My friend was about to buy a million-dollar house with no research

73 Comments

Note: I’ve created a new category called “Real estate” (see the other categories on the right side of the blog).

One of my friends is 28 and she’s looking to buy a house in San Francisco pretty soon. Now, as you know, I’m not a big fan of real estate for investment reasons, but because I’m not an expert, I’ve been researching it more and more (see my links here). So when she mentioned wanting to buy a house, I asked one question: “Why?”

This is where things fell apart.

Her responses included things like:

“I don’t want to waste money paying rent.” I’m convinced this awful phrase was invented by Realtors BECAUSE IT’S SIMPLY NOT TRUE FOR EVERYONE. YOU ARE NOT WASTING RENT IF YOU LIVE IN AN EXPENSIVE AREA. Here’s a good article with more details.

I asked what she thought about the real-estate market right now, considering many of the ARM resets are still coming. One response: “The market is already bad, so there’s upside potential when I sell? what do you think of that logic? Prices are supposedly lower right now as a result.” I don’t think logic is enough to justify the biggest purchase of your life.

I also pasted a couple of the best articles on real estate: This one (Yahoo Finance) and this one (New York Times).

The result was interesting. She hadn’t seen these, so she asked me what I would do with my money. At this point, I was at a coffee shop and one of them lived near me, so she came over to talk about this in-person. I looked over her finances and realized she had tens of thousands of dollars just sitting around, earning hardly any interest. Even putting it in a Capital One 360 (formerly ING) savings account would have gotten her hundreds of dollars a month (open a Capital One 360 savings account in 10 minutes).

The first thing I did was suggest three books to her on investing (more books I recommend). We talked for a while, and I suggested some things she could do to improve her finances and start earning more. After about 20 minutes of back-and-forth, I asked her what she was going to do for her next steps. “I’m going to be honest,” she said. “I’m not going to read those books.”

I thought this was really fascinating. Here’s someone who has tens of thousands of dollars earning 0.5% interest and she’s so resistant to the idea of reading investment books that she almost bought a million-dollar house instead. Five years ago, she had a significant amount of money. What if she had invested it in the stock market?

And five years from now, wouldn’t she be happy that she spent 5-10 hours reading a few books to get her finances in order?

Why young people still think of real-estate as an investment
One of the best things to happen from the real-estate bust that we’re undergoing is to make people think twice about real estate as an investment. That’s right — to actually consciously think about why they’re making the biggest purchase of their lives, rather than just buying a house because “it’s the next thing to do.”

And yet, I’m still stunned when I hear about my friends “investing” in real estate, especially in the Bay Area. (Yes, real estate can be profitable and great, but in some areas of the country there are far better investments).

I thought about it over the weekend, and I think there are a few reasons why real estate still seems to appealing to my friends:

1. They have some money lying around and know they should be doing something
2. They don’t know anything about investing, and the barriers to knowledge seem high
3. Real estate represents something tangible — and something their parents probably keep reminding them about
4. Society still explicitly and implicitly rewards homeowners (just think about a young friend who owns a home — are others impressed?)
5. THEY HAVE BEEN IGNORING EVERYTHING IN THE NEWS EVERY DAY FOR THE LAST 1 YEAR ABOUT REAL ESTATE (???)
6. It’s easier to do new things than to look back at old things, like reading books or handpicked articles about real-estate (Seriously, how many people will click and read through those links?)

Research for gargantuan purchases = good
Here’s the point: Buying a house is the biggest purchase you’ll ever make. When you do it, you need to understand exactly why. That means an extensive amount of research. When I bought a car, for example, I spent months learning about every trick under the sun. I had 17 dealers negotiating with each other to get my business. And that was to save a few thousand dollars! Now, I’m Indian and I’m weird, but I did that for buying a car. When I buy a house, I expect to enlist the help of several third-world researchers for months of research and, when I walk into the final negotiation, I will be accompanied by a large hairy man, a metal baton, and a chimp. IT’S THE BIGGEST PURCHASE OF YOUR LIFE. WHY WOULDN’T YOU SPEND TIME UNDERSTANDING THE PROS AND CONS OF IT?

You know, on one hand, much of this site is about getting started and not spending too much time doing endless research. But there’s a balance, as I describe in my article on conscious spending — you need to know the basics, and you need to know much more for real estate, which you can’t just sell the next day if you decide you don’t like it. When I pointed out sites like Patrick.net to my friend, she had never heard of them.

As usual, there are lots of ads and media influences to buy, but ultimately we make the decision on how much to research our real-estate purchases. I’m not saying it’s a bad decision — although my real-estate colors are clearly showing — but when I read a real-estate blog like SocketSite, I realize I’m not nearly as knowledgeable about real estate as others.

The 3-Book Solution
For many, what seems like an intimidating amount of research can be broken down by buying 3 books and reading them. Instead of coming in with a blank slate, you go to Amazon, find the highest-rated books in your area, and read them in a couple of weeks. I’ve done this with books on marketing, venture capital, and psychology. I keep a notepad and write down my questions. After 3 books, you’ll have very targeted and specific questions to ask someone. (Instead of “what should I do???” you might say, “Should I choose a Roth IRA or Roth 401(k)?”)

In July, I wrote about how asking targeted questions can get you targeted answers. To get the right answers about investing, pick up a few books — whether these ones or other ones — and get started by asking the right questions. Here are the three best books to get started investing.

bogleheads1.jpg

swensen.jpg

orman-fabulous-broke.jpg

Want more content just like today’s post? Sign up for my free Private List

I love helping my readers tackle life’s biggest financial challenges. For more where this came from, join my free Private List. Each week, I share:

  • Overcoming financial barriers that stop us from doing the right thing with our money
  • Using systems and automation to grow your money on a schedule
  • Earning more money with skills you already have
  • Much, much more

You can sign up for free below:

facebooktwittergoogle_plus

Related Articles

How this guy can get people to read his emails

I send millions of emails a month. I also publish blog posts. Why do people read them? Today, a counterintuitive ...

