As a renter, you might wonder whether 2012 will be a good year for you to buy real estate. The answer to this query depends on your personal situation, finances, life plans for the next few years, and several other issues. While it is true that real estate can be a great long-term, wealth-building vehicle, it can also be a wealth-draining fiasco! Herein, we will discuss some considerations we believe you should mull over so you can make an informed “to buy or not to buy” decision.
As you can imagine, the most important thing in real estate is that you want your wealth to improve as a result of taking on property ownership. And this is a high risk venture. To better your chances of having that venture pay off and improve your wealth, here are some things to keep in mind:
1. Only buy property if you are very sure that you will own it for at least five years. The longer you live in that property, the better.
2. Don’t buy more than you can afford.
3. Take the time to educate yourself on real estate risk issues and do the hard work to mitigate the known issues that cause risk.
Looking over the first point, you may wonder why you shouldn't buy property that you'll only own for a shorter period of time. The answer is relatively simple — when you buy property, you want the value of it to increase over time, and in a normal market, it will. But if you only own the property for a few years, that doesn’t give it much time for the value to increase. For example, let’s say it goes up in value $5,000 in two years. That may sound good, but the purchase and sale of real estate generally has significant transaction costs on each side. When you purchase, you pay closing costs, escrow costs, loan fees, transfer taxes, etc. that will add up to several thousand dollars. Then, when you sell, you pay sales commission, give repair credits, pay for title insurance, etc. which will probably be at least 7%-8% of your sales price, which typically comes out to around $7,500.
This means if the property price goes up $5,000, but you have to pay out $7,500 in fees on your purchase and sale, you are worse off financially by $2,500! The breakeven point is usually at least five years, so if you do not plan to own the property for at least that long, you probably will be better off staying as a renter of someone else’s property until you find a place you're ready to commit to for at least half a decade.
The second point, “don’t buy more than you can afford,” would seem to be common sense, but you can’t imagine the number of people who stretch every dollar to buy real estate, as detailed by Mark Fitzpatrick . A lender also may tell you that you are qualified to purchase a property up to a certain amount, but that doesn’t mean you have to spend that much. You want your home to be an asset, and if you can comfortably afford the monthly housing expense (mortgage payment, property taxes, insurance, HOA fees), it is an asset. On the other hand, if you buy too much and can’t afford your other bills or are stretched every month, it is a liability. Even someone who isn’t a Certified Public Accountant knows that assets are much better than liabilities, so don’t overspend!
Finally, real estate purchasing and ownership has significant other risk issues. Everything from buying a property in bad condition that takes all your money to fix to not properly reviewing your title insurance policy and having a significant title problem could pop up as huge obstacles. There are also issues with people in condominium communities being hit with special assessments from homeowners associations, individuals not having the proper dwelling insurance in place when there is a fire or burst pipe, and many other things that can go wrong.
The way to reduce these types of risks is to properly educate yourself on those risk issues before you purchase property. Here’s a Zillow article I wrote on this issue: Want to Make Smart Wealth Building Real Estate Decisions?
This year may be the year for you to stop paying rent to someone else and start earning some home equity, but it is important to realize that owning a home is not always a winning situation. It can also leave you in a much worse financial position than you believe. Your taking the time to learn and make smart purchases will hopefully help you earn that wealth for your future.