Pinning Down Your Equity
For most people, buying a second home is often a great place to retire or take vacations, but there can be other significant benefits such as growing your equity over time That is a sweet deal simply because property is one such asset that will never get up and walk away. While these statements may be true, buying a second home may not turn out to be the best investment for everyone.
Although such a purchase could earn you long-term equity, you might be better off buying rental properties or even investing in a well-managed syndicate or real estate investment trust (REIT). One of the most unappealing aspects of buying a second home is that it doesn’t pay dividends, interest or other net rental income.
Think Carefully About A Second Home
You have to pay money in maintenance, renovations, taxes and insurance, and let’s not forget those mortgage payments. So you’re anticipating that the property will be worth a lot more in a few years to compensate for these negative cash flows, but you are covering them at the moment by taking from your other financial assets such as mutual funds, stocks and bonds, which are either less expensive to hold and produce income or likely grow equally fast, or both.
And if you really give it a second thought, your financial assets were earning you interest and dividends, weren’t they? So instead of earning a minimum of five to seven percent annually on a well-managed pool of assets, you have a property that’s not bringing in the cash also known as the “The Lost Opportunity Cost of Capital”.
Investment Property Math
Over a period of years, all those negative cash flows and the lost opportunity to earn dividends and interests on your financial assets are going to add up. Take for example a $250,000 property, where you spend $25,000 annually to maintain it. The missed opportunity could be over a million in financial assets that you could’ve accumulated after a period of twenty years. But if you’re in luck and the home does happen to go up by eight or nine percent for those twenty years for a total value of $1.25 million, you might break even, if you are lucky!
But keep in mind and according to current real estate trends, property tends to appreciate at approximately four percent over long periods of time. So if you’re buying a second home with the goal to earn wealth, you may very well be successful.
It is however important to note that there are other high quality investments that may be worth exploring. If it is for the enjoyment it may be the finest way to spend your earnings. However, you should really give it a fair bit of thought first, especially if you’re investing in a second property in the hopes that will earn you a sizable return in a few years.