When Buying a House Doesn’t Make Sense
There are many reasons why you might want to own a home: privacy, stability, prestige, value, etc. best investment you can make.
It’s almost a financial tradition to buy your own house as soon as possible, we hear it from our parents, it’s repeated by some personal finance experts and we watch our peers do it. But is it really a good idea or is it just a fad?
Is buying a house a good investment?
Without a doubt, a house could be an investment vehicle as it can help investors transfer money from the present to the future, with a very likely increase in the value of their money, but is it a good investment ? To answer this, we have to place it side by side with other investment options taking into account certain factors for better contrast.
1. Interest rate
With the exception of certain strategies, a typical home will only increase in value by 3 percent per year. Other conventional investment options, stocks and bonds, rose 10% and 5% annually, respectively.
Some may argue that although the rate of appreciation may be very modest, it is certain and constant because it is less volatile than other financial assets. While this may be true in some sense, it is also important to point out that home values tend to depreciate, just like in the housing bubble that lasted 6 years from 2006 – although highly unlikely. Also, in terms of consistency in the appreciation rate, home insurance and maintenance costs tend to counteract the very modest 3% return and turn the whole business into a sum game. nothing. Other investment options that have been considered – stocks, bonds or even treasury bills – do not charge for insurance and do not require maintenance of any kind.
More so, a 3% return is very little to hedge against inflation in Nigeria, as the inflation rate hovers around 12%.
Diversifying your portfolio is very key in investing. What that really means is investing in different companies in different industries. This protects you from any shock – idiosyncratic and systemic – and also makes you available to participate in any spectacular gain in any sector or business.
Investing in a home goes against this iconic investment strategy. Houses are expensive and buying one would mean setting aside a major part of your assets for a single investment. This puts you at inordinate risk, as anything that affects the home or the housing market, in general, would be disastrous for your finances. Taking the money and spreading it across many industries puts you in a better position.
Illiquid investments are securities or assets that cannot be easily sold or exchanged for cash. Real estate that includes homes falls squarely into this category.
It is common for some assets in an investor’s portfolio to outperform others to a large degree. For fairly liquid assets like stocks, the investor has plenty of options in situations like this. He could quickly use the proceeds from the high-performing assets to buy more low-performing stocks at low prices.
When sensitive news that would affect an industry is released, an investor can also make real-time decisions in response to that news. This is rarely the case with real estate. The time required to liquidate illiquid assets creates a time lag that could hamper the flexibility of an investor’s decision.
When is buying a house a good investment?
There are many strategies we could employ to get around the very low 3% real estate interest rates and earn an even better return. More so, owning a home might have some other advantages over other asset classes.
There are two basic ways to market a home: renting and flipping.
Renting a home involves buying or building a home and then renting the spaces while flipping a home involves building a home or buying a home for well below market value, rehabilitating it and then reselling it quickly. at a high price.
Both have pros and cons, but in terms of returns specifically, flipping might be a better option.
Let’s say there are two investors who are looking to invest in real estate, the first investor buys a house at 50 million naira and decides to rent the building which has say 6 units at 250,000 naira per year per unit, which will total about 1.5 million naira in passive income per year, in this situation it will take the investor about 33 years to break even i.e. realize the 50 million naira in returns, even before accumulating the profits and around 20 years if he leases the units of the house at an outrageous price of N400,000 per year. This is without considering vacancy costs – periods when certain units sit idle without any paying tenants due to recent evacuation or any other factor.
If the other investor buys a substandard house in financial difficulty and applies the 70% rule which states that an investor must not pay more than 70% of the after repair value (ARV) of a property less repairs required. ARV is what a house is worth once it is fully repaired.
In this case, a house requiring repair of around 8 million Naira to reach an After Repair Value (AVR) of around 50 million Naira would be purchased by an investor at a price of 26 million Naira. The investor makes a profit of more than 15 million naira (50 million naira – [N26 million + N8 million]) almost immediately. It would take more than 50 years for the first investor to accumulate the legal and management hassles he would face as an owner.
2. Forced savings.
Although we’ve talked at length about how money used to build or buy a house would have been better off invested in stocks and other asset classes with better returns, most people aren’t not very good at keeping money aside for investment. Building or buying a house can then be a means of persuading these people to invest or save their money in an illiquid form.
More so, the illiquidity of real estate which has drawbacks that have been taken into account also has an upside as it mitigates overspending among people with reckless tendencies. While one can easily trade stocks for cash to satisfy a need or want in minutes, this is not feasible with real estate.
3. Fundamental analysis.
If your primary intention is to profit from real estate, you need to do some fundamental analysis before buying or developing one.
The cost of real estate is not as important as the rate of appreciation. A half plot that costs 2 million naira where development is booming can be worth more than 2 plots that cost 1 million naira in a village with no signs of development.
As mentioned, the housing and real estate market is experiencing a growth rate of around 3%, but certain conditions can cause a real estate investment to disobey this rate and experience meteoric growth of even 100%. Development.
A house purchased in an area where large constructions and projects such as stadiums, airports, etc. are taking place. could show a spectacular rate of return for very obvious reasons – development attracts population and population growth is proportional to rate appreciation.
If profit is your primary goal, be sure to perform your fundamental analysis and identify areas with greater opportunity for development.
Most Africans, especially Nigerians, make decisions like building a house in their home town where hardly anyone lives and then paying rent in the cities. It is financial irrationality and can be driven by factors such as social proof, tradition, pursuit of importance, etc.
Building a house for such a reason may not be the best financial decision if you are in a period of wealth building, as you would suffer both the disadvantages of owning a house (maintenance and repairs) and also that of to pay rent. You can of course follow this path when you have reached a certain level of financial freedom and not before.
Should I buy/build a house?
Real estate development can be poor in terms of return on investment (i.e. if the strategies outlined above are not put in place), but owning your own home has several other benefits that may not have- be nothing to do with profit.
If you want a stable environment for your family, privacy, security, self-esteem and esteem, then building your own house may be the best bet, but if you are looking for profit, then you may reconsider or better still implement the strategies already discussed.
Also, it is financial wisdom to buy/build with your profit, not your capital. Your assets should pay for your home, not your savings.