It’s a common misconception that you ought to own your own home before buying investment properties. Also, the information really shows that previously, living the “American Dream” meant homeownership and a nice car or two in the driveway. However, changing ideas, modern lifestyle preferences, and even a renewed unwillingness to commute to work have gained significant shifts in rental real estate investing.
Contingent upon where you reside and your desired standard of living, it may make more sense to rent your home while you build an investment portfolio. To determine whether you should rent or buy your primary residence, you can (and have to) utilize what’s known as the 5% rule.
The 5% Rule
The 5% rule is a simple methodology to discover if it costs more to buy or rent a home. On the renting side, assessing your cost is not difficult: it’s the amount you pay in rent every month. On the homeownership side, however, things are somewhat more challenging. The costs of owning a residential property entail more than just your mortgage payment. This is where the 5% figure comes into play. It is a way to compare the cost of renting to owning a home more accurately.
How It Works
The three main components of the 5% rule include property tax, maintenance costs, and the cost of capital. These are costs that homeowners spend, and renters do not. Let’s break down each one:
- Property tax. Using this easy technique, the cost of property tax would be roughly equal to 1% of the home’s value.
- Maintenance costs. Routine maintenance and repairs are also something homeowners pay for more often than renters do. Such as property tax, this category is also expected to be roughly 1% of the house’s value.
- Cost of capital. The cost of capital makes up the remaining 3% of the 5% rule. In basic terms, the cost of capital is what you could be making with the money tied up in your home (usually in the form of a down payment) if it was invested into another form, such as an investment property or the stock market. It’s a cost because of the interest you pay on your mortgage, often around 3%.
Applying the 5% rule would seem like this:
- Multiply the value of the property you own/want to get by 5%.
- Divide by 12 (to get a monthly amount).
- If the resulting amount is more than you would spend to rent an equivalent property, renting your home and investing your money in rental properties might seem reasonable.
Why You Should Use It
Although the 5% rule is an oversimplified way to compare the costs of renting with homeownership, it can be a great tool for rental real estate investors. Besides the fact that you can utilize it to make personal decisions regarding your personal residence, if you own rental properties in areas where the cost of living is high, you could also teach it to your tenants to assist them in understanding the benefits of staying in your rental home longer. In markets where property values are very high, this tool might wind up being a crucial resource as you make all future real estate investments.
Are you determined to make your next move as a rental real estate investor? Our San Antonio property managers can help! Contact us online for more information on finding and evaluating investment properties.
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