Have you ever dreamed about owning a cute condo in a bustling city?
You know, the type of place where you can have your friends over and everyone gushes over how great your condo is?
If so, you’re not alone.
Many young professionals follow a traditional path in hopes of buying that cute condo as a “starter home.”
First, they spend a lot of money for an education to get a good job.
Then, after a few years of working that good job, they think about buying a starter home instead of continuing to rent.
These young professionals go into the home-buying process knowing that the home they may purchase will only be a temporary fit.
Even though it may be years down the road, they tell themselves they can simply upgrade if a significant other or children enter the picture.
For professionals living in cities, the search for a starter home typically leads them to condo buildings.
This makes sense. Condo buildings are attractive for a number of reasons.
I get the temptation to buy a cute condo.
Condo buildings are usually in locations ideal for young professionals.
Condo buildings oftentimes come with enticing amenities.
Plus, condo buildings typically offer one or two bedroom units, the perfect size for an individual.
Because of these features, condo buildings tend to attract other young professionals, making the building even more attractive.
While I never owned a condo in Chicago, I happily rented directly from owners in condo buildings for 10 years before buying my first rental property. So, I certainly appreciate the allure of living in a condo.
All this being said, I highly encourage you to think twice before buying a condo, or any other “starter home” for that matter.
That’s because owning a unit in a condo building comes with two significant downsides: (1) the actual cost and (2) the opportunity cost.
Instead, I recommend you think about these two alternatives to buying a starter condo:
- Continue renting until you’re ready to buy a more permanent residence; or
- Buy a small multifamily building where you can live in one unit and rent out the other units.
Before covering these two alternative ideas, let’s talk about the (1) actual costs of owning a condo and the (2) opportunity costs of owning a condo.
What are the actual costs of owning a condo?
The actual cost of owning a condo is like owning any other property, with one additional cost to be acutely aware of.
Besides the mortgage, insurance, taxes, and maintenance, condo buildings involve an additional cost that can be very expensive:
HOA Dues and Special Assessments.
Remember all those attractive amenities that drew you to the building in the first place?
Those amenities come with a price. Oftentimes, a substantial price.
On top of the HOA dues, be aware of unexpected special assessments, which can wreak havoc on your finances.
Special assessments may be needed to cover major maintenance or renovation projects in the building. When special assessments are due, you don’t have a choice but to pay up.
Ask any former condo owner why they no longer own a condo. My bet is most of them will blame the HOA dues and special assessments.
The other reason you’ll hear from former condo owners?
They outgrew their place.
This should not come as a surprise to any single person who buys a condo while also seeking a significant other.
You know how the saying goes: first comes love… then comes marriage… then the condo’s got to go.
That means additional money to prepare your condo for sale, for closing costs, and for moving expenses.
By the time you add up all these costs, you likely won’t walk away with any profit from owning a condo as a starter home because you only gave yourself a few years to benefit from appreciation.
Even if you do make a profit, it’s a gamble. Owning any home for a short period of time is not a good investment strategy. The transactional costs are simply too high.
Besides these actual costs, you should also consider the opportunity cost of owning a condo early in your career.
What is the opportunity cost of owning a condo?
While you may be OK with taking on the risk and these actual costs, don’t ignore the opportunity cost of owning a condo.
The opportunity cost refers to what you are losing out on by choosing to buy a condo.
In this context, the opportunity cost is that whatever you paid for the condo could have been used to invest in other assets. For example, instead of a down payment on a condo, you could have invested in stocks.
Or, you could have purchased a rental property that generates long-term wealth for you and your family (or future family). More on that below.
So, before you opt for the cute condo, think about both the actual costs and opportunity costs involved.
There’s nothing wrong with renting until you are ready to buy a more permanent home.
Owning real estate is a long-term proposition. The conventional wisdom is that you should not buy a property unless you plan to hold it for at least 7-10 years.
If you are not planning on staying in your starter home for at least that long, just keep renting. Invest your money elsewhere.
Save yourself the headaches of being a homeowner while building your net worth through an increased saving rate and other investments.
This is not groundbreaking information. This is Personal Finance 101.
Yet, many young professionals can’t resist the temptation to finally own a property after years of school and finally earning an income.
It’s up to you to set aside your ego, keep renting, and build a strong financial foundation.
By the way, many smart people think it’s financially foolish to buy a primary residence instead of renting.
And, I’m not just talking about buying a cute condo early in your career.