Read More

Watch this 18-minute video on happiness

I have something cool for you today. I’m sharing part of my video interview session with Gretchen Rubin, the ...

Read More

73 Comments

 
  1. A possible limitation of this approach is that you have to be aware of MLS rules about advertising other peoples’ listings if you use this formula, so you may want to talk it over with your broker first. On the other hand, most listing agents would undoubtedly give you permission if you call them.

  2. Hey Ramit
    First, The area I live in (Waterloo, Ontario Canada) has housing prices that are about, say 25% of prices in the San Fran area, and I understand what you’re saying about really expensive housing.

    I agree that people should research before they do any sort of investing, or a large purchase. As Buffet has said, education mitigates risk significantly.

    Personally, I strongly favour real estate over stocks or mutual funds as an investment vehicle. Here in my area I can invest in a condo for $130K that has steadily appreciated year after year, and rents at a rate that covers my cost. Doing this I can easily turn a 100K initial equity investment into 650K in 10 years – an opportunity the stock market hasn’t yet afforded me (and I can show you how I do it if you are curious).

    Also, this is an investment that I can live in if I have to, and in fact my first investment was a condo that I lived in.

    I used to be a big proponent of the stock market, back when I worked at a large national investment brokerage. History has shown me that it’s just not as powerful a tool for wealth creation for most people as rel estate can be.

    Ben

    (PS – I’m a real estate investment broker)

  3. Hi Ramit,

    What do you think about buying a place with the specific purpose of renting? I am in New Orleans, where a large amount of properties are doubles. I am currently renting 1/2 of one in a more expensive neighborhood (my rent and water is $900/month), and have been thinking of buying one down the street from me — my thought is to live on one side, and then rent out the other. I would love to hear your opinion on this — my money smarts are non-existent.

  4. Hey Ramit,
    I also think another reason why people are into real estate is probably Kiyosaki’s influence. His get rich books are very real estate focused so I would assume he had some sort of influence.

    Also, real estate is a very traditional thinking. Most of our parents probably groomed us that way. A lot of the older generation people I talked to had the same thoughts such as, “renting is a waste of money,” “home is the best ‘investment’ you can make because of equity and tax deductions,” and so on. So those types of thinking is part of our society.

    Maybe it’s because back in the old days a home was a decent investment. And that’s what people believed ever since. Who knows.

  5. Hi Ramit,

    There are three reasons why real estate might also be a good investment:

    1. It allows you to leverage yourself in a way very few other assets can. Thus even a small gain relative to stocks is multiplied by the leverage of your mortgage.
    2. It has attractive tax benefits.
    3. Many people feel more secure and happier in their own home given that they cannot be forced to move and can alter it as they please.

    Note: I don’t think these imply that it is a good investment. I am grappling with this problem now myself with the prospect of buying my first home in the Bay Area. What I would emphasize is that you take your liquidity requirements into account. As an actuarial student it was emphasized that one needs to take one’s liquidity needs (defined by your liabilities) into account. Moral: don’t buy now if you even think you are going to have to move in less than 3 years. You could realize a loss that will be multiplied by your mortgage.

  6. Great post! In spite of all the news, I’m actually thinking about getting a house in the next year and will probably be considering sub-prime mortgages – I have a good credit but haven’t had time to save up a 20% down payment. I’ve run a few scenarios in excel and the cashflow doesn’t look like a problem – just the down payment. The biggest reason I’m considering it is that my rent is going up very fast, and will probably be more than a mortgage on a small house in a nice area. Between payments lower than my rent (and with a fixed value while my earnings go up) and a few extra principal payments here and there I think there’s a good chance it would be the better value despite the fact that I seem to be in the risky category of borrowers. House prices here also went up quite a bit last year so there’s a risk of short-term depreciation but with a fixed mortgage I wouldn’t be worrying about remortgaging to stay in the house.

    It looks like this is a solid decision for me (although it may not give me the absolute best return numerically), but it’s always hard to be sure with something like this… what do you recommend for researching your first house purchase?

    Apart from that I fully agree on the investment value of houses. Too many people are generalizing a few cases into the whole market and thinking there’s easy money. If making half a million dollars was as easy as living in the same place for 10 years you’d think there would be a lot more rich people.

  7. Ramit,
    The major point that you are missing about Real Estate is that it is not likethe stock market. Real Estate is very regionally oriented. Thus, the broad strokes that the news paints may apply in San Fran, Miami, etc. but may not apply in Minot, North Dakota!
    In addition, Real estate has more power to compound wealth due to the simple fact that it offers leverage to the average person.
    Sure, many stock investors may have the opportunity to go on margin or become a Prop trader to increase thier leverage for investment. However, the average person has no access to large amounts of leverage (even 100% financing) except for Real Estate.
    Yes, highly leveraged mortgages are what got us into trouble – but they also made a lot of people a lot of money. This is wealth that these people could not have compouned without the assistance of financial leverage (ie mortgages).
    Feel free to e-mail me if you would like to discuss these points further. I would be glad to be of assistance to you.
    Regards,
    Tyler

  8. Here’s a different way to look at it. I purchased a house for my family moving from an apartment. Our expenses are a lot higher now (if you include the basement, our new place is near 3.5 times the size of the apt).

