Quote:
Originally Posted by Mike Oxlong
Never said anything about an interest free loan. However at current interest rates it is a very cheap way to borrow money. When you buy a house it's not like the interst accumulates every month and starts increasing. If you buy a house for $100,000 you don't owe $101,000 the next month. (I think you know that but not sure after reading your post)
If you rent and are paying $1000 a month rent that is $1000 you will never see again.
If you buy and are paying say $1400 a month some of that money is interest and some of the money goes towards principal which contributes to your equity. Meanwhile when the value of the property goes up that is also contributing to your equity.
I'd rather pay interest and get some equity in a place than pay a landlord and get nothing. That's just my opinion. Everyone is entitled to their own and obviously there are many varying opinions.
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Mike, I see what you're getting at, but you need to temper your view on real estate as an investment. It is a good way to leverage yourself into a position of wealth, but it's returns are not good.
There are four types of home ownership in my mind - personal use, revenue, speculation, development.
"Personal use" is buying a house and living in it as your primary residence (obviously). Lots of people argue whether it is better to buy or rent. A mortgage is split into a number of equal payments on the principle over a long period of time. Let's say you buy a house that is worth $300,000 with a $75,000 down payment (25% down), and amortize it over 35 years at 6.5% interest rate. You end up paying $300,000 for the house, and $340,000 in interest over that time period. So, in order to not lose money, your house will have had to appreciate at 2.58% per year. That is the return on the asset (your property). The return on your investment is $0, since your house has appreciated to a value equal to the interest you paid over that time. Every dollar that you make over that can be compared to your initial $75,000 down payment as your return on invested capital, which is the important figure for all investors to look at. Fortunately, the average return on property in Calgary historically has been 3% per year, so our home owner in this case, at the end of 35 years, will have a house worth $856,000, and will sell for a profit of $116,000. On a $75,000 down payment over 35 years, that is a return of 1.3%/year - a modest return at best.. and likely not much relative to what inflation would have been during that period. Fortunately, the homeowner will not be taxed on that sum when they sell. Is this a good investment? No. You could have made a better return by putting that $75,000 into a government bond and renting at a cheaper cost over the same period. So what is the benefit? In the case of home ownership, you have more options - such as investing in improvements that allow you to rent a suite out, or developing the land at the end of your time of use. That, and the gains are tax free, and the house is an asset you can borrow against for other investments.
"Revenue" is buying a house that is not your primary residence to rent it out to help cover your costs. Depending on your financing and the rental market, you will need anywhere from 25 - 40% down payment to have an 'income neutral' property. This means that your rental income will cover your financing and operating costs. Two things are significant about this scenario. 1. The interest payments on the loans that are used to finance this purchase are a tax deduction in Canada. 2. Any capital appreciation on the property will be taxed when/if you sell it, and transferring this asset onto family tax free is not really possible (I don't think).
"Speculation", like you mentioned above, is a situation where a person buys a piece of property on the idea that it will be worth a lot more very soon, and they hope to flip it over before they actually start paying for the property. Obviously, this is a very risky thing to do, and the investor may be stuck in a bad situation. There are a lot of people doing this with the condo buildings going up in Calgary. Get in for a $10,000 deposit, and hope to cash in 3 - 5 years later on the difference in values between the time at sale and the time at purchase. The problem with this is that short term, real estate can be volatile, and you are not guaranteed to make money. Nor are you guaranteed that you will not be cash called during construction, or that you will have a person willing to buy or rent when the property is completed. You get taxed on the gains that you make in this situation.
"Development" is the type of investment where you buy a property to either renovate it, or re-build. This, in my mind, can be the most consistently lucrative option... but as anything else that can generate returns, it requires heavy investments of time, labour, capital, material, before it will work out. And even still, you can do everything right, but if you pick the wrong location, or do it at the wrong time, you can really screw yourself over. The other problem with this is that you are limited as to how much you can make unless you have good organizational skills and can start a business that can do a significant enough volume to make you real money. Again, you get taxed on the income earned upon sale.
Now, the "returns" vary in each case, as does the level of work required to ensure that your investment is a good one. Real estate rarely has a good return on asset rate, and unless you strike it lucky and can move quickly, it is difficult to make a good return on invested capital, especially when tax is taken into consideration.
So, when you make a blanket statement and say that there are not many better investment options than real estate, I would have to beg to differ. Real estate has a purpose in any investor's portfolio, but it is not to generate high rates of return. There are a number of investment options that give you better rates of return than real estate... but it all depends on what you are looking for as an investor.
In my mind, real estate is good for accumulating "securable" assets (things to offer for collateral to get a loan), that may or may not be able to pay for themselves. You can use that money to go for real growth without ruining yourself if you fail.
This is why I focus on purchasing small businesses. A business can consistently deliver a return on asset rate of 25% per year, and depending on your financing, can give you a 100% return on invested capital, tax free (as growth of retained earnings on the balance sheet - which can in turn be used to acquire other businesses). Obviously, this is not for everyone.