Owning a house can turn into a sour investment for some homebuyers: Here’s when

Property experts look at ways to make your property generate more income, avoid losses

Dubai: Beyond the obvious benefits of having a place to call your own and reside for the long-term, homeownership is known for the profit perks that come with it being a worthwhile investment. But UAE real estate experts warn that owning a house can sometimes turn into a sour investment.

“Depending on the price you pay for your home, and the appreciation rate you get when you plan on selling it, you could end up with a negative return on your investment, among other factors,” suggested Stephanie Myrtle, vice president of a Dubai-based real estate research firm.

“As banks finance a home purchase more favourably than any other business investment, you can use your primary property as an investment and bump up your potential returns. Unlike a small business or purchasing securities, you can get a home loan at a 20 per cent down payment.”

When you take a home loan, banks give a maximum of 80 per cent of the property’s value as a home loan, with the rest 20 per cent being raised on your own. Once the bank starts loan disbursement once your down payment is paid, you’re on your way to an easy investment, or so we thought.

It doesn’t always help to put a bigger down payment

Ideally, you are to pay at least 60 per cent of the property value from your pocket and the remaining can be paid through a bank loan, as the key chunk being paid by you ensures total interest cost you are bearing to buy the house is not too much. Also, monthly instalments shouldn’t overburden you.

However, even though investment in a house is usually done with the objective of creating wealth, and generating additional source of income etc., there are downsides at times to paying more to keep your debt levels secure in the future.

“For instance, while it’s often recommended that you make a larger down payment so as to avoid paying interest charges on your home when you take a long-term loan against it, there are times when making a much lower or the required 20 per cent as a down payment will help,” added Myrtle.

“It isn’t always effective for the long term, but making a lower down payment can get you a good return on capital at times. This works best in a scenario where you will be able to get revenue from your property rather quickly — say, profits from an immediate sale or by renting out the property.”

Making a lower down payment gives better return at times: An example
An example would be purchasing a home that requires Dh50,000 for the down payment and closing costs, but the house earns you Dh36,000 a year after you’ve paid all expenses. By year two, you’ll already have netted Dh72,000, which is a 144 per cent return on your initial investment of Dh50,000.

It helps homeowners to increase value of their own homes

If you’re a homeowner, the mortgage payments you’re making every month can help you build a powerful asset: ‘home equity’. Home equity represents the amount of your home that you own free and clear, as opposed to the amount you financed (and still owe).

“While you still reside in the place, though, home equity can be tapped to pay for remodelling, or other financial needs. For all these reasons, increasing home equity is an important part of homeownership,” said Prakash Bhat, a real estate and mortgage consultant based out of Abu Dhabi.

“As you pay down your mortgage, the amount of equity you have in your home grows over time, allowing your home to become a more valuable asset, and your net worth to increase. Of course, you can always wait to cash in the equity when you sell the home.”

So, equity is simply the difference between what you owe on your mortgage and what your home is worth. If you owe Dh1.5 million on your mortgage loan and your home is worth Dh2 million, you have Dh500,000 of equity in your home. It is how much you own in your home after subtracting any outstanding mortgage on it; that is, (2,000,000 - 1,500,000 = 500,000), which is the home equity.

How realty market conditions passively affect property’s equity

Here’s an example. If the market goes up and the value of the property increases from Dh1 million to Dh1.2 million, then there is an additional Dh200,000 equity in the property, regardless of if there is a mortgage or not. That’s the upside of property investment, but that’s not always the case.

On the other hand, if the market declines and the value decreases from Dh1 million to Dh800,000, then there is a Dh200,000 loss in equity. “A loss in home equity or ‘negative equity’ due to market-related factors beyond your control are an overlooked issue when ‘distress selling’,” added Bhat.

Glossary: ‘Negative equity’, ‘Distress selling’
Negative equity is a deficit of owner's equity, occurring when the value of a property asset used to secure a loan is less than the balance on the loan. It is essentially potential indebtedness arising when the market value of a property falls below the outstanding amount of a mortgage secured on it.

Distress selling occur when the seller urgently sells an asset like a property, often to pay debts or other emergencies. A short sale is a form of distressed sale in which the homeowner attempts to sell their property even though the current market value is below the amount owed to their lender.

“First-time home buyers are saving up lots of money for the down payment – usually between 5 per cent and 20 per cent, hoping that the rest of the financial burden will be eased with small monthly instalments. In doing so, they often have barely any money left for emergencies.

“Another instance is if you take all the money from the sale of your current home and put it all down on buying the next one. That again leaves you with no financial wiggle room and at risk of being ‘house-rich, cash-poor’.”

Bottom line?

“Real estate investing can be lucrative, but it's important to understand the risks. Key risks flagged above were negative cash flows or the lack of liquidity, plummeting market values, or just the unpredictable nature of the real estate market in general,” added Myrtle.

“Also, making payments toward the ownership of a real estate property can be a good investment in the long term, but it can also quickly turn sour if you run into money trouble and fail to account for the number of unexpected costs that often arise when taking on such a big commitment.”

Bhat further noted that you can protect yourself from having a sour property investment by considering or estimating how much you should spend on a home, which is roughly 2.5 times your total annual salary, “but some acknowledge that this figure will often have to be quite a bit higher.

“A more precise way to determine how much you should spend would be to calculate what percent of your monthly income will be spent on housing costs. This is referred to as the ‘debt-to-income’ ratio, or front-end DTI. The rule of thumb is that this number should be no more than 28 per cent.

“Other factors to consider are your down payment amount and the mortgage interest rate. If you don’t want to get caught off guard by unexpected payment increases with a variable rate mortgage, opt for a fixed interest rate. Also, save for maintenance costs or sudden changes to your finances.”