    Over the past two days I’ve been in my back yard shoveling all the snow from the grass in to a 7 foot sloping pile right beside my deck. It probably took me around 6 hours work total. Last night, my family (kids 6 and 3) spent the evening sliding from the deck, in to my back yard. Not the safest thing on the planet, but darn fun. My 6 year old commented that the apartment was always inside and boring, and now we have a house we have way more fun. Who cares about money when you hear things like that?

    Heres the catch though, we live in an area where we got a great home for a small family (4 person) for under 2 times our annual family income. You can walk to a grocery store, a library, and the schools all the way up to grade 8. We would be renting if we had to pay 4-5 times our annual income for something as nice as what we have.

  9. I came across your blog through blog hopping and loved your book recommendations. I am putting in an order in to Amazon as soon as my salary comes out. I’ve just started thinking about saving money seriously and haven’t got the first clue when it comes to investing.

  10. I *REALLY* don’t like Suze Orman, but I do think her book is a good starting point.. although she does grate on my nerves.

    For me, the book that changed my life was The Millionaire Next Door. The path to life, is smart spending (frugality), and smart investing (not buying into the hype)… so I hope she takes some kernel of your advice and puts it in an interest account earning 4% a month.. at the very least.

    I’ve since come around from the idea of buying a house too. I’m saving up for one just in case, but I’m happy renting (or not really renting) instead. I think I’d buy a house if I had a family. Then it might have some value to me.

  11. Ramit,

    Right on about doing your research! You are wrong, however, about real estate in the long-run.

    1. Please make the distinction between investment real estate and a personal residence. Investment real estate has a number of benefits over stocks and bonds and should be considered. Real estate is not a bad investment when it really is an investment as opposed to a residence. Further, commercial real estate offers a means of diversifying across different property types, such as multifamily apartments, office buildings, retail space and industrial warehouses. When you combine the cash flows (dividends), the appreciation in the long-run (price) and the tax benefits for owners, real estate provides many advantages over other investments. I would challenge you to look at the after tax returns on equity invested among stocks, bonds and real estate.

    2. In the yahoo article you linked to it used a number of submarkets where the price of residential real estate remained flat for a decade or so. While this is certainly true, the same argument can be made for stock markets located outside the US. I wrote about it here (http://www.ideatrending.com/2007/12/11/the-american-anomaly-stocks-dont-always-go-up-in-the-long-run/).

    3. Given the inherent volotility and risk associated with stocks, bonds and real estate, wouldn’t you agree that it must make sense to difersify your portfolio using all of these?

    I think what you are essentially trying to say is that buying a home for your personal residence is not the investment you should be hoping to retire on. But instead of knocking true investment real estate please make the distinction.

  12. Nice post.
    I didn’t see you mention the NYT’s “rent vs. buy” tool, which is the best one I’ve seen. It’s at: http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html

    Also, given your psych background, I would have thought you’d include “Why Smart People Make Big Money Mistakes (by C. Belsky)” in your 3 book list. It’s a great summary of insight on the psychology of personal finance.

  13. I think a $1Mil purchase demands a LOT of research and even MORE research if you are borrowing to make that purchase. Of course a foreclosure a few years down the road where you lose all of your home equity can “save” you the trouble of doing some research before the purchase. If your friend won’t do it now, she may have to learn the hard way.
    Real-estate can be a good investment- but it may NOT be a good investment where you want to live! Also, I can’t see having to sell my stock investments because I want to move! REITs offer the possibility of diversification into real-estate without having to become a landlord or have a huge amount to invest.
    I left the bay area in 1999 because it was already terribly overcrowded and I thought housing prices in the Bay Area were nuts! I figured that at some point people will stop paying a massive premium to live there… I guess it hasn’t quite happened yet. However, I can’t believe there is no ceiling. So what if you buy near the top and the market crashes then what?

  14. Hi Ramit,

    Having never been through the home buying process, let me tell you – even when you think you have done your homework, many purchaser will still be thrown a curveball when they sit down to sign at closing. when is your interest rate not your interest rate (APR)? mulitple $k of fees that you had never seen before added to your statement. etc.

    It’s like going to the car dealer – and after you haggle your price you think you are done, but then they hand you off to the finance guy who tries to sell you alarms and cleaning kits – except with the home purchase there is 100x the pressure and all those extras are on the document that they want you to sign or NO HOME FOR YOU.

    I worked as a notary/loan signing agent and saw many people get befuddled by new items and terms at signing time…and the agents just hold their hand and thell them it is routine…

  15. rkt: Sounds fascinating. I always love behind-the-scenes stories. Would you be interested in writing a couple of guest posts? If so, please email me.

  16. I echo one of the earlier comments regarding the distinction between investment real estate and a personal residence. In areas like San Francisco and Washington D.C. (where I live), there is a tendency to think of a personal residence as an investment. It’s NOT. I’ve seen people buy houses and renovate the heck out of them because they want to reach a certain selling price so they can retire in style. The bottom line is that a roof over your head is just that, a roof. While your home provides many benefits, it should not be viewed as an investment vehicle in which you sink all of your cash. Now, investment real estate is a different story. If you can find a good deal with a high cap rate and a steady tenant, then this kind of deal should pay off for you. I have invested in several commercial properties and, with the help of leverage, have made money both in the rental income and the ultimate sale of the property..

  17. The problem here is that one’s home is not, can not be earmarked as an investment. A home is an expense. It is an expense that has the potential (but not the guarantee) to appriciate in value and offer a return in the future. Home ownership also creates a number of liabilities besides the mortgage (death grip) including taxes, insurance, and maintenence. These negative impacts to your cash flow must be calculated when making the decision to rent or buy.

