Should you Invest in Property before Buying your Home?
Is it important to own your own home? Some cultures certainly seem to think so. In the US, it's seen as part of the “American dream”, while in China, it's almost a requirement before a man can even think about getting married. In the UK too, homeownership is seen as an ultimate goal for many British families.
Even with the on-going Covid-19 situation, purchasing a home especially in major cities will still take up a significant chunk of one’s savings (if one could afford it). Is it really better to straight-out purchase a 3 or 4 bedroom apartment rather than invest in a studio or 1 bedroom apartment earlier on? Which could you potentially gain more from?
To answer this, let's compare some of the main differences between various factors of the 2 types of properties.
Capital Growth:
To understand which is a better option for capital growth, it’s important to know the type of property being purchased. In many cities, a larger 3 or 4 bedroom apartment typically commands better capital appreciation than a 1 or 2 bedroom apartment. The reason for this is that many property buyers tend to be either starting a family soon or staying with one in their new home. It's less common for people to purchase a property just so they can live on their own, even though there are still many such buyers who do so.
That's not to say, however, that larger apartments will always outperform smaller apartments in terms of capital growth. As with every investment, there will always be a range of other factors that might allow a smaller property to grow more in value than a larger home. These include locations or properties which might be more attractive to young working professionals and less so for families.
Summary: Larger properties tend to perform better in terms of capital appreciation, especially if other variables such as location are kept constant.
Rental Yield:
While many investors aim to realize the bulk of their investments from the capital gains and liquidation of their assets, the ability for a property to generate a substantial passive income is one that also contributes to its value. If you’re buying a home, it's unlikely that you are going to rent it out for income, at least in the near-term. But just for comparison, let's just say you do.
Unlike capital growth where larger properties tend to appreciate more than smaller ones, the inverse tends to be true for rental yield. Typically, the more expensive an apartment is, the less annual yield it will generate. This means that should either property fail to achieve any significant capital gains, then you’re going to be earning a higher rate of return simply by renting out a smaller property compared to a larger one.
Summary: Smaller properties tend to provide higher rental yields than larger ones.
Affordability:
While it’s common knowledge that a larger property will cost more than a smaller property, what people tend to not think about is that in the time taken for them to save up for the purchase of a larger home, they are actually likely to miss out on potential returns that could be obtained from a smaller property.
Assuming you have the intention of purchasing a $1,000,000 dollar home and are saving $30,000 per year, It would still take you slightly more than 3 years just to save enough for the down payment (assuming that only a 10% down payment is required). On top of that, you’ll still be saddled with the responsibilities of a mortgage payment.
Compared to a smaller property costing half the amount, it would take you only half the time needed to save up for the down payment, and you’ll have an asset in hand which pays for itself (or more) each month if you invested wisely.
Even if you’ve already saved enough, it might still be worthwhile to consider redirecting some funds to an asset that could provide an alternate income stream should any undesirable situations happen.
Summary: Smaller apartments will cost less and will allow you to start building an investment portfolio earlier.
The last key difference:
Mindset.
At the end of the day, most homebuyers first take into account the non-financial aspects of a home. Other than the budget, many home buyers first consider things like:
Is it convenient for me to get to where I need to?
Would I like living in the property?
Does it have everything I need? (such as space, facilities, etc)
These factors will always change depending on the buyer and their personal preferences. An investment, however, should revolve around financial factors that remain consistent regardless of the personal preferences of the buyer. These include:
Does this area have convenient access to a variety of locations around the city?
What makes this location somewhere people would like to stay in?
What is the potential for prices and rents to grow in this location?
As such, if you’re purchasing a home with the hopes of utilizing it as an asset at the same time, then you’re already severely limiting yourself to options that may not necessarily provide the best outcome.
In conclusion
Whether or not your first property should be a home purchase or a smaller investment property depends entirely on your personal circumstances, and your investment objectives.
If you already have the funds to purchase a larger property to invest in or use as your home, then there is definitely greater potential for capital gain in doing so.
However, if you’re looking to generate a passive income stream and still earn from potential capital gains, then purchasing a smaller investment property first should be the way to go. It's also a viable option to consider growing your wealth if you’re just “settling” for a cheaper home merely because the one you want is out of your budget, and you’re not under any pressure to move.
Another key benefit of deciding to invest is that you’re not limited to your home country or city. Many opportunities for property investment exist around the world, some of which could be more affordable, or provide greater potential for growth than in your home country or city. However, as with any investments, there are certain risks associated with investing in property, especially more so if they are located in countries you are unfamiliar with.
DWG is a well-established global real estate investment service provider. We also invest in the projects we take on and conduct strict due diligence on them to minimize risks to investors. If you’re looking to invest in real estate, contact us today to see how you can start exploring investment options with us!
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