plan that converts a basic cost of living into property ownership. If that’s not part of your plan, you’ll want to think about how to integrate similar long-term asset growth into your strategy.
Diversify Your Assets
The more diversified your assets, the more choices you have in the future. Real estate is a traditional mainstay among asset choices. Renters have to know how to get diversification with the same characteristics of real estate. The costs of ownership are so high in so many areas that it does make sense to rent – if you can invest the difference. Yuval D. Bar-Or, assistant professor at the Johns Hopkins Carey Business School, recommends, “Start by validating your decision to rent. Map out both the renting and owning scenarios in order to make a detailed comparison.â€
Weigh Property Appreciation
Weigh property appreciation against the costs of property ownership. This includes property taxes, utilities, maintenance, improvements, homeowners insurance, and the reality that you’ll lose approximately 6% of the property’s value when you sell, owing in large part to realty commissions.
Consider Long-Term Gains
There are two ways to capture long-term gains: equities and real estate. Bar-Or recommends two categories of equities that are likely to diversify the typical retirement portfolio and serve as a stand-in for home equity: foreign stocks and domestic small-cap stocks.
Another strategy is to approach real estate ownership purely from an
investment standpoint. The two ways to accomplish this are through investment vehicles or direct ownership. Real estate investment trusts (REITs) and real estate-based funds invest in real estate, as opposed to stocks. Typically, REITs hold commercial and large-scale rental properties, although some specialize in portfolios of single-family homes, while others focus on the stocks of publicly traded home builders.Owning Rental Properties
For some, directly owning rental properties may be a more feasible option. If you can identify a potentially sound business investment –Â that is, a fair, affordable price; good location; and the ability to build equity with profitable cash flow –Â then it’s a smart business decision. But beware of the down side. Being a landlord can in itself be costly, time consuming, and stressful. You are at the mercy of your own landlord’s decisions about the rent you pay, while you are, in turn, a landlord at the mercy of your tenants. Consider if it is worth the cost to hire a property management firm to buffer you from the daily headaches.
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However, apply caution. Forget assumptions about the investment returns on owning single-family rentals. Houses
that are rentals for a relatively short period when they go on the market typically sell for 8% less than similar houses. However, properties that have been rented for years don’t suffer the same discount. The difference might be explained by landlords’ reluctance to polish or spend on properties they know they’ll be selling.Work With a Tax Advisor
Work with a tax advisor to ensure you have the correct information to offset income and appreciate the various tax benefits that are available to help you as your wealth grows. These benefits may include various deductions for interest, depreciation, repairs, and local travel. As a landlord, the IRS even allows you to deduct costs for legal and professional services related to the property management or maintenance, loss due to casualty or theft, and insurance premiums related to the rental property.
Don’t Sell
Selling a rental property is the number-one way of killing the passive income that comes from this type of investment. If a property cannot be rented or is otherwise costing more than it’s worth, the decision to sell may be warranted. Otherwise, to build wealth, keep rental properties as long as you can. Once the mortgage is paid off, nearly 100% of the income will be yours to keep. Reinvesting this income can further help to build additional wealth.
Building Wealth Doesn’t Happen Overnight
Patience is important when investing in rental property to build wealth. Be careful not to over-invest or attempt get-rich-quick scenarios that may put you at risk of losing everything you’ve invested. Keep in mind that your rental property may not rent immediately, and until you find a tenant, you’ll have to fork out the monthly mortgage payments, which is counterproductive and a potential drain on your income. Also, be mindful of overspending on property taxes or repairs and wiping out your savings or investment funds.
Remember that building equity is not the same as gaining through investing. Yes, you might sell at the ideal time for a profit, but it’s not a sure thing. Your motivation for buying a home should not be that it’s an investment, but because you want the security of having a home and building equity.
To find out more on building wealth through renting, visit www.rentalhomecouncil.org.