    I live in Miami, and am a home owner, and probably older than the typical reader of this blog. When I purchased in 1991, the cost of a mortgage plus escrow was less than the cost of rent, and I got two more bedrooms to boot. Purchasing was a no-brainer. Even at the prevailing 9% interest rate, which was refinanced as soon as the rates came into the 6% range a couple of years later. However, I have a girlfriend now who would love to buy, but these days the cost of the mortgage, let alone the escrow costs, is much higher than rents are, and would take too much of her income to support. So she rents.

    It was George Carlin who said, “A house is just a place to keep your stuff while you go out and get more stuff.” You need to be that detached when making the buy vs. rent decision, and the subsequent “how much should I spend” decision. You also need legal representation for this transaction. When I read the post about people who were befuddled at time of closing, I am betting they only had their agent, not a lawyer in their corner.

    People who are not interested in learning about different ways to achieve financial security frustrate me, as they clearly frustrate you. However, if they are willing to put some of their eggs in the one basket (real estate) then it is better than doing nothing with their eggs at all (savings account). I also agree with the post that Kiyosaki has had some influence over real estate investment. (as have the endless TV shows about home improvements, flipping real estate, etc….) I don’t agree with everything he has written, but he does have a few valid points in between the Rich Dad parables. One is that he was selective with his choice of real estate purchases and did considerable investigation into making those choices, and two is that he purchased when the prices were right. I am wondering if your friend has invested time in that type of due dilligence. If they are not, then they are not investing, they are speculating.

  18. Those interested in further reading on this topic should hunt down “Irrational Exuberance” by Yale economics professor Robert J. Shiller in their local library. The latest edition contains an excellent analysis of long-term trends in the U.S. real estate market. Many people will be surprised to see than on average, U.S. real estate has, as Ramit has pointed out, produced minimal returns since such information has been recorded. The only exception has been during this last decade, which appears to be based on speculative pressures subject to inevitable market corrections.

    Ramit, have you seen this book? Although Schiller is a critic of efficient markets (which is in my eyes somewhat unfortunate), he research on real estate seems robust.

    -J

  19. We’re buying a home now, but we’re buying it to live in it, not to invest in it. We can afford the home, we’re not relying on appreciation for our financial success, and perhaps when we move into a new house, we’ll keep this one as a rental, and then it will become an investment.

    Regardless, we focused on a few things when buying this house: a monthly payment (tax, insurance and maintenance inclusive) that we could afford, and buying something we would be comfortable living in for as long as possible. The first one was non-negotiable, the second one we were aiming for a time frame of 5-7 years minimum, and found a great home that will last us 8-12 years. Beyond that, we found a foreclosure in great shape that is worth at least 15% more than what we’re paying for it.

    Given all of that, it’s a safe bet that this will be a strong purchase for us, but it’s still an investment in our lifestyle, not our savings.

  20. good post. I’m sure your friend will do research when she is truely serious about buying a place (crazy if not!), unless she literally has all that money in her bank and need not worry about anything else. However, I doubt that that is the case; otherwise she wouldn’t be talking to you and going over her finances with ya. :)

  21. Great post Ramit… Real Estate is one of those areas where there’s a lot of mis-information regarding investing. The best way to make a decision, in my point of view, is to look at rents.

    In a normal market, what you pay for rent and what you would pay for principal, interest, taxes, and insurance (PITI) with a traditional loan should be pretty much the same.

    If, on the other hand, you can rent a place for $2k/month but would have to pay $5K in PITI, well, that should tell your friend something about that “investment” (you would be subsidizing a renter to the tune of $3K per month).

    A good option, if you have the money, would be to rent for $2K and invest the other $3K on an index fund.

    As for the upside potential of real estate, ask your friend to please take a look at this graph, which shows the price run-up in SF real estate for the last six years:

    http://mysite.verizon.net/vzeqrguz/housingbubble/san_francisco.html

    Does this look like a market that is going to turn around any time soon? (I rest my case).

  22. [...] Buying a home when it doesn’t make sense There are many sites that talks about this. I’ve talked to many people that bought their house too early [...]

  23. >I asked her what she was going to do for her next steps. “I’m going to be honest,” she said. “I’m not going to read those books.”

    So when you asked her why this was, what was her response?

  24. rkt: “when is your interest rate not your interest rate (APR)? mulitple $k of fees that you had never seen before added to your statement. etc.”

    If this happens then you are not dealing with a reputable lender. The APR or Annual Percental Rate is NOT the interest rate. It is another way to disclose the fees that are being charged to you. It is a tool that borrowers can use to shop different lender and compare apples to apples. For example one lender may charge a 6.00% interest rate and very few fees giving you an APR of say 6.14%. While another lender may charge a 5.00% interest rate but have several thousand dollars in fees giving you an APR of 7.25%. The APRs are NOT the interest rate, but a way to say, “Hmm. Lender number two might be overcharging me on my closing costs.”

    Also, the Good Faith Estimate (GFE) is a required federal disclosure (Regulation Z) that must be given within 3 days of application for a home purchase loan that the borrower can use to shop around. The lender must estimate EVERY cost that may be associated with the loan. So if the borrower gets to closing and the costs are extremely different, they need to speak up. Demand to know why, and don’t sign until they are satisfied or walk away. The borrower also has the right to review the Settlement Statement BEFORE they close or sign anything. The Settlement Statement will list all the fees that will be charged at closing. Ask for it the day before you close. Take it home, look it over, compare it to your GFE. If you have questions or concerns, call your lender pronto. You should never feel pressured. And a good lender will have opened that line of communication and will have explained everything that was happening before you get to the closing table.

