Episode 16
LET'S TALK ABOUT HOUSING! WHAT YOU SHOULD KNOW BEFORE YOU PURCHASE A HOME
Episode Description
In episode #16 of The Big Bo $how, Big Bo (a.k.a. Jason Blumstein, CFA®, the CEO & Founder of Julius Wealth Advisors) discusses housing and home ownership. Including, the information you should know before you buy a home. The $how takes a deep dive into:
Why owning your home is NOT an investment
Helpful math to consider when deciding to buy vs. rent a home
People you should have in your corner during the home-buying process
Bo Knows Housing!
Hope you enjoy the $how!
Episode 16 Key Takeaways:
00:00 - Should you look at your home as an investment?
2:47 - How does the U.S. housing market actually work?
05:11 - Investing in the U.S. housing market vs. the S&P 500: A $26 million difference.
09:54 - Why the stock market is no more volatile than the housing market.
11:00 - The pros and cons of owning vs. renting.
14:10 - The boom-or-bust nature of leverage in home ownership.
16:19 - Should you rent or buy? Breaking down the numbers to help you decide.
24:29 - The 3 steps all home buyers should take before making a final purchasing decision.
29:33 - An objective wealth advisor's crucial role in choosing your housing situation.
Episode Transcript
All right, let's get after sweet episode 16 of The Big Bo $how It's springtime. We're sitting here in the middle of April, spring has sprung. You see, growing up in south Florida had no clue what seasons were. My dad, who was from New York and from the northeast, knew about seasons. But me being born and raised in South Florida, I had no clue. He only tells me, Florida has three seasons. Hot, hotter, and beeping Hot. Spring has become my favorite season. Why? Because it's the start of baseball season. Flowers are starting to blossom, birds are chirping, and finally we have some more weather. This springtime just gets me in a good mood. Spring also tends to be the start of what is known as housing season or home buying season, which is often a new process for many. And I've also found that when I talk with people about housing, there's a lot of misperceptions.
There's a lot of ambiguity. Unfortunately, it seems like many people go through this process blind due to the lack of financial literacy in this country. So I thought it would be very timely as we enter the home buying season with the springtime to talk about housing. So let's talk about housing. One of the biggest misperceptions that I've often heard about housing is that housing is often regarded as the best investment. A can't miss investment. So of course, I need to buy a home. Everybody always gets spoon fed from their young ages. Owning a home is quote unquote the American dream. But whenever someone tells me what, I always like to dig a little deeper and understand the why behind the what. So let's take a couple moments here to understand how the US housing market actually works. The first thing that I think many people do understand is that the US housing market, about 50% of it, and this is data from 2021, about 50% of the housing market is actually backed and owned by government sponsored entities in Fannie Mae and Freddie Mac.
So of course the US government with its government sponsored entities in Fannie Mae and Freddie Mac is going to tell you about how housing is the American dream because they essentially subsidize half of the housing market. The next player in this whole housing market are banks and lenders and banks and lenders. While you might go to a bank or a mortgage company to get your mortgage or get a loan, they are not typically the company, the people that actually hold your loan, typically within a week or so after you close on your mortgage, they will sell your mortgage to somebody else, whether that be the government, whether that be another private party who will then chop up your loan and securitize this. Now we, a lot of, a lot of people have learned about this a little bit during the housing crisis, but this is essentially how the housing market works.
You no longer get your money from somebody who then has your loan and then he can talk to the person who's actually lending you the money after you get your money. It's typically sold either to Fannie or Freddy or package to someone else in the types of securitized products. Chopped up, sold around, buttoned, sold many different times in the, in the form of a mortgage backed securities. So who owns your mortgage? Good luck trying to figure that out. Now, where the banks still operate, when you send your money every single month in the form of a mortgage to your, to a bank or to your mortgage company, they are collecting what's called a servicing fee. They simply collect your payment and send it to the end party that actually owns your mortgage. And they collect very lucrative, very lucrative servicing fees to simply collect your money, send it to somebody else, not a very tough process.
