Buying a property to put down roots – A case study of investment property

You have been working overseas for an US employer for the past two years. Things are going well and your family is enjoying the expat lifestyle, which offers new culture, scenery, and food, plus a free, fully furnished apartment.

Now you can see staying in this job for the long-term, you start to think about what it means for your children to grow up overseas. For all the experience they will have traveling around the world, you still want them to have a root and understanding of their homeland. Furthermore, your parents constantly request that you visit often so they can be part of their grandchildren’s lives.

Given that you would like to take your children back to your hometown every year, but don’t want to stay at your parents’ weeks at a time, buying your own property seems like a good idea. Not having to pay rent overseas, you have saved a lot and have a cushion in your budget, so you can definitely afford to buy a property. The question is, is it a good financial decision? Is there a better place to put your money in than a house you will only live in few weeks a year?

Here’s what the “Should I invest in a residential property?” worksheet can do for you.

Assumptions

Property and Mortgage

• After research, you decide that a house that fits your need costs about $300,000.
• You will put 20% down, which is $60,000.
• You are pre-approved for a Fixed Term 30 year mortgage at 4% APR if it’s considered your primary home.
• Your hometown is a mid-size town without too much growth in the past 30 years. (In fact, that’s why you left.) Therefore you expect the property will grow slowly, around 0.5% above inflation per year.
• Given your youngest is only 3, you would like to hold on to the house at least until he goes to college, which means you expect to own the house for 15 years.

Rental Income and Expenses

• Since you expect to return every year, you can’t rent it out for the long-term. Therefore you decide to put the house on AirBnB. Your parents said they will help you manage it for free.
• You expect your family will at least stay for one month there per year.
• Your hometown has an influx of vacationers in the summer months, so you expect to get guests about 60 days a year, or about 2 months.
• After scoping out your competition, you decide that you can get $250 a day for renting out the house. Monthly rent = $250*60/2 = $7,500. You don’t expect it to grow beyond inflation.

Annual Ownership Cost / Rental Expense / Transaction Cost of Purchase + Sale

• See the screen shot below for my assumptions. Note that they may not be representative of what you will pay, since they are dependent on the property, locality, state, and various other factors. Make sure to do your own research on how much it would likely cost you.

Taxes

(Consult your tax adviser if you are not familiar with tax liability and benefits relating to owning a property or receiving rental income.)

• Given your particular circumstance, you were advised to file the same way as you would have if you lived in the US and take Foreign Tax Credit.
• You will pay income tax on the rental income at your marginal tax rate. You can deduct some expenses, but only proportion to the amount of time you rented out per year.
• Since you consider this property your primary home, you are able to take itemized deduction on your mortgage interest and property taxes. However, since you don’t have too many other deductions, and the mortgage interest decreases over time, you estimate you will have annual net income tax benefit of $500 on average over the lifetime of the loan.
• Assuming you sell this property as your primary home, the moderate gain on the property is exempted for federal capital gain tax. Also you assume that you won’t bother taking depreciation on partially rented property.
• Lastly, your state and locality may have a sales tax of 0.5% combined.

Other considerations

• You assume the cost of owning and selling the house will increase by inflation of 2%.

Result

Given all the assumptions above, your real investment return is 1.97% year over year for 15 years.

 

That may not be as good as you expected, but at least it’s not negative, especially when your rental income does not cover all your annual expense of owning the house. You need to expect to be out of the pocket for a few thousand dollars a year from now on.

Decision

So is a real annual return of 1.97% good or bad? It depends. If by not investing in this house, all you do is leaving the extra cash in a savings account, the annual return is likely lower than that. However, if you have the discipline to invest consistently over the long-term in the stock market without selling when you shouldn’t, historically the 10-year median real return for investing in US S&P 500 index is much higher, although there is still a slight chance of losing money. If you extend your timeframe to 20 years, then investing in stock market is likely to give you a higher return without too much risk in losing money, historically speaking.

Of course, the benefit of having a house for your children to return to as their “home” is hard to quantify, and may trump all other financial calculations. In this particular scenario, you have the potential to make a little money on the house while fulfilling your wish for the family, so it should be an easy decision. However, it’s as likely that the house you have your eyes on actually gives you a negative return. Therefore do your research and have an open mind before you committing to the idea of owning a particular house in a certain neighborhood or in a unsustainable way.

You can also play around with the different parameters to help you determine which housing decision may give you a higher return while meeting your goals for the family. Maybe buying a house the next town over has higher income potential because it has longer tourist season. How does that impact your return? Maybe that will turn a negative return decision into a positive one.

Summary

As you can see, the worksheet is a tool to help you make smart decision. It’s easy to decide you need to buy a house for personal reason, but there are many unforeseen cost and benefits to your personal finance you need to consider. I hope this helps give you the incentive to do more research and make the financially beneficial decision for your family.

Still have questions about how to use the worksheet properly? Have suggestions to make it better? Leave your comments below.