    By the way, I was a lender for a community bank for over 5 years, and have been in the regulatory compliance field for 8.

  25. This is why blogs play such a huge role in the world of consumerism today: it is allowing people who are averse to reading books about things like finance a chance to learn about these topics in an accessible way.

    It’s one way of breaking down that barrier of entry that so many people have. Blogs like this one speak to people and allow them to “get into” these kinds of topics, educating them and eventually improving their financial IQ.

  26. Ramit, you are missing a very key point. As others have pointed out, a personal residence vs. investment real estate are two different things.

    Buying a home for a personal residence is nearly always better than renting because, for most people, housing is our largest expense. If you rent, your largest expense if fully exposed to inflation. For example, you may be paying $2000/month now in rent, but in 30 years it will not be $2000…it will likely be much higher than that. Even worse, after you retire, your largest expense continues to be exposed to inflation. When you buy, you are fixing (and hopefully someday eliminating) your largest expense…and decreasing your expenses in retirement.

    I bought my condo ~ 5 years ago, and today what I am paying in mortgage, rent, insurance, and maintenance is less than what comparable monthly rentals are. Even better, my mortgage payment is fixed…rents will continue to go up. I can save much more money by owning than by renting, long-term…

  27. JT, that’s simply not true. You’re forgetting what you could do with the extra money you save on rent (hint: invest it). Read the articles I linked to above, or check out the NY Times Rent vs. Buy simulator. Also, check historical inflation rates.

  28. [...] a great commentary on the importance of doing research before deciding to buy a house — or any other investment! Your housing decision has to be based on your individual financial [...]

  29. Ramit,

    I am not sure why you are telling JT he is wrong. He said in the long-run owning is better than renting, which the NYT rent. vs. buy simulator proved (when I inputed realistic figures).

    Unfortunately, the simulator still does not take into account after-tax returns. Please keep in mind that there are many tax benefits to owning a home in America that are not realized when you are paying rent. We must take this into account so we can really compare true costs. Going back to my first comment, I would encourage you to take a look at these after tax returns.

    JT is also correct in pointing out the fact that debt is good for you when we have inflation. As money loses its value over the long-run you still owe the same fixed amount. Inflation is good for the borrower and bad for the lender.

    I would disagree with JT in that I don’t think owning is ‘nearly always’ better than renting. As your NYT tool correctly shows, in the short-term (using realistic figures) renting is a better option. And surely it matters where you are located geographically and what your specific market is doing. For these reasons I am sub-leasing an inexpensive room right now, even though I believe in the long-run owning is better. I know that the additional money I am saving can be re-invested into the stock market (heck, even an ING account) and I will realize a much more liquid and much less risky investment.

    Again great job on pointing out the need for reasearch. It is refreshing to hear you call out the often misunderstood conventional wisdom. I can’t stand Donald Trump and Kyosaki. They are motivational meatheads and often lead people to make bad real estate decisions. It is important that we look for the meaning behind the wisdom, instead of just accepting and acting.

    But, on the other hand, please don’t make broad generalizations about real estate being a bad investment. That is almost as bad as making broad generalizations about real estate being a good invesment. There are a lot of variables, and there are many things that you are not considering.

  30. I think there are some assumptions and conventional wisdom about real estate that BADLY need to be understoon by anyone considering buying a house.

    1. The dollar is nose diving. Any investment not making a profit is in fact going down in value.

    2. “At least I’m getting equity for my money rather than getting nothing from rent.” : This conventional wisdom assumes that Real Estate doesn’t crash, which it is. IF YOU DON’T SELL FOR AS MUCH AS YOU PAID: YOU LOST MONEY! Buying real estate right now is like maxing out your credit cards to buy Enron stock. Rent to own if it make’s you feel better.

    3. This isn’t a temporary crash. The ARM resets haven’t even begun. Buying real estate now is the fastest way to turn $10,000 savings in to massive debt that I can think of. PLAYING ROULETTE IS A BETTER INVESTMENT!

    4. Buy Commodities. Inflation hasn’t even begun. I would not even trust the Chinese Yuan. Real estate crash = Stagflation. Most investment sectors are going to perform shitty. Commodities will do well.

  31. I don’t understand why some people have no problem spending years in college and spending a lot of time to earn their money, but they won’t bother with reading a couple simple books to protect it, and even make it grow. Boggles my mind.

    Beating the market or being an “expert” investor takes a lot of knowledge and probably a bit of luck. But just doing the basics and making your money work for you is SO SIMPLE.

  32. This was a great post. We have a mutual friend that told me to come check you out. I am in the Mortgage Banking industry and I do agree with you in the many points you make on researching before buying. Why would anyone ever want to go $1,000,000 in debt without knowing what they are doing? A home is a huge investment but also a secure investment. I am not being bias when I say this. Some of the most successful people around invested and still invest in real-estate. I totally agree in what you say if it is a business you are trying to succeed in. Although, if it is a house that your friend is buying to live in and making money off of it is not her priority, I would encourage her to buy something she likes but something she can afford. She will need money to buy the place and she will still need to qualify. Get qualified legitimately. If you don’t know what that means it’s simply:
    1. Get credit looked at
    2. Get income looked at
    3. Figure out the debt to income.
    You should never exceed 45-50% debt to income.
    If you do don’t buy it. (Unless you have a plan to rent out rooms. Don’t ever rely on people though!)

    So, if your friend can afford it and she loves it, then go for it. I am not a real estate agent, but I will always educate people in what they are getting into before they sign for it. She doesn’t need to read a book to figure out if she can afford that house. Use a calculator… it’s much easier and less timely.
    Real estate is a good investment. It always will be.