So of course, banks are also incentivized to tell you how housing is the quote unquote American dream. But let's check the numbers, right? As I always tell people, numbers don't lie. People do. Often when I'm talking with people, they think the first thing they need to do when they start to create wealth is to buy a home and they think it's an investment. And I'm not saying that you should never buy a home, which will get into more info a little bit later in the show. But I do not think you should think of your home as an investment because if you're comparing it to an investment, you have to then compare any investment to any alternative investments and where's the best potential return that you can get. Now let's compare. If you look at the data, and this is data that I pulled from the Federal Reserve economic data.
So this is government data going back to 1964 all the way back to 1964, which is the latest data they published. The first information I'll provide you is what was inflation from 1964 through 2022, the end of last year. Inflation during this time period averaged about 3.9%. Again, from 1964 through 2022, US housing, the national average increase was about 5.9% per year, or about 2% more than inflation. So you're increasing your real wealth. Again, your real wealth increases what you're increasing over inflation or purchasing power. You're increasing your real wealth by about 2% per year owning housing. So you might say, well, that's not that bad. At least I'm increasing my real wealth. Let's check some more numbers. Another alternative is just owning some of the biggest US businesses. And by that I mean the S&P 500. So the S&P 500, which represents 500 of some of the largest US businesses, which is another alternative someone could have put their money in during this time period from 1964 to 2022, the S&P 500 increased by an average of 11.3% per year.
So this number 11.3% is 5.4% greater than US housing and 7.4% greater than inflation. While these numbers seem small, the other thing I always talk to people about is a miracle of compounding because when you hear a number like, oh, it's only 2% greater than inflation, oh S&P 500 is only 5.4% greater than housing, these numbers seem small on the surface potentially, cuz you're only looking at, oh, it's just one year. But let's extrapolate this from that time period from 1964 to 2022, given the miracle of compounding. So just to put this into perspective for you, if you had a hundred thousand dollars in 1964, the equivalent of a hundred thousand dollars at the end of 2022 on an inflation adjusted basis, that's simply taking the a hundred thousand dollars and compounding it by inflation through 2022, the equivalent would be about $942,000 or about 9.4 times greater.
US housing a hundred thousand dollars in 1964 would be worth about 2.7 million. You would've increased your money by about 27 times, not, or you would've had about, made about a real return of about 1.8 million greater than inflation. So you increase your wealth. So now let's look at the S&P 500. So the same hundred thousand dollars in the S&P 500, compounded at the 11.3% rate that we discussed earlier, would be worth $27.3 million or about $26 million more than having a home that you bought for a hundred thousand dollars and then sold at the end of 2022. So there you see the miracle of compounding. And then when you, when people say, oh, housing is the best investment and it's the safest investment, well, let's look at the numbers. Would you have rather had 2.7 million or 27.3 million? I think we all know the answer to that.
The other thing people think about when they, when they say housing is safe, and it's one of the best investments, I think a lot of times people, this is one of the things I talk to people about a lot, about how your mindset gets in your way. A lot of times because when people see the stock market or the S&P 500 or in investments that are traded on a public exchange go up and down every single day, they say, oh the, it's so risky, it's so volatile. And I always tell people, well, if your house was traded on an exchange, if you were able to buy or sell your house on a liquid exchange that trades every single day between nine 30 and four, you would see very similar volatility. The pro of publicly traded equities being liquid that you can buy or sell them any single second when the market's open, tends to be a con in people's eyes when they think that one is riskier than the other.
Well, your house, it's not liquid. That's why it doesn't look as volatile. Pros and cons. And this dovetails into the next piece of the pros and cons on housing. Now, one of the alternatives to buying a home is renting a home. And I think renting a home gets a very bad reputation. Again, a lot of that reputation, that bad reputation in my mind comes from this marketing that's perpetrated into our brains from a young age that the American dream is owning a home. And I just gave you some reasons earlier of why I think this gets into our psyche as Americans. But let's look at some of the real costs and the pros and cons of renting versus owning. If you rent a home, there's pretty simply two costs. You know your rent and you're gonna have to probably pay your utilities. When you own a home, you have to pay your mortgage, you have your real estate taxes, which on average, according to the USA today, on average, people's real estate taxes are 1.1% of the price of their home.
