Las Vegas, Denver and Charlotte, in this order, offer sellers the highest rate of return, according to the financial services robo-adviser Betterment. And, in all three of these cities, Betterment has determined that it’s cheaper to own a home than to rent one.
With an average rate of annual internal return of 13.29%, Las Vegas has the highest Internal Rate of Return (IRR) among 13 major cities analyzed by this robo-adviser business. (An IRR is an investment’s return based upon related cash flow over time. This cash flow includes the cost a homeowner pays each year to live and maintain the property.)
According to Nick Holeman, a certified financial advisor with Betterment, “Some of the cities with the highest real estate appreciation have the lowest IRR from a homeownership perspective.” Holeman believes that the biggest factor in an investment’s rate of return is the cost of owning the home compared to the cost of renting the home.
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A realistic expectation of an average rate of return on housing turns out to be approximately 8.6%-10%, similar to a realistic expectation of investing in stocks, according to Betterment. Holeman said, “People view homeownership as a magical investment and a way to build wealth. The research shows (homeownership) can be a way to build wealth but it’s no better historically than stock market returns.”
The catch with homeownership and home price appreciation is tenure. The longer homeowners stay put in the same home, the greater the rewards. As just one example, it takes approximately four years to break even on upfront closing costs that can range between 2%-5% of the purchase price of the home. Another example is the yearly cost of “regular” repairs that amount to 1% of the home’s purchase price.
Other costs of homeownership include yearly property taxes to the tune of a median amount of $2,709/year. And remember that 2017’s Tax Cuts and Jobs Act limited tax relief to $10,000 for state and local taxes as well as property taxes. (According to July 25, 2019 IRS data, just 6.18M deducted personal property taxes for the 2018 year whereas 17.6M returns took the “unlimited” property tax deductions for the 2017 tax year.)
Holeman crafted a checklist for potential homebuyers to help protect their IRR:
- Purchase with intentions of staying long-term. The National Association of REALTORS® indicates that home tenure is now approaching 8.5-9 years.
- Remember the costs of homeownership…utilities expenses, property taxes, homeowner’s insurance, repairs and maintenance.
- Treat buying a house as an investment. As with all investments, doing your due diligence on the specific property, the specific neighborhood in which that house lives and the specific area in which that neighborhood is located is essential. And, to reiterate, be aware of homeownership expenses over the long-term.