    Ronnie,

    http://www.talkrealmoney.com

  33. Ramit, you mention the 3 books that you like in the fields of Marketing, Psychology, and Venture Capital. What are they??? Thanks…

  34. While I agree with some of the comments concerning real estate for investing versus personal residence, the thrust of the article is that many people still consider the purchase of their primary residence as a really good investment,. The problem is a blind belief that this is always the case and that it is a good deal for everyone, everywhere. People and articles are comng forward to challenge this idea and using some of the tools on the web you can see if in your area if it’s better to buy or sell from a strictly financial point of view. (I’d recommend seeing Millionaire Mommy Next Door’s blog for an example of a person who’s found renting a house more profitable and a better fit for them rather than owning).

    I’ve run the numbers for my area and given what I’d need to rent as a reasonable minimum for my family, I am better off having purchased a home. But I can see where others would not be. Additionally, I can’t see a good reason for a single person (like Ramit’s friend or my older brother) to buy a home given that in most cases they could rent a one or two bedroom apartment in many areas of the country far cheaper than paying for a house and then they can invest the difference to help their net worth (Of course, I’m asuming they’re running the numbers so the person is making an informed decision one way or another)

    The other thing I’ve learned is that many people, much like the woman in the article, don’t do anything substantial with their money, and sinking it into a home, even with some modest appreciation, ends up increasing their overall net worth and ends up being a forced savings plan by default, where they didn’t even have that before.

  35. One thing to keep in mind about buying a house for an investment, certainly right now is NOT the time. But keep in mind, if your “friend” is looking for a primary residence,
    LONG TERM. Nobody has ever lost that gamble in California Real Estate.

  36. Ha ha, Rob, JT is a she…but no way you could’ve known that so no worries…but you’re correct, the short term is where the statement breaks down. Clearly, if you’re not sure you’re going to be in a location for the long term, than renting is a much better situation. But if you have settled on an area that you want to live in long-term (I would define this as the foreseeable future, 7 + years) buying is nearly always better long term. And thank you for pointing out the tax benefits, I neglected to point that out. They are substantial for owning, and non-existent for renting.

    Ramit, historical rates of inflation are fine for normal planning but NOT retirement planning. You have to assume a much larger percentage of your expenses will be allocated to heathcare, which is growing at a much higher rate of than historical inflation averages can predict. That is why, if you can eliminate the majority of your housing costs in your retirement years, you will be better insulated against the inflation risks in retirement.

    The other point I neglected to mention is that the common mistake people make when buying…is buying too much or too little house. Buying too much will stretch you so thiin that you cannot save for other goals (retirement) and are one step away from disaster if you lose your job. Underbuying will cause you to sell in a few years, and incur all kinds of transaction fees to buy the space you really needed in the first place.

    I stand by my earlier statements…buying is nearly always better than renting in the long term for most people (with the added caveats of buy when you’ve settled in a location, and consider carefully what you need to buy…not too much or too little).

    Also, it may help to know that I work in Corporate Real Estate and deal with buy vs. lease decisions for a Fortune 500 company on a regular basis…and the answer is the same for a large multi-national: buying is better than renting, if you’re there for the long-term and know what size of space you’re looking for … inn the corporate lingo, this would be called something like duration matching the asset for purpose, but I won’t bore you with that :)

  37. [...] Will Teach You To Be Rich: Why do people decide to buy homes without much research? I’ve got a friend who got so excited about becoming a landlady that she bought a duplex in [...]

  38. Just think if I had invested my $5,000 4 years ago it would now be worth about $6,000, instead I bought a $280,000 house with only $5,000 down and just sold it for $390,000. Does anyone know what the rate of return is when you make $110,000 over 4 years on a $5,000 investment?

    Oh yeah I also got to live in a pretty nice house for 4 years. And also I had gotten a Home Equity Line of Credit loan that allowed me to buy a Porsche Boxster and a F-150 free & clear, and I used the rest of the money to buy and sell a small house which I used the profit to pay off the total HELOC loan and I still had $5,000 left over. Isn’t this country great.

  39. There should be more talk on here about the leverage that purchasing your home affords. Lets use the assumption of 6% annual appreaciation, vs 12% for stock. If I have $40K, I can buy the equivalent in stock or put 20% down on a $400K house. After 1 year, I made $4,800 with stock vs. making $24,000 in the appreciation of my house.

  40. [...] Siwal article is brought to you using rss feeds.Here you will find the latest real estate news for buying and selling homes.Now, as you know, I’m not a big fan of real estate for investment reasons, but because I’m not an expert, I’ve been researching it more and more (see my links here). So when she mentioned wanting to buy a house, I asked one question: … [...]

  41. [...] itching for some good discussion, you can read a great debate on this subject at Ramit’s I Will Teach You To Be Rich and a breakdown of the financial decision to Buy vs. Rent from Jim at Blueprint for Financial [...]

  42. Ramit,

    I have to agree with you that one needs to truly understand what they are buying when they purchase a home. But there a few things that you have said that are just not true. First you mentioned that you are not wasting money by renting if you are renting in an expensive area. You are ALWAYS wasting money if you rent!!! When you own a home every dollar you pay towards that house you will get back when you sell the house or at least part of it. When you rent you are spending money that you you will never see again. Also when you own a house you have something called a tax write off, at the end of every year you have to pay less in taxes to uncle sam (this is a huge savings in its self). Obviously you have to be able to afford a home but you are never saving money by renting. Did you know that 65% of the US owns a home and of those people 85% of all there wealth is in there home. This means that the one thing you are telling people not to do is the one thing they should do and not just once but multiple times. Find anyone you know that has owned a house for 10 years or more and ask them if they could go back and make the decision to buy their house again would they? I guarantee that everyone you ask would buy their house.