And this is a constant cost that doesn't go into increasing the value of your home. It's just a cost of doing business to have the luxury, quite unquote, of owning a home. And this is a variable cause you don't, your real estate taxes can go up every single year. The other thing you're gonna need is homeowner's insurance. And your homeowner's insurance is probably gonna be another, let's just say 0.25% of the cost of your home every single year. And don't forget, you gotta then maintain your home, whether it be something breaks in your home, your refrigerator, your roof, your air conditioning, your heater, that's all you outta your own pocket. So should you buy or should you rent? Let's try to summarize some of the pros and cons of each. When you rent a home, you have the flexibility to move whenever you want without a penalty after your lease sends.
And maybe sometimes if you talk to your landlord, you can get out of it early. You have a consistent monthly payment. Anytime something breaks in your home, the landlord is going to cover it. The major con of renting is that your landlord could then raise your rent at the end of your lease, or the landlord could then decide to sell your property or potentially not rent it back to you, and then you better look for another place to rent. So there's a little bit less stability of where you know you're gonna live and in the proper neighborhood that maybe you want to raise your kids in. Now, the pros and cons of owning a home, the con of renting is the pro of owning a home. It provides a sense of stability and a sense of community. It also helps you build equity into your home.
And we'll get into this equation a little bit more later on in the show. The con is that you have to pay for all repairs. Again, anything breaks that's on you. Housing also takes on a lot of financial leverage. If you buy a home that's, let's just say a million dollars and you put 20% down, you are taking on leverage almost five times. Leverage a million dollar home, $200,000 in equity, a million to divide by 200 is five. So you're taking on a lot of leverage and we saw the cons of leverage during the financial crisis. The other piece, which could be a pro or a con, which goes into the point of financial leverage, is the potential upside or downside. So the price of housing goes up and you're levered. That's a pro. If the price of housing goes down and you're levered, that's a con. Leverage works well on the upside, but works terribly on the downside. So those are the pros and the cons of renting and owning a home. And we're gonna take a quick break, but when we get back, we're gonna try to break down a helpful equation that you can use in your decision to either buy a home or rent a home.
All right, welcome back. So let's go into a helpful equation that I typically lay out and walk clients through here at Julius Wealth Advisors that I think could be helpful as you start to make the decision as we're in the home buying season of, does it make sense to rent or buy? Well, there'll be a lot of numbers in this. I will try to go through this as efficiently and effectively as possible. So let's go through the equation on buying a home. And in this case, I'm gonna go through the equation of buying a million dollar home. So the first thing you need to do when you buy a home is you need to come up with a down payment. Typically, you need to come up with a 20% down payment. So if you're buying a million dollar home, you need a 20% down payment, you need to put down $200,000, which then means you need someone to loan you $800,000 to get to that million dollar purchase price.
The first thing you need to look at is interest rates. A lot of people have been talking about interest rates in the past year with the Fed raising interest rates and especially mortgage rates have been going up. So I'm gonna use in this equation an interest rate that I've seen a lot recently, currently of about 6%. So if you have an $800,000 loan and a 6% interest rate on a 30 year mortgage, your monthly payment will be about $4,800 a month, $4,796 to be exact, leaving your annual mortgage payment or that $4,800 times 12 at about $57,500 for the year. Now don't forget, you also have to now add in real estate taxes, which I said before on the national average is about 1.1%. You have to check your local area. This is just a national average in some areas that might be higher, like I know where I live in New Jersey, some of the highest real estate taxes in the country, they're a lot higher than this 1.1% number.
