Real estate is supposed to rival gold as one of the safest investments you can make. As the late rancher (and multimillionaire) Roy Rogers put it, "Buy land. They ain't making any more of the stuff."
SEE: Exploring Real Estate Investments
So why does a brief observation of the housing market tell us otherwise? Foreclosure, subprime loans, predatory lending, defaults, homeowner assistance … all these terms have become part of the national lexicon in the last few years, leading the easily intimidated to think that it's impossible to ever build wealth (or at least not lose it) via real estate. Like most things in life that come with a reward, successful real estate transactions require diligence and discipline. They also require you to steer clear of some easily avoidable pitfalls.
Get Emotionally Involved With a Property
You say you "fell in love with" that custom-built 1960s-era, two-bedroom bungalow with the trellis and the orange trees? Good for you. Make sure you let the seller know that, so he can raise his price accordingly. Because monopoly power is a wonderful thing to give to the person you're doing business with. Also, don't think about resale value. The more tailored a piece of real estate is for you, the less appeal it'll have to the public at large. If you ever want to sell it, you will have fewer potential buyers.
When you start thinking in non-financial terms, you're already losing. Yes, a house has benefits (and drawbacks) beyond its price. That's not the point. The point is that every transaction involves tradeoffs, and a slightly less desirable house at a far more agreeable price can make the difference between building wealth and overextending yourself.
You fall in love with people, maybe pets. Which is to say, beings that don't come with inherent economic potential. Real estate is for investing in, not for having an irrational attachment to.
Buy the Pick of the Litter
The neighborhood is so-so, but the house in question is radiant. It's twice as big as any other on the block, with decorative water fountains and a regulation basketball court to boot. It stands to reason that such a house will make a better investment over the crumbling shacks adjacent to it, right?
It won't. You might not like this reality, but a house's surroundings have as big an impact on its value as the house itself. The most modest single-family home in Chicago's Gold Coast will appreciate far more than a palace in Hunters Point, San Francisco.
Remember, sticker price is everything
A $100,000 house beats a $110,000 house every time, right? How couldn't it?
Interest rates, for one thing. Remember, a typical real estate transaction is different than buying an everyday item. When you purchase real estate, you're not trading a flat sum of your money for a good or service. You're trading what's essentially a reverse annuity (from the seller's perspective) for land and any improvements. That "annuity" – monthly or semimonthly payments from you – is subject to several variables.
Shopping around for a favorable interest rate is at least as important as shopping around for a suitable price tag. Taking out a mortgage loan with a few basic points in your favor can put you in a considerably larger house than you might otherwise have budgeted for. (Or, if you prefer, keep you in a smaller house at a much lower payment.)
Put Down as Little as Possible, Preferably Nothing
Why should you have to delay your gratification? That's for suckers! You want what you want when you want it. Saving up 20% of the price of a house for a down payment could take years. Much better to obtain 100% financing, and pay private mortgage insurance until you've got 20% equity in the place. Which could take years, but what fun is it to buy real estate if you're not going to flush at least a little bit of money down the toilet in the process?
Never leave money on the table. By the same token, never spend money you don't need to. When you put nothing down, you're already overextending yourself. Putting anything less than 20% down requires you to take out extra mortgage insurance courtesy of the lender, which is the equivalent of undergoing a credit check that costs you hundreds if not thousands of dollars every year.
The Bottom Line
When you buy a house, you're buying it all: not just four walls and a roof, but decades' worth of mortgage interest and possibly, mortgage insurance. It's helpful to think of the entire purchase as one item, and understand that a $100,000 house can end up costing you over $190,000 among principal, interest and insurance - to say nothing of taxes.
Understand that a desirable property has financial potential. Most people who switch houses, whether they're trading up or trading down, never think to keep the original house and rent it out. "That's unrealistic. I need the cash to buy the new place." What if you rented it out for a premium, and used the difference between the rent charge and the mortgage payment to pay for part of the new house? Or perhaps you could engineer a lease option, whereby a renter can choose to purchase the house after a fixed period if he has the wherewithal?
Yes, a house is a home. But you're missing out if you see it as nothing but. Real estate is a financial instrument that, under the right conditions, can help you generate lasting wealth.
Home & AutoNot all renovations are created equal. Here are five that are most likely to make a property appreciate (and be appreciated by househunters).
Personal FinanceWhat to look for in a box to protect your irreplaceable belongings.
Mutual Funds & ETFsGet information about some of the most popular and best-performing mutual funds that are focused on commodity-related investments.
Mutual Funds & ETFsLearn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
Personal FinanceA look into the high, high, high end of New York City real estate.
Mutual Funds & ETFsRead about four of the best global real estate mutual funds, which invest in the securities of real estate companies or real estate investment trusts (REITs).
Stock AnalysisUnderstand the online real estate industry and how Zillow and Trulia are industry leaders. Learn about alternatives to Zillow and Trulia.
InvestingCommodity prices have been heading lower for more than four years, being the worst performing asset class of 2015 with more losses in cyclical commodities.
Home & AutoGoing in with friends to buy a vacation home will save you on the mortgage and expenses. But if there's conflict, it could end up costing your more.
Investing BasicsBuying a beach house or big-city pied-à-terre with friends can save money and make sense, but only if you set it up right. Here's how to avoid trouble. thoroughly research and discuss potential ...
Generally, penny stocks are traded through the use of the Over the Counter Bulletin Board (OTCBB) and through pink sheets. ... Read Full Answer >>
Some penny stocks, those using the definition of trading for less than $5 per share, are traded on regular exchanges such ... Read Full Answer >>
The price of an American depositary receipt (ADR) is determined by the bank or other financial institution that issues it. ... Read Full Answer >>
American depositary receipts (ADRs) are bought and sold on regular U.S. stock exchanges, either in the over-the-counter market ... Read Full Answer >>
While regular funds from operations measures the cash flow generated by the operations of a real estate investment trust ... Read Full Answer >>
Typical leasehold improvements include partitioning a large, open space into smaller, more structured areas such as dressing ... Read Full Answer >>