    Secondly you made a point in your article about spending and you also made a statement in your abc special about paying attention to your expenses. This logic is what make poor people poor. People need to stop focusing on there bills and start focusing on how to get out there and make some money. When you focus on things like “how much money do i spend on coffee” in order to become wealth you are sacrificing things you like to save a few dollars. Instead of focusing on how much money you spend on coffee focus on what you are going to do to make money. If you do this you will not have to worry about stupid stuff like coffee. I know this because that used to be me. Until I changed my mind set, now am 26 years old produce an income in the 7 digits and own multiple homes. I never have to worry about how much i spend on coffee. Also I have achieved all of my success through real estate, if i had never purchased my first home i would never be where i am today.

    Lastly I think that you need to spend more time educating yourself on real estate and how with the power of leverage you can be multi multi millionaire if all you do is buy a few properties and hold them for a long time. Real estate is a game of buy and hold. Real estate is not a vehicle for building fast cash it is a way to build tremendous wealth. If someone in there 20′s can acquire 10 $300,000 condos by the time they are 35 and hold those ten places till they are 65 they will have an approx. wealth of $24,000,000 just from real estate. You show me an investment in which you can use $300,000 (10 300k homes at 10% down) and turn it into 24 million in 30 years, I guarantee you can’t. Also you have such a short view on real estate and you don’t understand what drives real estate. Have you ever heard of “replacement cost”, that is what it would cost to replace an existing house. Since we have something called inflation the cost of wood, copper and everything that goes into a home cost more as the years go on. This increases the price of real estate and ensures that real estate will never drop like stock can. Real Estate can level of or slow down like it is now, but in the long run it will alway go up. My father in-law in one of the largest condo developers in chicago, he has developed such buildings as the John Hancock and lake point tower and has bought, built, and sold more then 15 billion dollars in real estate over the last 30 years. He knows first hand how prices in real estate have risen and how materials have risen. Real Estate will ALWAYS ALWAYS going to appreciate. This is something you should realize now because in thirty years I can guarantee that you will look back to today and wish you bought everything you could get your hands on. I ask you to please stop advising people on real estate until you really understand it. Also you need to stop listening to all the news media out there, you have to understand a few things. One the media is very short sighted in the way it looks at topics, they view stories as “what will sell now”. Have you ever heard of a book called The coming crash in the real estate market by John talbott, it was writing in 1998 and it told everyone to sell their homes. So many people went out and sold there homes fearing a real estate crash. Since then real estate has doubled in value. Because people decided to listen to the media they lost out on hundreds of thousands of dollars. Secondly the people reporting what is going on in the real estate market have not made crap on real estate, so they have no idea what they are talking about. I could go on and on for ever on this subject but i just don’t have the time.

    Well i hope you have learned a little bit more about real estate and will think twice before advising people to not do something that will help make them a lot of money.

  43. Brad, thank you for making my point for me better than I ever could have.

  44. Ramit, you are missing Brad (and JT’s) point. Real Estate is a legitamite option for most people to build substantial wealth over the long term, and you are fairly ignorant of how you could do that. Until you educate yourself on the topic, don’t tell people about it.

    BenjaminBach.com

  45. [...] the past several months I have been studying home buying (trying to be one of Ramit’s other friends), reading books, blogs and asking questions to people who have some experience in the area. [...]

  46. Hey,

    I personally disagree with you on this topic. I think no matter what, you should always buy a house if you can afford it. You can use it or put out for rent and have rent cover the mortgage. A better idea is to target students. If you are smart, you can build multiple rooms and have a community bathroom, kitchen and living room. For example, lets say we have a two story building and the top floor has like 4-5 rooms and we charge $500 per room. That’s $2000-$2500. Not to mention, you still have the bottom floor to yourself. If you decide to do that, it’s all about location. While all this is happening, you’re house’s value can grow which is a positive thing or it can depreciate. BUT! if it depreciates, you still have a house to live in! To me, it’s a win-win situation.

    Doug

  47. I know you can read this, I had a few typos in my previous comment. I would appreciate it if you can fix it for me. Feel free to contact me.

  48. Doug – You have a point about “having a house to live in” even if the house’s value falls. That’s true for people that are already settled down in their chosen city and don’t want to move or will never experience having to move because of a job, significant other, or wherever the wind will take them. However, as a 25-year old, there’s tons of value for me in MOBILITY. What if I got sick of my job and wanted to move to take up a whole new career another city? Sure, I could sell my house, but that isn’t always easy to do, especially in the current market.

    Also, the rent doesn’t always cover the mortgage. Unless you’re ready to cover the shortfall of the excess of the mortgage over the rent income, then you’re screwed.

  49. Hi all comming into a few millions 4 or 5 . I want to buy my first home. Just on out skirts of town .little country living.for sure 500,thousand for sure.would it be good idea to pay it right off on the spot , just wondering. Well come back after

  50. Very interesting. I actually read the whole blog. Very good advice in short neat way. Perfect for low attention spanned. Good advice.

  51. Incouraging her to pick up an investment book is a really great thing to do. It is just that their are many different ways to invest.

    If she wants to buy real estate she should learn how to make money in real estate. Real estate is an investment too. People got to live somewhere. .