But for this equation, I'll use this 1.1% number, which 1.1% of a million dollars is $11,000. Then as I stated, you need to add in the fact that you're gonna have homeowner's insurance and that from what I've seen, is typically about 0.25% of the value of your home. So in this case, it'll be about $2,500. Now we're up to about $71,000 in annual payment. But wait, there's more. Now, one of the other benefits of owning a home, and I will preface all this, is that I am not an accountant, and this is not tax advice, check with your local tax professional. But one of the benefits of owning a home is that you have the ability to write off some real estate taxes and mortgage interest. However, after the 2017 tax cut and Jobs act, a lot of these benefits were greatly diminished, mainly being what's called salt or state and local taxes, where you used to be able to write off all of your state in local taxes.
So your state taxes and your local taxes, which are typically your real estate taxes, used to be unlimited. Now that's capped at $10,000. So in this equation, if your real estate taxes were $11,000, you would only be able to write off $10,000 of that and then none of your state taxes. So again, cap that 10,000. Also in this tax cut and jobs act, it limited mortgage interest write offs to the first $750,000 of your mortgage. So again, in this equation where in this case the mortgage is $800,000, $50,000 of that would not be able to be written off in the terms of the mortgage interest. In this equation, you would probably have roughly $30,000 roughly of interest and thousand dollars of state and local taxes gets you to $40,000. Then you have to understand what your marginal tax rate is, because the benefit is whatever your marginal tax rate is.
So in this case, let's assume it's a 35% marginal tax rate. So 35% marginal tax rate will get you about a $14,000 benefit. So it would take the 71,000, you subtract 14 from it, and you're down to about $57,000 in total payments. So this $57,000 roughly of total payments on your mortgage, your real estate taxes, your homeowner's insurance, and then the benefit of tax deductions would be the equivalent of paying about $4,750 per month in rent. So now we can make an apples to apples comparison. So if there's a home in that market that you can rent for $4,750 less, or maybe it's more, now you're starting to make an apples to apples comparison at least on a financial decision. And now you might be saying, well Jason, what about building equity in my home? We have to understand the concept of an amortization schedule because when you're paying your mortgage, and in this case this roughly $4,800 a month, a portion of that is going to pay your interest, and then a portion of that is going to pay the principle of your loan and to build equity in your home.
However, the way an amortization schedule works is that the bank or the person who's loaning you the money is gonna want their interest first. So if you look at the amortization schedule, typically in most to all cases you are paying the vast majority of your first year's payments of your mortgage are going to pay your interest. It's not going to pay down your loan. If you look at the amortization schedule of this particular loan is a $1 million loan, and in this equation roughly only 11% of your total annual payments of about $57,500 for your mortgage, about 11% of that is going to pay down your loan. Hopefully, this equation gave you a way to think about an apples to apples way of comparing the price of your home and the price of renting. The other things again that we have to consider that we did not talk about in this equation are maintenance costs.
Again, if your refrigerator breaks or a pipe breaks in your home, who's fixing it? If you rent it, the landlord, if it's your home, it's you. And for me, I usually use a proxy of anywhere between one to three to one per four, 4% of the price of your home. You're probably gonna have to put in maintenance every single year. So hopefully this was a helpful way for you to think about the buy versus rent equation. And again, we're gonna take a quick break and then when we get back, I'm gonna talk about some helpful tips to learn about if you decide to purchase a home.
All right, welcome back to a Bo Know$ segment on housing. Bo Know$ housing. Now, I'm not gonna make a prediction on this segment. I'm gonna go into some real life examples that I've seen, whether working with clients or in my own experiences of owning a home. Now, things that you should look for if you've now made the decision, if you run the numbers and you think it makes financial sense to own your home. Now the first thing that I would tell you that you need to consider is to read your contract and read it again, and not only read your contract, but get a competent real estate lawyer who can help ensure that everything that you are going to sign is in your best interest. Because I don't want to knock real estate agents out there. There are good ones, but the fact of the matter is the way that real estate agents are incentivized, they are incentivized to sell you the home.
