The Case For Investing In Income Property Before Buying Your First Home

Would-be homebuyers in America are finding themselves caught in a wicked squeeze play, with high-interest rates and even higher prices combining to severely limit their buying power. 

This is changing the nature of homebuying, especially for first-time buyers or people looking for an affordable starter home. Has the paradigm shifted so radically that it makes more sense to begin making passive income investments before buying your first home?

It's an intriguing question that will have different answers for different homebuyers. Here is a breakdown of why becoming a landlord or buying income property before buying your first single-family home might benefit you.

Buying Homes Is Expensive — Really Expensive

This is an obvious and perhaps an understatement in states like California where the average home costs $800,000. Without getting into the fairness or unfairness of the same home the previous generation bought for $150,000, the reality of pulling off a purchase this large is daunting.

With a Federal Housing Administration (FHA) loan with 3% down being out of the question for many homes, would-be buyers must have a significant income to qualify for a jumbo loan. To purchase an $800,000 home with a 20% down payment, prospective buyers would need $160,000 — far more than most people can come up with by simply saving money.

The median income for a single earner in California is $60,360, according to the 2020 data from the U.S. Census Bureau, the most recent available. That's roughly $5,000 per month. But the average rent in the state is around $2,100 per month. After other expenses like taxes, food and gas are deducted from average income, it's easy to see how it will take decades for an average wage earner to come up with the $160,000 down payment for an $800,000 house.

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Making the Payments is a Challenge, Too

Assuming a buyer came up with the $160,000 down payment on an $800,000 home, they would still be looking at financing $650,000. At today's average mortgage rate of around 7%, that's nearly $45,000 per year in interest. The interest payment alone would be $4,000 to $5,000 per month. After principal, property taxes and insurance are added in, the average $60,000 per year wage earner doesn't make nearly enough to qualify for a loan.

Investing First Is Now One Of The Only Roads To Ownership

It's clear that the housing market is so difficult for many people, and there doesn't appear to be any relief from the Federal Reserve on the horizon. Interest rates and home prices aren't likely to drop by 30% or 40% in the next few years.

This leaves a lot of would-be homebuyers at a crossroads. The models their parents and grandparents used such as FHA, GI bill and Veterans Affairs (VA) loans are increasingly out of their reach. That's especially true in America's largest metropolitan areas on the East and West coasts. It's also equally unlikely that wage earners can ask for their wages to be doubled or tripled so they can afford to buy a house.

That leaves investing and building passive income streams as one of the only remaining avenues for everyday people to acquire the capital necessary to become homeowners. It's a shift in how the process worked for their parents, who purchased their family home first and then began acquiring income-generating investment portfolios.

Owning Investment Property Offers Passive Income

Massive amounts of investor cash flooding the housing market has pushed prices up, which will continue unless the federal government makes it illegal, which is unlikely. But investing in real estate opportunities that generate passive income is easier than it's ever been. 

The initial investment to build a real estate income portfolio used to be tens of thousands of dollars. Now, real estate crowdfunding platforms and real estate investment trusts (REITs) allow you to take advantage of passive income offerings with buy-ins as low as $100. It will take time to build your passive income if you are starting with less money.

The same thing is true of putting money into a savings account in increments of several hundred dollars at a time. The difference is that if your investments pay off, you'll earn higher returns while getting some of the benefits of property ownership. As an equity owner, you also get to claim depreciation write-offs or tax breaks on pass-through income at a rate proportional to your investment equity.

The Duplex, Triplex Or Fourplex Option

One of the potential downsides of buying equity shares in a REIT or real estate crowdfunding offering is that even though you have equity, you don't have any control in the day-to-day management of the asset. If you don't trust fund managers to handle your investment properly, there is another way to buy a home and investment property at the same time.

In many states, duplexes (two units on one property), triplexes (three units) and even fourplexes are still classified as single-family homes. This classification is important in terms of financing because it means you can finance them for 30 years instead of the customary 15-year mortgage that comes with properties designated as multifamily.

If you're able to buy one of these types of properties, you'll get the best of both worlds. You will get long-term financing and collect rent to help pay the mortgage. That comes with the caveat that you will be a property manager and pay for maintenance expenses on your tenant units.

The Ultimate Duplex, Triplex Or Fourplex Play

Multiplex units don't come up for sale as often as they used to, but it still happens. If you are determined in your search, you may find one in bad enough shape that many buyers are scared off by the prospect of rehabbing it. That could work in your favor if you get a 203(k) loan, which is a U.S. Department of Housing and Urban Development (HUD) program that lends you the purchase price of the property and the money needed to renovate it.

It's not a widely known program, and you must live at the property you purchase. What you could get in exchange for that commitment is a fully functional, modernized income property with units you can rent for top dollar. You can also borrow through this program to buy a single-family property.

Buying a 203(k) multiplex may be the ultimate play to simultaneously buy your first home and develop a passive income stream. If you're looking for a home, and you feel priced out of the market, scouting 203(k) loan opportunities is an option worth considering.  

Homebuyers Will Have To Become More Creative

The housing market in most of the country is unfriendly to buyers at best. It was hard enough in the mid-2000s when prices were too high. But low-interest rates were somewhat of a cushion for buyers to fall back on. Today's interest rates feel more like falling back on a bed of nails than a cushion.

People determined to buy a home must get more creative to realize their dreams. One way to do that is to develop passive income streams through real estate investments. You will be building passive income for your future even if you don't end up purchasing a home with the proceeds.

Remember that doing something is better than doing nothing. Bemoaning the state of the market and getting stuck in negative inertia will not get you closer to purchasing your first home. Rome wasn't built in a day, and neither are income-generating portfolios. The sooner you start building yours, the sooner it will begin paying off for you.

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