Primary or Investment?
Primary residence or investment property—that is the question. The gurus tell you that owning a primary residence isn’t an investment; it’s a “liability.” Okay, so you want to buy an investment property, but how do you manage something that you can’t drive to and touch? What financials should you include in your analysis?
This is the internal conversation that most individuals have with themselves every year as they start to write down their New Year's resolutions. They know that they need—or think they know—that they should own real estate, but they don’t know where to start. They don’t know what asset class to even look at because, quite frankly, there is so much information out there that it’s overwhelming. So here is some information—information based on stats—that hopefully will help you make a better decision when preparing for your first or next real estate purchase.
Let’s get this straight: no matter how you buy the piece of real estate, whether it’s a primary residence or an investment property, it IS AN INVESTMENT! Now, when you capitalize on that investment is the question, but it is an investment. The purpose of this article is to help you feel more comfortable when making the decision of primary vs. investment, no matter the market that you are in. Let’s get to it.
Primary Residence
A primary residence, or as my mother likes to say, “home is where the heart is,” is where you will live, sleep, eat, raise your family, and be yourself—your safe place. Everyone needs one! Yes, even those individuals who own RVs and travel the world; their home address is their license plate number. You will have to live somewhere, whether you own it or rent it. But as I stated in the intro, many gurus or “social media influencers” are telling you not to own a home but to strictly invest in rental properties and rent where you live. I think this has its place, and I will explain who I think that applies to below.
When you are analyzing a primary residence, you need to know a few metrics because, remember, we are evaluating this as an investment:
Purchase Price: What will you buy the property for?
Appraisal: What is the property actually worth in the bank's eyes?
Down Payment %: With a primary residence, you can consider the following options:
• FHA**: 3.5% Down (typically, you can only have one of these loans at a time and have higher PMI) (great for buying small multifamilies or if you have a lower credit score/higher DTI)
• Conventional 1st Time Buyer**: 3% Down (cheaper PMI, good for single-family homes and condos)
• Conventional 2nd Time Buyer**: 5-10% Down
• Conventional/FHA higher % Down**: You can put as much down as you want. But remember, the more money invested, the lesser the return.
Monthly Cost: Principal, Interest, Taxes, Insurance, & Condo Fee (PITI)
Duration: How long do you plan on living in this home?
Exit Strategy: What is your plan with the home once you are ready to move?
Rents: What will this home rent for once you move out (if you decide to keep it as a long-term rental)?
Appreciation: What’s the average annual appreciation in your market? The historic average is 2.7% over the last 40 years (I use this for most of my evaluations).
That’s it! Once you know these metrics, you are ready to become a primary residence real estate investor! Now, what do these all mean and how do we find the actual return on this purchase? With primary residences, just like investment properties, you need to find the ARR (Annual Rate of Return), so let’s find it.
Stick with me.
Let’s say you are looking at a $400,000 property. So let’s find our numbers.
Purchase Price: $400,000
Appraisal: $400,000 (using this for safe measure; hopefully, you buy with some initial equity, but that’s not necessary)
Monthly Cost: (assuming a 7% interest rate, 3% Down conventional): $3,076/month
* This includes: $283/month Taxes, $50/month Insurance, and 0.5% of the loan amount for PMI ($162/month)
Duration: This is a big decision and makes or breaks your return. The longer you stay, the lesser the return; the shorter you stay, the greater the return.
Exit Strategy: Are you going to sell this property and liquidate your equity (down payment + principal paydown + appreciation), or are you going to keep this as a long-term rental?
Rents: What will it rent for? In this case, we will assume $2,800/month.
Appreciation: What's the value of the unit once you move out? Whether you sell it or rent it out (remember we assume 2.7% appreciation).
That’s a lot of info. Now let’s find our return:
$400,000 Purchase Price
$12,000 Down Payment
$3,076/monthly Payment
When you buy as a primary residence, TYPICALLY 25-30% of the payment you make every month goes towards your principal paydown (equity); the remainder is your “rent.” For this example, we are going to use 25% of:
$3,076/monthly payment x 25% = $769/monthly principal paydown
= $9,228 annual principal paydown for year 1.
Appreciation (2.7%) = $410,800 value at month 12.
So let’s find our return for year 1!
Total Money Invested While Living There: $12,000 Down + $3,076/monthly payment x 12 months = $36,912
* $12,000 + $36,912 = $48,912 Total Money Invested
Total Money Gained: $9,228 annual principal paydown + $10,800 appreciation
* $9,228 + $10,800 = $20,028 Total Money “earned/saved”
Total Annual Return Year 1: $20,028 gain / $48,912 invested
* $20,028 / $48,912 = 40.9% ARR
YES, YOU CAN EARN 40%+ ON A PRIMARY RESIDENCE PURCHASE.
Now, you must know that the equity is locked up until you liquidate it. *We have many videos and articles on how to unlock your equity at www.bpgholdings.net or follow us on social media.
So, the moral of the story is that a primary residence CAN become an investment as long as you are evaluating it as such. Now, turning it into a full-blown rental is the next step. Reach out to us to learn more!
Happy Investing!
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