These really smart people think it’s almost always a better idea to rent instead of own in any circumstances.
While it’s beyond the scope of this post, you can find an in-depth analysis on the question of buying vs. renting in this video from Khan Academy.
I believe in the power of real estate as an asset class, especially small multifamily properties.
Instead of buying a condo for a starter home, consider these four reasons to invest in rental properties:
When these benefits combine, real estate investors can generate significant wealth over the long run.
Below is a quick breakdown of each of the four main benefits.
For a more detailed description of each benefit, you can read my series on investing in real estate here.
1. Rental property cash flow is king.
With cash flow, you can cover your immediate life expenses. For anybody hoping to reach financial freedom, it is essential to have income to pay for your present day life expenses.
For my money, cash flow from rental properties is the best way to pay for those immediate expenses.
If your present day expenses are already covered, you can use your cash flow to fund additional investments.
That might mean buying another rental property or investing in another asset class, like stocks.
2. Long-term wealth through appreciation.
Appreciation simply refers to the gradual increase in a property’s value over time.
While cash flow can provide for my immediate expenses, appreciation is all about the long-term benefits.
Like investing in stocks over the long run, real estate tends to go up in value. The key is to hold a property long enough to benefit from that appreciation.
To benefit from appreciation, all I really need to do is make my monthly mortgage payments, keep my property in decent condition, and let the market do the rest.
3. With rental properties, other people pay off my debt.
When I buy a rental property, I take out a mortgage and agree to pay the bank each month until that mortgage is paid off. At all times, I remain responsible for paying back that debt.
However, I do not pay that debt back with my own money.
Instead, I rent out the property to tenants. I do my best to provide my tenants with a nice place to live in exchange for monthly rent payments.
I then use those rent payments to pay back the loan.
As my loan balance shrinks, my equity in the property increases. Equity is just another way of saying ownership interest.
When my equity in a property increases, my net worth increases.
4. Real estate investors earn massive taxes benefits.
When you earn rental income, you must report this income on your tax return. Rental income is treated the same as ordinary income.
However, the major difference between rental income and W-2 income is that there are a number of completely legal ways to deduct certain expenses from your rental income.
Common rental property expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs. We’ll touch on a few of these deductions below.
With all of these available deductions, the end result is that most savvy real estate investors pay little, or nothing, in taxes on their rental income each year.
Yes, you read that right.
I’ll say it again, just to be clear:
Most savvy real estate investors legally pay nothing in taxes on their rental income each year.
I highly recommend you consider house hacking if you’d like to start investing in real estate.
When you buy a small multifamily property, you can live in one of the units and rent out the others.
If you pick the right property, you can end of living for free because your tenants pay your mortgagee.
The strategy of living in a building you own while tenants pay for it has been around for ages. Brandon Turner popularized the name “House Hacking” for this timeless concept.
You can read all about house hacking on BiggerPockets here.
For even more information on house hacking, Craig Curelop wrote a book for BiggerPockets called The House Hacking Strategy: How to Use Your Home to Achieve Financial Freedom.
My wife and I house hacked for years before buying our forever home.
Without a doubt, there is no better strategy for entry level real estate investors than house hacking. We talked about the financial upside earlier in this post.
Besides the financial upside, it’s like landlording with training wheels. Since you live on site, you can more easily learn how to manage a rental property, including responding to tenants and handling routine maintenance.
The naysayers will say something like, “I don’t want to live with my tenants. They’re going to stress me out. I don’t want to be bothered at 2 a.m.”
Ignore them.
My wife and I lived with our tenants for five years at our first property and two more years at a subsequent property. We did this while working full-time jobs as lawyers and raising two kids (now three kids).
Because we didn’t listen to the naysayers, we now have four income-generating properties and our “forever home” just outside Chicago.
Even though we’re no longer living for free, the income from our rental properties is enough to cover the expenses of our home.
Before buying that cute condo, think about house hacking instead.
There’s no better time to house hack than at the beginning of your career. This one decision can pay massive dividends for years to come.
No, your friends might not gush over your cute condo.
But, you’ll be well on your way to generating long-term wealth for you and your family.
Even if you’re not just starting out in your career, house hacking is still an incredible wealth-building strategy.
My wife and I house-hacked until I was nearly 40 years-old with two kids. We wouldn’t be where we are today if we instead opted for a cute condo.
Did you buy a starter home in your 20s or 30s? Any regrets?
What do you think of house hacking?
Let us know in the comments below.
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