Welcome to the latest installment of “Dear Urbaneer”, where we field questions from clients experiencing a real estate conundrum. This time, a prospective buyer is considering home ownership, and wonders how long on average, it will take before she begins to realize some growth on her investment.
I’ve been weighing the pros and cons of making the leap into home ownership. I know that real estate is an investment that utilizes a long term horizon to reap investment rewards. What if I decide to sell in a few years’ time? Realistically how long is it likely to be before I’m even going to “break even” on my initial purchase? What factors contribute to this?
What’s my Bottom Line?
Here's our response:
Dear Bottom Line,
Clearly you’ve already done some research into the numbers and some of the financial requirements involved before you make that lofty (and ultimately profitable) leap into home ownership. This itself is good – because due diligence leads to knowledge – which leads to an informed purchase.
In the current market, where the journey to find that perfect home can be long, peppered with bidding wars and buyers fatigue, the vastly emotional part of a real estate purchase can pull at balance, and at times, pragmatic decision making. The temptation to throw the budget to the wind in an effort to secure a home purchase (and passage to home ownership) intensifies, and people will ultimately find they overextended their means.
Ultimately, your budget should be your guide – because there are implications in the short, medium and long terms that will very much impact day-to-day activities in your life. You don’t want to move from income rich to house poor. Part of setting a budget incorporates what your price point and desired housing type can realistically be, while also developing an understanding of the mechanics behind the investment vehicle itself.
First, Do The Math
The math of homeownership is not as simple as house+buyer-mortgage payments=immediate equity and asset growth, nor can you measure a “break even” point based on a simple rent versus mortgage metric. No – the formula is slightly more variable – and complex.
Many homebuyers overshoot their budget, hinging on the assumption that their property will continue to climb in value at the same rate that the market currently supports. While it is true that real estate is an investment that has shown its ability to grow, the growth is typically realized over an extended period of time. Yes, it's a well-known fact that the property market in the City of Toronto has experienced (and is experiencing) meteoric price appreciation. However, hedging your bets on the assumption that the property market will continue to ramp up at the rate it currently is equals an investment strategy built on a house of cards.
At urbaneer, we lean to being risk adverse, meaning we recommend you adopt a more realistic, lower rate of growth + increased costs for your real estate investment. Look at worst case scenarios and pragmatically address these factors into your 'What if' calculations. Factor variables like a potential increase in interest rates (which could impact how much and how quickly you are building home equity) or, should Toronto experience a general economic slowdown, the rate of growth will come down. Be property specific too. If you're considering a condominium, reconcile how a potential oversupply could trigger a flood of inventory on the market and impact your resale value. Or if you're purchasing a house, factor in the potential for a costly repair like a foundation issue or leaking roof. Our point is, create a contingency plan to address the multitude of variables that accompany any real estate purchase.
This is why it's essential Buyers should assess all the “break even” factors as it relates to their particular investment. And then one must not only determine how long one intends to stay in the property in question, but make the commitment to hold it for at least that duration. Note, the shorter the term, the higher the risk, especially if you are a high ratio insured borrower leveraging yourself with a significant mortgage debt.
Next, Remember All The Costs
For most buyers with smaller down payments, the cost of owning a property versus renting it is ultimately more expensive. The big upside, of course, is that you get to build up your own equity, rather than handing it over to your landlord. But this privilege of ownership does come at a cost, beyond obvious expenses, like home maintenance and repairs.
When determining your “break even” point, remember to consider all of the costs that surround the purchase, including the initial transactions costs to make the buy plus all the costs associated to sell down the road. Because you'll see they quickly add up. Inlcude expenses like land transfer taxes, legal and real estate fees, interest payments on your loans, operating expenses including property taxes, insurance and utilities, plus all the maintenance and home improvements one undertakes during their tenure as a property owner. This can easily be ten to fifteen percent over your original purchase price!
So when you add up all of these expenses and put them against an increase in equity in the property (which again relies heavily on variables like the health of the property market and interest rates), there should ultimately be an advantage between your costs of ownership and the equity you'll have built. The question is… “Is it sufficiently lucrative to be worthwhile?”
Comfort of home ownership has far more to do than just checking off the boxes for your most wanted features. It’s about extending yourself financially to a point that won’t keep you up at night – or missing out on the living of your life because you effectively back yourself into a house-poor corner.
It all comes down (and most things in real estate and economic vibrancy do) to affordability. So where does that comfort zone generally lie?
In today’s marketplace, we recommend you aim for a mortgage payment that is no more than a few hundred dollars per month more than what the property in question might rent for. This mitigates the risk for a buyer against a change in circumstances (i.e. divorce, relocation, etc.) that requires a quick sell. In theory, the buyer can weather the change, covering a small shortfall if unable to sell but have to rent the property in the interim.
So, how long before you can expect to start accumulating on the growth side of your balance sheet? Truthfully, it can take five years (sometimes more) before a homebuyer can reach the “break even” point. Yes, it takes time to build wealth.
Contemplating the jump to home ownership? Have questions before you embark on your journey? At urbaneer we combine decades of experience with personalized focus on our clients, fully understanding their wishes and needs- and then finding them the property to match. We’re here to help!
~ Steven and the urbaneer team
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