We’ve all dreamt about it: One day having a loving family, buying a four-bedroom house and a white picket fence on your own quarter-acre slice of the American Dream™.
What many don’t realize, though, is that investing in the four-bedroom house can quickly turn into the biggest money and time sink of their lives. In fact, buying a house is just another one of those invisible scripts that we blindly follow without giving it a second thought.
“What’s an invisible script, Ramit?”
Invisible scripts are those guiding beliefs that are so deeply embedded in our day-to-day lives that we don’t even realize they’re there.
We’ve all heard them before:
- You need to make sure you get a college degree.
- After you graduate, you need to get married.
- After you get married, you need to have kids.
And the compulsion many have for real estate investing is one of those scripts — despite the fact that it’s one of the biggest, life-altering decisions you can make.
In fact, I receive emails every day from people saying, “I have a horrible financial problem. Plz help!” and 30% of the time, it’s directly related to their mortgages.
In chapter 9 of my book, I’m hyper-critical of people buying real estate because they think it’s a “good investment” or because they think they’re “throwing money away on rent.”
Those myths — and many others — are just that. Myths. And they’ve been so detrimental to many people’s financial situations that I feel like I need to dispel some of them today.
Here are the 4 myths of real estate you need to know before you even think about buying a house.
Real estate myth #1: Purchasing real estate is a great investment
One thing I always hear from people who are about to buy a house is, “Buying real estate is an investment! One day this house is going to be worth WAY more than it is now.”
Look, I get it. We’re always hearing stories from old farts who bought their homes way back in the Truman administration for just $30,000 and now it’s worth $450,000 or whatever.
When the truth is the people who say things like this don’t account for the invisible factors like inflation.
In fact, Yale economist and Nobel Laureate Robert Shiller reported that from 1890 to 1990, the return on residential real estate was just about ZERO after inflation.
Realtors and homeowners are going to flood my inbox with hate mail for saying this, but the fact is real estate is the most overrated investment in America. And returns on that investment are mediocre at best.
Even Warren Buffett, one of the world’s wealthiest men, points out that houses don’t necessarily increase in value. That’s why he’s still living in the same 5-bedroom house he bought in Omaha, Nebraska, back in 1958.
My good friend, James Altucher, wrote about why entrepreneurs shouldn’t buy a home, and he suggests the following:
“Take 1/20th of the down payment amount. Start a business.
Your investment might go to zero (which it might also do with a house) but it might also go up to 10,000% returns.
Eventually, as an entrepreneur, if you are persistent enough, you will get one of those 10,000% returns. And you will be persistent because you didn’t waste all the money and time that a house would’ve cost you.”
Real estate myth #2: I’m throwing away my money if I keep renting!
A reader once told me, “Ramit, I pay $1,000/month renting my apartment, so I definitely can afford $1,000 a month on a mortgage and build equity!”
So I asked her, “Well, how nice is your apartment?”
She admitted that the hardwood floors were old and the kitchen was very outdated.
“So will you want a house like that,” I asked, “or will you want a nicer place — one with recessed ceilings, newer appliances, and a balcony large enough for entertaining?”
She looked at me as if I were an idiot. “Of course I want a nicer house.”
“Okay,” I replied. “But that will cost more than your current rent, right?”
When I said that, a lightbulb went off in her head. She hadn’t even considered that.
Chances are people who want to buy a house haven’t either.
Of course, you’ll want a nicer house than the apartment you’re currently renting — ESPECIALLY if you’re committing yourself to a long-term investment like a mortgage.
But that means your monthly payment will be higher.
Of course, that seems pretty obvious — but it’s only the beginning.
What many people often ignore when they say that they don’t want to throw money away on renting is the Phantom Costs.
Phantom Costs are things like:
- Property taxes
- Utilities (eg internet, electricity, gas, water, etc)
- Home maintenance fees
- Toilet drains breaking randomly at 2 am forcing you to awkwardly ask your neighbor if you can use their bathroom before you spend a few hours Googling 24-hour plumbers
When it’s all said and done, these costs will add hundreds per month to your living expenses.
After all, you’re not just paying the mortgage each month. You’re also paying for the oven if it breaks down, or the hot water heater if it isn’t working, or that cockroach problem you inherited from the previous owner.
When you rent, you can just call your landlord if any of those things happen, and he or she foots the bill.
When you own, though, you have to fix those things or call someone else to fix them for you. And of course, that comes out of your own pocket.
Sure, the plumber here and the exterminator there doesn’t sound that bad…but imagine that in the course of owning a house, your roof breaks. All of a sudden, that’s $25,000 you need to invest in repairs.
So even if you have a mortgage that is the same as your rent — let’s say $1,000 — you still need to add 40% – 50% to that monthly amount to factor in the phantom costs. Now you’re paying closer to $1,500/month.
Check out this graph. It shows the true cost of buying a home over 30 years.