That's typically the only way they get paid. If they're telling you to sign something, sign this, sign that. Take a step back. In my opinion, get a competent real estate attorney in your corner that can help you out and read everything that you're about to sign and make sure that it's in your best interest. I've seen people leave stuff out that potentially could have cost them hundreds of thousands of dollars in the process with a competent person in their corner that was able to put those clauses back into contracts to prevent them from losing out on hundreds of thousands of dollars. Step number two, get an inspection. Hire a highly competent inspector for your home. Now, in this, I'll share a personal example. When I graduated college, I bought my first apartment. When I bought this apartment, I just took the recommendation of an inspector that the real estate agent gave me.
I was young, I was in my mid twenties and took this inspector. The inspector came during his inspection. I went to turn on the water to see if there was a hot, there's hot water, no hot water was coming out. The inspector said, don't worry about that, I'll do the inspection. He did the inspection, signed off on everything, everything looked ao, okay, closing the house. First day I move in, I go to take a shower. I'm waiting for it to get hot, waiting five minutes, 10 minutes, 20 minutes. Water's not getting hot. I figure at this point the water's not getting hot. So I go to search around and look, well, what may be the issue? And I go and I look at the hot water heater and there's no electrical circuit going into the water heater. All you had to do is, look, I had to open the door and look.
And the inspector didn't even do this. And it ended up costing me about $5,000 to replace this, and this was all out of my pocket. Fast forward to when I bought my current home that I'm living in. Like I tell people, it's okay in life to make mistakes as long as we learn from them. So I went and I found the most competent home inspector that I could find, did a bouncer research, paid more money than others, and asked to find the person that was highly vetted to be the best. And this guy came out, he did a two or three hour inspection. Everyone's like, nobody takes this long, but it didn't matter. He wasn't charging me per hour, he was charging me a flat rate. So who cares how long it took him and what did he do? He found about $20,000 worth of issues in my home that I eventually got taken off the purchase price of.
Now, that's huge. All this goes into the fact that the third thing that you should do is get all the right people in your corner. There's a lot of people that you're going to need in this process of buying a home to have it go as smoothly as possible. And I say as possible because there's always gonna be something that doesn't make you go a hundred percent smoothly. That's just life. So you're gonna need a highly competent real estate agent, someone that knows the local market. You're going to need a highly competent mortgage banker. Someone again, who knows the local market. You're gonna need a highly competent real estate lawyer. Again, someone who understands the local market, understands the state laws, and has them in your corner before you even try to sign any document. A great inspector, a great inspector, can actually save you a lot of money.
And the other person I would argue is a good wealth advisor that objectively looks at everything for you. Not only who's able to do this equation of does it make sense for you to buy a home or to rent for you, not what everyone's tries to spew at you as owning a home as the American dream. Is it right for you to know your income, know your balance sheet, know your psychology, know what your goals are? Great. Now we made the decision, well, is the real estate agent gonna look out for your best interests? I'm not gonna say they're not, but I will tell you they're not incentivized to. Is the mortgage banker gonna look out for your best interest? Again, I'm not gonna say they're not, but they only get paid if the mortgage closes. So who are the right people that someone can get the right people in the corner for you?
This wealth advisor should be acting as your quarterback, if you will, to get the right people in your corner, which is something that we do for clients. Again, here are Julius Wealth Advisors. You need that objective opinion, someone that can look out for things for you and has your best interest at heart. So I'm gonna wrap this up on episode 16 of The Big Bo $how Let's talk housing. I hope you learned a few key lessons here. Number one, why housing shouldn't be looked at as a quote unquote investment. Even though people tell you, home ownership is the American dream, a helpful equation for you to use to make a decision to either buy or rent a home, and helpful Bo Know$ pro tips on what you need once you decide and people you need in your corner, once you buy a home. With that, welcome to spring. Welcome to home ownership or renting, whichever makes sense for you. But once you're in your home and it's springtime, invite people over for a nice summertime, barbecue with some beers, smoke some brisket, and watch some baseball. And until next time, as I end every show, always remember to live a life of integrity, a life of knowledge, obtaining as much knowledge as you can, and always live a life that you're passionate about. All the best. Until next time.
Disclosure:
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