This column has often focused on intangible investments like stocks that a young investor might hold in their portfolio. While these are one of the most important components of an investment plan, it is not the dominant one for most young people. Even for some who are much further down the path of life, stocks and bonds often pale in comparison to the role that a home plays in their investment life.
Buying a home is an enormous investment. It's easy to overlook the size of it, because the down-payment required is relatively small. Still, we all realize that we're investing the whole purchase price. Nonetheless, most people don't give the investment aspect of their home a second thought, thinking of their home as nothing more than a place to hang their hat. Since this may be the largest single investment made in the first half of one's life, it might be wise to look at it less as an expense, and more as a financial decision. There's no sense in scrambling to save a thousand in your retirement account if you're going to miss out on tens of thousands on your home.
This leads to a whole raft of questions related to neighborhood choice, price ranges, over-extending oneself, and the trade-offs between immediate comfort and long-term wealth. There are more questions that can be covered here, so let's focus on a few key points that can help most people pick up an extra ten or twenty thousand dollars or more.
First, any good realtor will tell you that neighborhoods are critically important. What's the phrase? The three most important factors are location, location and location. But, let's extend what we've learned about stocks to that truism. We know that we want to buy low and sell high. So, if you want to make a profit on your home, buy in a neighborhood that is improving. Don't look only at the current state of the neighborhood. As an investor, the trend of the neighborhood is far more important. Look for signs of deterioration or repairs taking place. Repairs of older homes may signify a neighborhood on an upswing, while homes in a nice neighborhood left un-repaired may demonstrate the beginning of a downturn.
The tax laws relating to home ownership also provide some incredible incentives. In the last decade, opportunities for homeowners have improved, and this is especially true for those lucky enough to see their home value increase. Under current laws, profits on most single-family residences sold at a profit are completely tax-free, as long as you've lived in the home during two of the last 5 years. The tax-free amount can be up to $250,000 (or $500,000 for a married couple). Many people still believe that these profits are rolled over into their next home, but that was the old law. Today is the time to take your home profits, because they are tax-free. My approach is to take these profits whenever I can, because one never knows when those tax laws may change again.
For many young couples struggling to make ends meet, this relatively new law can be a windfall, and it is especially popular among those who are handy doing minor repairs. Many have bought fixer-uppers, added a little paint and wallpaper, and come out a couple years later with a sizeable profit. Let's say you've decided that it is time to buy a home. If you plan to buy a $150,000 house, would you be better off to take a traditional suburban home in perfect shape, or a mansion in a trendy neighborhood near downtown that needs paint and upgrading? Consider: after two years, and maybe $20,000 in repairs, that big old house may bring $350,000, netting our home entrepreneurs a cool $180,000 in profits, all completely tax-free. On the other hand, our suburbanites will be lucky to sell for $180,000. Of course, even they are better off than the renters, who have moved their investment into someone else's pocket.
Naturally, it isn't as easy as it sounds. There are issues with building codes, neighbors, upkeep, higher heating bills, and contractor disputes. Let's not make believe that money comes without any headaches. Still, $180,000 is worth quite a few headaches, and it would take quite some part-time job to make up for it. Don't forget, this is tax-free money. How many years do you work on your regular job to make $180,000 after taxes? That's like $300,000 before taxes for many people.
Finally, the real key to success in this (or any) investment is to buy at the right price. No matter how well you fix it up, and regardless of how advantageous the tax rules are, a bad starting price will limit your potential gains. My rule of thumb is to never pay more than half of what I think something is worth. That means that I end up walking away from a lot of good deals, but I also find that I'm protected from just about any disaster that may strike. Consequently, even if you find yourself subject to Murphy's Law, you'll still stand a good chance to come out a winner.
Scott Pearson is an investment advisor, writer, editor, instructor, and business leader. As President and Chief Investment Officer of Value View Financial Corp., he offers investment management services to a wide variety of clients. His own newsletter, Investor's Value View, is distributed worldwide and provides general money tips and investment advice to readers both internationally, and in the U.S.
Scott Pearson can be reached directly at Scott@valueview.net or by visiting www.valueview.net