What your home is worth depends on why you ask the question. It could be one value based on a purchase or sale and an entirely different value for insurance purposes.
Fair market value is the price a buyer and seller can agree upon assuming both are knowledgeable, willing and unpressured by extraordinary events. This value is generally indicated by a comparable market analysis done by real estate professionals.
Insured value is determined for insurance coverage. Homeowner policies typically have replacement clauses in them and the cost of demolition, new construction and the added complexities of matching existing construction could exceed the cost of new construction.
Investment value is based on the income it can generate during its useful life. This value is dependent on what kind of yield an investor requires to capitalize the value over time. The formula for this is to divide net operating income by the capitalization rate required by the investor.
The assessed value of a home is used to determine the property taxes the owner must pay. This value is determined by the responsible state government agency.
Homeowners are generally more familiar with their home’s market value. Since it can be lower than the replacement cost, owners should review the insured value with their property insurance agent periodically.
There can be a surprising difference in each of these separate values. It is important to know the purpose that it is going to be used for the value.
These questions will help you decide whether you’re ready for a home that’s larger or in a more desirable location. If you answer yes to most of the questions, it’s a sign that you may be ready to move.
- Have you built substantial equity in your current home? Look at your annual mortgage statement or call your lender to find out. Usually, you don’t build up much equity in the first few years of your mortgage, as monthly payments are mostly interest, but if you’ve owned your home for five or more years, you may have significant, unrealized gains.
- Has your income or financial situation improved? If you’re making more money, you may be able to afford higher mortgage payments and cover the costs of moving.
- Have you outgrown your neighborhood? The neighborhood you pick for your first home might not be the same neighborhood you want to settle down in for good. For example, you may have realized that you’d like to be closer to your job or live in a better school district.
- Are there reasons why you can’t remodel or add on? Sometimes you can create a bigger home by adding a new room or building up. But if your property isn’t large enough, your municipality doesn’t allow it, or you’re simply not interested in remodeling, then moving to a bigger home may be your best option.
- Are you comfortable moving in the current housing market? If your market is hot, your home may sell quickly and for top dollar, but the home you buy also will be more expensive. If your market is slow, finding a buyer may take longer, but you’ll have more selection and better pricing as you seek your new home.
- Are interest rates attractive? A low rate not only helps you buy a larger home, but also makes it easier to find a buyer.
Is the stock market keeping you up at night? Are you consuming more antacids than ever before? Are the ups and downs causing more stress than you want or need? There is a simple alternative in rental real estate.
Single family homes for rental purposes offer an excellent rate of return in an investment that most people understand better than other investments. The concept is simple: stay with predominantly owner-occupied homes in a slightly below average price range. In most areas, tenants are easy to find and they’ll usually stay two to three years or more.
For the person who doesn’t want to be bothered with calls from tenants, professional management is available and commonly won’t dramatically affect the rate of return. Managers can achieve economies of scale that individuals can’t due to managing multiple properties and having good connections with the best workmen.
Unlike most commercial property, single family homes are much more liquid because of the higher demand for residential property. Single family homes offer the investor the opportunity to borrow high loan-to-value mortgages at fixed interest rates, for long periods of time on appreciating assets with tax advantages while providing the investor a higher than normal level of control.
Spend an hour investigating the benefits and you might sleep better at night, eat less antacids and find yourself more mellow than you’ve been in years.
If you invest in a savings account, you’ll make less than 1% and would have to pay income tax on the earnings. On the other hand, contribute something extra to your house payment and you’ll earn at the mortgage interest rate which is certain to be more than you are earning in the bank.
Making additional principal contributions on your mortgage will save interest, build equity and shorten the term. An extra $100 a month in the example shown will save thousands in interest and shorten the term of the mortgage as well.
Reducing your cost of housing is another way to improve the investment in your home. Becoming debt free is a worthy goal that is achieved with discipline and good decisions. Suggestions like this are part of my commitment to help people be better homeowners when they buy, sell and all the years in between.
Check out what would happen if you were to make additional payments on your mortgage.
Sometimes, there are costs associated with not taking a particular action. If a person left their money in a certificate of deposit earning 2% when they could have made an investment that earned 8%, the difference is the opportunity costs associated to not taking action.
If a couple has a down payment and good credit, locking in a low interest rate mortgage for 30 years could easily provide their lowest cost of housing. If that couple waits three years to purchase a home, the price would probably be higher as would the mortgage rate.
However, assuming the price and interest rate remained constant, look at what the opportunity costs might be compared to doing nothing.
If their money was invested in a certificate of deposit at 2.00%, in two years their $8,750 would have grown to $9,104. They would have earned $354 and had to pay ordinary income tax on the interest.
If their money was invested in the stock market that had increased 7%, in two years they would have a profit of $1,268 which would be subject to long-term capital gains tax.
On the other hand, it the same investment was used to buy a home that increased in value at 3% annually, the equity would be $31,938 or an increase of $23,188. Tax would not be triggered until the home is sold and may not be due then based on their homeowner’s principal residence exclusion.
The home goes up in value due to appreciation and the unpaid balance goes down because of amortization. The dramatic difference in growth in the equity of the home is effected by leverage: the use of borrowed funds controlling the asset.
A home is a place of your own where you can feel safe and secure, to enjoy with your family and friends and in many instances, a very good investment. It is difficult to measure the opportunity costs of intangibles but not necessarily money.
Make your own projections with Your Best Investment.
Many years ago, Las Vegas hotels would entice customers with inexpensive rooms, meals and entertainment so they would gamble. It may have worked initially but if you’ve been to Las Vegas recently, the bargains are gone. Hotels expect each division to be a profit center on its own. As a consumer, I might not like the changes but as an investor, I’d have to be pleased with increased profitability.
Years ago, real estate investors used to accept negative cash flow buoyed by tax incentives in hopes of making a big payday due to appreciation when they sold it. Today’s investors are focusing on tangible, current results like cash flow and equity build-up.
Cash flow is the amount of money you have left over after collecting the rent and paying the expenses. Since rents have gone up considerably due to supply and demand in the last few years and mortgage rates are at near record lows, income is up and expenses are down, making the cash flows attractive.
If the cash flow is sufficient, you could have a good investment even if the value of the property never increased. Cash on Cash doesn’t consider appreciation and measures the cash flow before tax advantages by the initial investment. A rental with $3,170 CFBT divided by an initial investment of $29,000 would generate a 10.93% Cash on Cash rate of return.
Low down payments on investor properties are also a thing of the past. Non-owner occupied mortgage money is available but the investor should expect to put down 25-30%. An advantage of having a smaller mortgage is a lower payment.
Most mortgages are amortized loans with both principal and interest due with each payment. The forced savings of the principal contribution builds equity in the property and can be considered a part of the rate of return.
A $100,000 mortgage at 4.5% for 30 years would have $1,613.29 applied to principal in the first year. Divide that by the same $29,000 initial investment and the amortization would generate another 6%.
Without factoring in appreciation or tax advantages, this rental example generates much more than most alternative investments. There certainly are many different aspects that affect the risk and return on rental investments. If you haven’t scrutinized single-family rental opportunities in a while, you should look again.