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Homeownership is a key characteristic of the “American dream.” There’s good reason for that – owning a home has proven to be an important driver of wealth accumulation over the long-term (dig back into history, in addition to freedom, most people came to America to build wealth!). More recently, homeownership has become a popular way to take advantage of rapidly increasing home prices. Long-term or short-term, the housing market is one way to diversify your investment portfolio.

Building Wealth Through Homeownership

Let’s be honest, a house is going to be one of the most expensive purchases you make in your lifetime. Between the down payment, the monthly mortgage payment, taxes, insurance, utilities, and maintenance, it’s a serious financial commitment. While browsing online listings and visiting open houses on the weekend can be fun, you’re going to want to be sure taking the plunge is worth it before you get serious about finding your dream home.

Don’t worry, there’s data that backs-up the impact of owning a home on wealth. The median household wealth of U.S. homeowners is $231,420, according to the Federal Reserve’s Survey of Consumer Finances, published in 2017. That is 44 times higher than the average renter who has a household wealth of merely $5,200.

Adding homeowner to your resume can improve your net worth in a few ways: through growing ownership equity (the difference between what you owe on your mortgage and what your home is worth), home price appreciation, and income tax benefits. In essence, buying a home is a way to force yourself to save. Part of each mortgage payment goes to pay down the principal balance, which can result in increased equity in your house. The benefit of owning your home is that it’s an asset that can potentially appreciate, unlike renting where your lease payments are forever gone.

Home price appreciation over time is another way to increase net worth. According to historical data from the National Association of Realtors, the price of an existing single-family home in the U.S. increased 63% from December 2009 to December 2019. While you might be able to make higher returns investing in the stock market, the returns realized from home ownership tend to grow at a more stable pace and with less volatility. Homeownership is a great way to diversify your investments, a key tenet of diversification.

There can be tax advantages that come with homeownership as well. In some cases, interest paid on a mortgage, property taxes, and private mortgage insurance (PMI) can be deducted from your tax liability to reduce your tax liability. Talk with a tax professional that you trust to understand the tax benefits of homeownership.

Flip or Flop? Rental Homes and Flipping Houses

Millennials are coming of age, and demand for homes has increased. These trends, along with the popularity of Airbnb and TV shows like “Flip or Flop” and “Fixer Upper” have helped fuel interest in purchasing homes to generate rental income and/or renovating homes for profit (“flipping”). Interesting stat: The number of homes flipped in 2019 represented 6.2% of all homes sold that year in the U.S., an 8-year high, according to the 2019 U.S. Home Flipping Report published in ATTOM Data Solutions.

I think many of us would agree that flipping homes for resale and owning rental homes can be considered a business. Getting a business off the ground and to a point where it’s profitable requires upfront research and careful planning. And just like any other business, there are risks and rewards that must be considered when it comes to flipping and renting homes.

For example, the most compelling advantage to renting out a house or even a room in your house is the potential to earn income you generate from it. On top of that, you could potentially still receive many of the benefits discussed above related to wealth generation, because rental homes are still long-term investments. Likewise, an attractive benefit of flipping a house is the potential opportunity to sell it for a profit over what was originally paid for the house and the total cost of the renovation.

It’s important to keep in mind that the above are best case scenarios. When considering investing your hard-earned money, you’ll need to also consider all the potential risks associated with rental and flipping homes.  There are several costs associated with owning a rental home and flipping houses. The biggest are the upfront costs of a down payment and paying the monthly mortgage payment for a property that you don’t plan to live in.

If you own a rental home, the ideal outcome is to make enough rental income to cover the mortgage and other expenses. But there are some risks of being a landlord.  For example, keep in mind that if renters miss payments or if you don’t have a tenant for a period of time, then you have to be able to cover those mortgage payments by yourself.  Also note that you will have to pay taxes on the income (rent) received at the end of the year, and unexpected costs (like a damaged roof or water leak, etc.) will be the owner’s burden. The landlord is responsible for all maintenance and upkeep, and if you use a rental management service, that may cost 10% of the rental income plus the costs of any repairs. But once the mortgage is paid off, your rent becomes much more profitable. Another thing to consider is the type of insurance policy needed. Regularly renting out a vacation home or investment property, usually requires what is called a landlord or rental dwelling insurance policy. These policies generally cost about 25% more than a standard homeowner’s insurance policy.

In the case of flipping a home, you will have to factor in the expected renovation costs and be prepared for cost overruns. Financing the cost of the renovation will be the next big expense after purchasing the property. Will you do the work yourself or will you hire someone to do it for you? You should consider how long the renovation will take (because time is money), and whether the costs, when factored into the increased property value, will meet your expected return on investment. Flipping activity has been on the rise as its popularity continues to soar, but profit margins have been declining. Homes flipped in 2019 typically generated a 40.6% return on investment (“ROI”) with an average gross profit of $62,900 nationwide (the difference between the median sales price and the median paid by investors). That is a decline of 6% from the post-recession peak in 2017. Additionally, you should consider whether there are any tax implications associated with short-term ownership. When flipping, additional costs of staging, renovating, listing, and selling the home may apply as well.

Benefits to All Types of Homeownership

Renovations and other home improvements are ways to not only potentially increase the value of a home, but some improvements may be tax deductible. Not all updates and renovations will recoup the total investment, but a 2020 remodeling cost vs. value report from Hanley Wood Media shows that projects like adding manufactured stone veneer can recover an average of 95.6% of costs; a garage door replacement averages 94.5% ROI; bath remodels recoup 64%; and a master suite addition can recoup between 51-59% of costs. So, choose carefully what to update in your home!

One final item to consider when buying a home is interest rates. 30-year mortgage rates remain near historic lows. These rates make it more affordable to buy a home and help increase your net worth faster. That doesn’t mean potential buyers shouldn’t shop around for rates. According to data from 1995–2017 analyzed by Freddie Mac, 80% of borrowers who obtain five rate quotes can save $2,914 on average over the course of the mortgage (based on a $250,000 loan). Work with a trusted lender and talk to a mortgage professional to understand all your home financing options.

Homeownership: The American Dream

From my perspective, the American Dream of homeownership is alive and well, but it might look a little different than it has in the past for some. Whether you are buying your forever home with your eye on building wealth or if you are looking for an investment opportunity, this will be one of the biggest decisions you make. Be sure to evaluate your full financial picture and take your risk tolerance into consideration before making a decision. Purchasing a home will have an impact on the composition and diversification of your total net worth. As always, we are here to be your financial ally.

Don’t want to worry about managing an actual property or dealing with tenants? Learn more about Real Estate Investment Trusts (REITs) and see if they’re right for you.

Headshot of Lindsey BellLindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo-advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.

Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.

The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.