The National Association of Realtors estimates that nearly one in four homes bought in 2004 was an investment, not a primary residence. That's got me concerned. If you're thinking of investing—with an eye on a flip—make sure you understand the risks.
Markets don't always go up. Having a short-term sell-by date makes it more likely that you'll be caught in a flat cycle. And buying into a market that's been on fire increases the risk of burnout. As everybody knows, the surest way to make money on any kind of investment is to buy low and sell high.
Rents aren't guaranteed. If you need to collect rent to pay the mortgage, what happens when your tenant flakes out on his check? What if the place is vacant between renters? If you don't have an eight-month emergency fund to cover your mortgage payments, you have no business getting into the real-estate investment game.
Being a landlord takes time and money. Whether you replace the roof tiles and fix the dishwasher yourself or hire someone to handle upkeep, property is never easy to maintain. If your life is already jam-packed with career and carpools, think twice before adding demands to your schedule.
Let's review what kind of real-estate investment makes complete sense: owning a home you intend to live in for at least five years. There is absolutely no guarantee that real estate will do well every single year. Nor is it unreasonable to assume that values could tread water or even fall. It's happened before, and it'll happen again. That's not bad news, just rational thinking. Long-term, you should be happy if your home appreciates at an average rate of 4 percent annually.
Also remember that, when you bought, there were transaction costs and, when you sell, you'll typically have to pay 6 percent to your broker. So if you flip a property that has appreciated less than those costs, you'll lose money on the deal. And don't tell me you're sure your house is going to appreciate 20 percent. There are absolutely no guarantees over the short term, my friend.
Now, if you do have a long-term horizon, buying real estate could be very smart. Stick to a mortgage you can afford, and you'll build valuable equity. Graduating from renter to owner also earns great emotional rewards—not to mention a major break on your federal tax return, because interest payments on your mortgage are deductible, as are local property taxes. Moreover, when you sell a place you've lived in for two of the past five years, you won't pay a penny of tax on the first $250,000 of gains. (That's the difference between what you paid and what you sold for, adjusted to reflect capital improvements such as a new bathroom.) If you're married and file a joint return, your capital-gains exclusion rises to $500,000.
Take an Interest in Rates | Protect the Money You've Made