Which is better for building wealth: principal residence or rental property—RISK
Posted by John T. Reed on
There is a general belief that you can build net worth faster by investing in rental properties (apartments) than by simply buying your home and moving up to a more expensive one when your financial situation improves. Is that correct?
Maybe not. It is a multifaceted matter involving risk and reward as well as lifestyle.
Risk
All investments have risks. It is a finite list.
| Risk | Home |
Rental property |
| overbuilding | yes, generally visible nine months to a year in advance via permits approved and housing starts stats |
same as home |
| casualty (fire, flood) | covered by homeowners insurance |
covered by rental property insurance |
| political (passage of laws adverse to the property) | very rare; 65% of Americans are homeowners 65% x 330 million = 214.5 million homeowners/voters |
anti-landlord laws are passed annually; there are only 10.6 million landlords in U.S. (taxpayers who file Schedule E rent income of landlords); 35% of Americans are tenants 35% x 330 million = 115.5 million tenants |
| inflation | purchasing power of the property value keeps pace with inflation; since capital gains are not indexed in the US, tax rates during high inflation are confiscatory after-adjustment-for-inflation if you sell; mortgage balance, if any, becomes tiny after adjustment for inflation |
same as home only government generally imposes rent control on rentals during high inflation which can make the property unable to break even and therefore worthless as happened in NYC for many years |
| deflation | during Great Depression, which was deflation, property values fell about 90%; makes after-adjustment-for-deflation value of mortgage much higher perhaps leading to default |
during Great Depression, which was deflation, property values fell about 90%; makes after-adjustment-for-deflation value of mortgage much higher while rents fall leading to default and foreclosure |
| credit (risk that someone who owes you money will not pay it) | None |
Nationwide, tenants often do not pay the rent on time or stop paying permanently; landlords can affect this with good screening and management |
| litigation | only 1.9% of homeowners insurance claims are liability (lawsuits) rather than property damage | According to the Small Business Administration, 53% of small businesses are being sued at any given time |
| toxic contamination | rules for removal from your home may be less onerous than from other buildings | rules for removal from rental property may be more onerous than for your home |
| economic downturn | dependent upon how the downturn affects your household income and home values in your area | dependent upon how the downturn affects your tenants’ income and rental properties value |
| interest rate increase | only affects you if you are trying to sell assuming you have a 30-year, fixed-rate mortgage | May hurt you if you have a ballon payment which are common in apartment buildings |
| crime | generally lower in single-family neighborhoods | often higher because of nature of multi-family-structure design and lower-income in multi-family neighborhoods |
| fidelity (risk of employee theft or absenteeism) | none | employees like gardeners and resident managers or salaried handyman |
Except for casualty loss and credit risk, these risks are each serious enough to put you into bankruptcy. You can see that in the historical record going back to 1900. In most cases, the rental property has greater exposure to that risk.
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