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Is a personal residence an investment?

Published: Monday, Oct. 29, 2012 8:28 a.m. CDT

If you’re going to use your hard-earned money to buy a home, you might wonder if that home is an investment. And without doubt, for the vast majority of buyers, a home is an investment.

However, just because it IS an investment doesn’t mean the house you’re interested in purchasing is a good investment — an asset. It could be a really bad investment — a liability. That’s what you should try to determine before you make the decision on whether to buy property.

What is an investment?

When you buy a home, you’re taking down payment money from your financial assets (bank account, mutual funds, stocks, bonds) where you’re earning a rate of return on your money. If you’re going to take the cash from your financial assets and invest it into another asset — a home — where you’re taking risk, and in this purchase you hope it will go up in value, then it’s an investment.

The definition of investment is “taking risk with capital in expectation of earning a profit.” Think about this: If you were guaranteed the house would go down in value, would you buy it? No, you’d rent someone else’s house and leave your money in financial assets that would better improve your wealth.

So, because you’re taking risk, and you’re expecting it to go up in value, there’s no doubt, a personal residence is an investment.

What is a good investment?

Over time, most real estate should appreciate in value, which will cause you to earn wealth from your gained equity. And that’s a good thing. However, could you have done much better financially by taking another course of action, or purchasing a different home?

For a good personal residence investment, the most important factor is that you own the property for a long time. Short-term ownership, with transaction and other costs, rarely adds net wealth to your financial picture. So go long, and that’s a minimum of five years! If you’re not 99 percent positive you will own the property for at least that long, skip it and stay a renter. You’ll most likely be better off financially.

You should also buy a property that is in good physical shape, with a fixed-rate mortgage and a homeowners association in good financial, legal and operational shape (if the property is in a common interest development). Keeping the proper type and amount of insurance in place is vital, and of course make sure to verify that there are no title issues — before you close escrow.

Oh, and don’t forget to make sure you can comfortably afford the payments — if you cannot, it’s going to end up a liability.

What is a bad investment?

Bad investments are ones where the probability of the residence adding to your net wealth is low. Examples include fixer-uppers and prize properties, which cost significantly more to own than a similar property would cost to rent; condominiums with HOAs that are a disaster; or any funky real estate purchase or personal residence investment that may have extreme financial risk issues (rent-to-own, wrap-around mortgages, short-term financing, etc.).

Real estate, every parcel, is extremely high risk — whether the condition, the financial aspects of ownership or a myriad of other issues. Owning long term can compensate for many of these issues, but making smart choices upfront is the way to reduce or mitigate the chances of making a bad investment.

As we all know, real estate is “buyer beware,” so try to know what to “beware of” before you buy, and hopefully the home you purchase will be a net addition to your wealth.

Related:

Leonard Baron is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches potential real estate buyers how to make smart and safe purchase decisions. He is a San Diego State University lecturer, blogs at Zillow.com and loves kicking the tires of a good piece of dirt! More at ProfessorBaron.com.

Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.

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