First, sorry for the blogging hiatus! The holidays are the busiest time of year for me what with ResellerRatings and Dealighted both being diehard shopping sites, and with the usual family/holiday festivities. Thanks for coming back and sticking with me 
.
I was reading John Chow’s blog recently about a $5M house for sale in Vegas that he toured, and someone said, “I wish I had $5M so I could buy that place”.
If you sell your business or get another kind of cash windfall, don’t don’t don’t assume that you should go pay cash for a house UNLESS you’re a bad investor, or a big spending money waster, and have no intention of learning about good investing habits. Good investors know how to limit their risk by using well diversified assets, and earn an average 10-12% per year on their investments. For those investors, it’s much smarter to mortgage a house at 6.5%, and keep their money invested.
Why? For starters, on a $5M house, a 100% mortgage at 6.5% (without property taxes and insurance) costs $27,000 per month, but $5M invested at 12% earns $50,000 per month before taxes. Right there, you’re coming out ahead by having your money invested even taking monthly property taxes and insurance into account. Add to this, though, that your $5M home is an appreciating asset, and that it should appreciate at anywhere from 5% to 10% per year, and home ownership via mortgaging looks very attractive.
You have to be able to afford the monthly payments though, either via current income or by selling off investments over time. But having as much money invested and working for you as possible is the way to go for reasonably disciplined and educated investors.
These economics are the same on a smaller scale but again, it comes down to whether or not you know how to invest. It’s not rocket science to earn a 10% return by investing in well diversified index funds like an S&P 500 fund, a small cap U.S. fund, and an international fund, for instance, and you’d be better off with your money invested than sitting locked up as equity in a house.
The exception here would be emotional. It feels good to own a home outright, so a well-off person might pay cash for their primary residence and then mortgage vacation homes, for instance. It’s all about investing as much cash as possible, rather than having it tied down.
Glad to see you back from a busy holiday season.
This post just inspired me to go learn more about real estate investing.
Welcome back Scott.
I hope the holidays brought you lots of visitors and lots of money!
I have two properties on mortgages, and have just decided to sell the one I rent out because the interest rates have gone up a lot in the UK recently and it no longer stacks up as a rental investment.
That is the only thing I would say in addition to your post, if the interest rates go higher (in the UK they have been up to 15%) you could end up in a worse position.
This graph shows http://www.houseweb.co.uk/house/market/graph.html
Keep up the good work.
Happy New Year
James
Good points, but I think issue with just this:
The appreciation is not guaranteed and 5-10% a year is not normal (too high). Also there’s a great possibility, especially in the USA, that prices will fall. Other countries have that risk too.
Appreciation is the same whether you pay cash for the house or mortgage it, and mortgaging it lets your money work for you whereas paying cash does not.
In US, you also get tax write-offs. But in Canada, interest on a home mortgage is not tax deductible. That is why many Canadians have no mortgages.
Uhhh… who told you that? MANY Canadians DO carry a mortgage. If you live in Vancouver, BC the average price of a home is OVER $700,000 — try paying cash for that if you’re only making $65k per year. Unless you’re living in a VERY small community, Canadians do carry a mortgage.
Good post, Scott. If I had $5M I would:
- buy a house for $300K
- invest $3M to securities
- invest 1.7M to houses and other lower risk targets
Well, that’s just simplified, but the point is that instead of buying a house of $5M in cash, I would be satisfied with a regular house and use my capital money to make more money.
Not only that, but you can pull money out of your asset tax free
For example, if you have a mortgage of $5 million paid down to $1 million, then you can refinance to a mortgage of $2 million. This lets you extract $1 million from your property tax free! On an appreciating asset.
The trick is just to remember to always yourself a nice cushion. The recommended rule of thumb is never extract more than 40-60% of the total value of the asset. This protects you for bad times.
While this used to really hold true, the ability of even the truly wealthy/knowledgeable to earn 10-12% annually through investing, even with index funds, isn’t what it once was with today’s chaotic markets.
It has held true over the past 50 years. We’re clearly in a recession at the moment, but barring some sort of cataclysmic event, it should hold true for the next many years.
I disagree, buys. The wealthy earn way more than 10-12% on their investments. The catch is that they don’t use index funds or securities. They invest in starting businesses and buying rental properties for cash flow.