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Is It Smart to Buy Real Estate Right Now?

Peter Mallouk, JD, MBA, President

President of Creative Planning

Last Updated
August 25, 2021

It Depends on Which Kind, and Why.

Lately, pundits have seemed eager to slap the “bubble” label on the real estate market. But is that accurate, and what should you do if you’re thinking about buying a home or rental property? Since so many people were interested in our recent podcast on the topic, we wanted to recap and expand upon our discussion for your reference.

According to the National Association of Realtors, the median sale price of an existing single-family home climbed almost 24% over the past 12 months through May to a record high of $350,000.1 Affordability, which takes into account things like the typical home price, typical family income, and average 30-year mortgage rate, has deteriorated sharply this year. On the other hand, affordability is still substantially better than it was in the early 1990s or at the peak of the 2006 housing bubble, thanks in large part to today’s low, low mortgage rates.

Moreover, according to S&P data, while home prices are up 86% since the housing market bottomed in 2012, prices are up just 35% since the 2006 housing market peak. That 35% is a relatively tiny gain for a 15-year period.2

What to make of this seemingly contradictory data? It’s helpful to separate our analysis of real estate into two categories: personal home ownership and rental/investment properties.

The Practical Matters of Homeownership

We believe what we’re seeing in the current housing market is part generational and part supply and demand. Millennials are getting married, having children in increasing numbers, and are deciding they’re ready to purchase a home. Also, the COVID-19 pandemic accelerated work-from-home culture, and many people decided they wanted to upgrade their home-office situation.

When you combine this new demand with the fact that after the 2008-09 housing market crash, new construction came to a halt and was slow coming back (along with mortgage lending), it’s easier to understand what’s causing today’s shortage that’s driving higher home prices.

The recent sharp increase in prices in many markets across the country have people questioning if it’s smart to purchase a home. Generally, if you need a place to live, buying is better than renting. When you buy a house, you mostly lock in your housing costs. Your mortgage payment is fixed, and your housing cost increases may be limited to paying a little bit more in homeowners insurance and property taxes each year.

Homeownership also has significant tax advantages compared to renting. Your home mortgage interest and property taxes are deductible. If you refinance or take out a home equity line of credit (HELOC), the points you pay to the lender are deductible over the life of the loan.

Most importantly, with every mortgage payment you’re paying down the principal balance and building home equity. And, after 30 years, you potentially have a valuable asset that can add to your nest egg if sell and downsize in retirement, or that can pass onto your heirs.

An important consideration when buying a house is your time horizon. Conventional wisdom is that you should have at least a seven-year holding period if you’re going to buy a house due to the costs of buying, owning and selling real estate. You have a greater risk of losing money overall with a short time horizon, because typically annual housing price increases are usually minimal.

The Rental and Real Estate Investment Market

The other side of the real estate coin is the rental and investment market. Unlike your personal residence, where you’re putting money in and only getting money out when you sell your home years down the road, with a rental home or other real estate investment, the goal is to earn a steady income stream or return on your investment as soon as possible.

Real estate investment can also be a good alternative to stocks and other traditional investments because it provides further diversification, serves as a hedge against inflation, has return potential and risk mitigation during certain economic cycles. Physical real estate, however, is not as easily liquid as stocks and may require significantly higher upfront investment.

There are a couple different ways most people make real estate investments.

One option is investing with a third party who’s managing properties and dealing with everything for you, or by investing in publicly-traded vehicles (REITs). You have a lower expected return because you pay all those costs, in exchange for not dealing with any of the management hassles.

The other option is to buy a home, duplex or small apartment complex, put it in a Limited Liability Company (LLC) and rent or lease the space out. In that situation, it’s more like a mini business because you’re dealing with the tenants, repairs and turnover. But, because the tenants are paying the mortgage for you and the property may appreciate over time, it can be a lucrative source of income that adds to your balance sheet every month. You can also take advantage of certain tax benefits and deductions.

However, depending on the real estate market in your area, if prices are heavily inflated, now may not be the time to purchase an investment property. If rents aren’t keeping up with purchase prices, it’s harder to generate positive cash flow on your investment.

If you have questions about buying and selling a home, or investing in real estate, please reach out to your wealth manager. We’re here to help you analyze the market in context with your overall financial plan and goals.

Footnotes

  1. https://www.nar.realtor/research-and-statistics
  2. https://fred.stlouisfed.org/series/CSUSHPINSA
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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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