If you purchase a $300,000 house today, over 30 years, it could cost you almost $1 MILLION.
In the end, you’re not throwing your money away by renting — but you will throw your money away if you buy a house without knowing what you’re doing.
In the video below, I break down the myths of renting vs buying a house a bit more. Check it out.
Real estate myth #3: I can always leverage this house or take advantage of the tax savings
This is effectively two myths in one — but they both boil down to one idea: People think they can make money by investing in real estate.
I’m talking about leverage and tax savings, and BOTH can cause you to lose money.
So many homeowners point to leverage as a key benefit to their real estate investment.
For example, you can put $20,000 down for a $100,000 house, and if the house climbs to $120,000, you’ve effectively doubled your money.
That sounds great, but it’s ignoring one big thing: The price of a house doesn’t always increase. So unfortunately, leverage can work against you if the price goes down.
Obviously, when the value of your house rises then that’s good. But there are hidden costs to consider if the value of your house falls.
If your house declines by 10%, you don’t just lose 10% of your equity — it’s more like 20% once you factor in the 6% in realtor’s fees, closing costs, new furniture, and other expenses.
You need to be prepared to face this potential loss before you drop several hundred thousand dollars on a new house.
People think that they can deduct their mortgage interest from their taxes and save a bunch of money.
Though you can deduct your mortgage interest, people forget that they’re saving money that they ordinarily would never have spent.
Think about it. The amount you pay out owning a house is much higher than you would for any rental when you include all those phantom payments I mentioned. So even though you’ll certainly save money on your mortgage interest through tax breaks, the net is usually a loss.
As Patrick Killelea of patrick.net says, “You don’t get rich spending a dollar to save 30 cents!”
At the end of the day, both leverages and the tax breaks you get from buying a house just aren’t good enough reasons to justify investing in real estate.
So when IS a good time to buy a house?
Real estate myth #4: If I cut back on enough avocado toast I can afford a house!
Just… Stop it. Right now.
When you should actually buy a house
Warning: This is going to get a little bit complicated.
To know exactly when the right time is to purchase a house involves a lot of analytics and hours slaving over spreadsheets and A Beautiful Mind-style chalkboard equations.
You ready? Here’s when you should actually buy a house:
No really. It’s actually kind of simple, because the fact is there isn’t a right time that fits everyone. Your invisible script is going to tell you that you should buy a house after college or when you’re ready to start a family — when the truth is the right time is different for you as it is for the next guy.
Hell, there might not ever be a right time. And that’s okay too.
However, if you are genuinely interested in investing in real estate, I do suggest you do a LOT of research before you jump into anything.
Here are a few GREAT resources I recommend if you’re thinking about buying a house:
- The Boglehead’s Guide to Investing: This is a great website filled with a lot of helpful advice regarding all things investing, including real estate. It’s inspired by the teachings and philosophies of Jack Bogle, the founder of Vanguard.
- In the Long Run, Sleep at Home and Invest in the Stock Market: This is the seminal article from the New York Times on why we underestimate Phantom Costs like insurance, inflation, and taxes. Note the haunting story at the end.
- Fixed rate vs adjustable rate: An article I wrote a while back examining why people still take the risky route when purchasing a house.
In the end, purchasing real estate might be right for you and it might not. But do not make the largest decision of your financial life because it’s something you “should” do.
BONUS: How to buy a house — real estate investment basics
If you’re really prepared to put in the time to learn about real estate and make sound decisions, check out this seven-part series on real estate investment basics by my friend Owen Johnson. It’ll help you reap the rewards if you decide you’re cut out for it.
Of course, this is just the beginning. I suggest you have intermediate knowledge of real estate before you make your purchase.
- The Real Scoop on Real Estate
- Starting Down the Real Estate Investment Path
- The Transaction Mechanics
- A Primer on Real Estate Agency
- Leveraging Yourself to Grow Your Wealth
- Management Infrastructure
- Real Estate Basics – In Review
What you should invest in
In general, buying real estate is NOT a great investment for individuals.
Instead, I recommend conservatively investing in the stock market via index funds.
By investing in sensible, long-term investments, you’ll have a balanced portfolio that’ll earn you thousands well into your life.
And the sooner you start, the easier it is to get rich.
This isn’t BS either. There’s over 100 years of evidence in the stock market that suggests this.
Still don’t believe me? Let’s look at another real world example.
Say you’re 25 years old and you decide to invest $500/month in a low-cost, diversified index fund. If you do that until you’re 60, how much money do you think you’d have?
Take a look
That’s right. You’d be a millionaire after only investing a few thousand dollars per year.
Notice, I’m not talking about the Hollywood type of investing where hot-shot stock brokers make huge multimillion dollar trades while yelling “SELL” into a phone for some reason.
I said you should invest in low-cost, diversified index funds over time. That’s because smart investments are about consistency more than anything else — not chasing hot stocks. Or other weird investments:
Only through smart investments can you live a Rich Life.
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