    I perfer the stock market myself but I also know people who live off their real estate investments.

    http://www.stocks-simplified.com

  52. I think buying real estate as your primary residence in the Bay Area (as long as you buy something you can afford) is still a good idea if your goal is to live in the place and have it paid off (or nearly paid off) when you retire. You will always need a place to live, but probably not always want or be able to worry about a housing payment. More than that, I read an interesting article a while ago that said the 19th century was the British Century, the 20th was the American, the 21st will be the Asian…and I see a lot of truth in that. The Bay Area is on the Pacific Rim, so if the US is to benefit from the Asian Century in any way, having roots in this location will allow you to reap those benefits.

  53. Not paying rent IS a good reason to get property. Once you own a house you pay no rent – for enterity (until you die). As long as INTEREST on the loan ends up being LESS than rent (it will) you will have made money.

    Its funny you should a graph for the stock market that shows a 20% gain over 5 years, which is 4%. After taxs on your profits you would probably not even make inflation. If you buy the right property it can go up 25% or more PER YEAR. Do your research, but if you don’t live in a property and are paying rent, usually the best investment you can make is one to buy property. That way once you pay it off you never pay rent again for your whole life, and have much more money to invest. Its buying property FOR investment that is not a good idea.

  54. Hey Ramit,
    A sad little sign of the Times: That graph of the Vanguard fund looks completely hilarious and out-of-place right now. You might want to consider using a snapshot in the future, since that graph now does very little to support your article (which is still fundamentally a very good one.)

    If you showed me that graph as a new investor, I’d seriously consider a hole in the back yard (or worse: a .5% checking account!) for my savings. Probably the incorrect decision, but some people might not be prepared to watch the profits from 5 years of wise investing evaporate like that.

    However, any of the above decisions would have probably netted less long-term loss than Brad Parker’s strategy above…talk about irrational exuberance. 26 years old, making 7-digits w/ multiple homes? Hmmm, hope all that leverage didn’t catch up to you like it did to everyone else in America.

  55. Heh, good comment. How about this one?

  56. Better. It’s still quite a gut-check no matter how you look at it.

  57. I agree with Ramit. If one buys a house its just not the mortgage payment that’s there. There are additional expenses like taxes (Which is money gone down the drain), maintenance, higher energy bills etc. If you add this up that itself will come to I guess 50 to 70% of the rent. I think one should buy a house based on the amount one is able to save. If you can save a lot after affording an expensive house then go for it. If not buy a cheaper house. Before purchasing a house do a 10 year and a 15 year net worth calculation. Then keep changing the values (income earned, house price) and it will help you to decide.

  58. Ramit, you’re right in thinking that real estate can be a bad investment, but it depends on the market. Here in Oklahoma, where the median house price is $125,000, buying a house makes sense for most people. Not a McMansion – just a house. I bought a 2BR house for $43,000 in 1995. it hasn’t appreciated greatly, but so what? I acquired a place to live that costs very little and has good neighbors and a wonderful yard. My monthly payment is $150-$250 less than rent. Even when you factor in repairs, taxes, and interest, purchasing this house was a good idea.

  59. Ramit, yet again you’ve shilled ING in one of your posts. How much are they paying you for your integrity as a writer?

  60. I link to them because (1) I like them and (2) I use them. They pay whenever an account is created — which helps me run this site — but that’s not why I link to them. You’ll notice that I link to many, many other sites/resources that don’t pay me anything.

  61. Hello Ramit, how do you feel about the real estate market now that a year has passed? We have seen the stock market and real estate values collapse. We all know the real estate market will come back, the questions is when. So should we buy now or wait until the market corrects. I can tell you I got rich by buying weakness and selling into strength. Right now the real estate market is weak and right now is the time to buy as along as the properties cash flow you can hold on during the down turn. Just my 2 cents…

  62. “When the only tool you have is a hammer, every project looks like a nail.” Meaning: f your one-track mind considers nothing but ROI, then every situation in life becomes an investment. The point: a house isn’t always an investment; for some people it’s actually a place to live.

  63. [...] if you’re making the largest purchase of your life, you need more than a slogan — you need to take the responsibility to do some research. (And note that you can’t advocate for increased homeownership and also argue for Americans to [...]

  64. [...] itching for some good discussion, you can read a great debate on this subject at Ramit’s I Will Teach You To Be Rich and a breakdown of the financial decision to Buy vs. Rent from Jim at Blueprint for Financial [...]

  65. re: the patrick.net site, and the argument that owning costs more money than renting due to maintenance, taxes, fees, etc…

    that argument is silly and specious: there might be anomalies in the short run, but in the long run owners rent to COVER THEIR COSTS, which includes things like maintenance, taxes, fees, etc…

  66. [...] David Bach believes that owning a home is a big component of building wealth. He presents his six reasons why owning a home is a great investment. Ramit Sethi may argue that not everyone benefits from homeownership, you have to run the numbers.  [...]

  67. What about purchasing to rent when you know that rent already covers the mortgage, insurance and taxes, plus a little return and then once the mortgage is paid off in 20-30 years of your fixed rate you will have pretty good cash flow of $3500 a month.

  68. [...] to buy a house. Do you want a place to own or are you looking for an investment? He expects you to run the numbers thoroughly because this is probably the biggest purchase you’ll make. He argues that too many people rush into buying a home with being financially [...]

  69. [...] renting. You have to run the numbers yourself. Spreadsheet templates are an excellent solution to running the numbers easily. Find out and don’t just fall into the common myths of [...]

  70. [...] the illusion persists, whether it’s my friend wanting to buy a million-dollar house with no research, or people saying things like, “I wish I’d bought more real estate” after [...]

  71. [...] the illusion persists, whether it’s my friend wanting to buy a million-dollar house with no research, or people saying things like, “I wish I’d bought more real estate” after incurring a paltry [...]

  72. [...] « My friend was about to buy a million-dollar house with no research [...]