Being in the military presents unique challenges. We are burdened with moving every one to three years throughout our careers. While moving that often can be exciting, it can wreak havoc on our finances.
While I think most people make mistakes with real estate, those mistakes are magnified in the military because of frequent moves, especially when sent overseas.
Today I address the two biggest mistakes I see military members make with real estate. First, buying in high cost of living areas. Next, buying a home at each duty station. Both bad ideas.
Let’s take them one at a time.
Buying in a High Cost of Living Area
I just ran into this issue a few days ago. Somebody told me they were moving to Hawaii and everybody told them they have to buy because the prices of houses just keep going up! They usually say things like, “you can’t lose!”
I told them, don’t buy! Whatever you do, don’t buy in Hawaii!!
Why would I say that? Don’t I want everyone to be Rich on Money?
They sighed and remarked that I was the first person to tell them they shouldn’t buy in Hawaii.
Clearly, I don’t know what I’m talking about.
There are two problems with buying in high cost of living (HCOL) areas. One is the appreciation myth, and the next is cash flow.
The Appreciation Myth
There is a wide-spread belief if you buy in a HCOL area, you can’t lose because you’ll get massive appreciation, and even if your rent doesn’t cover the mortgage, (which is likely) you’ll still come out ahead.
Here’s the problem with that thinking. Appreciation is a fickle thing. In HCOL areas, it sometimes comes in spectacular fashion for a few years, and then disappears for several years. Those spectacular years are what get people’s attention, but you never know what years that will happen, where it will happen, and how long it will last.
In the end, appreciation in HCOL cities usually ends up being only slightly better the appreciation in any other city in the U.S. For instance, Honolulu may see a 4% appreciation per year on average over the long term compared to 3% for most cities.
I’ll give an example of the appreciation myth from my life. I bought a townhouse in Washington D.C. for $280,000 in 2003. Two years later it was worth $400,000. I was ecstatic! I could only imagine what it would be worth in ten more years!
I sold that house in 2016. How much did I get for it?
$400,000. All my growth (appreciation) happened the first two years, and then a net of no growth over the next eleven years. This works out to less than 3% appreciation per year.
You can’t count on appreciation when you buy in a HCOL area, especially in the military. During the one to three years you are there, it could easily stay flat or even go down in value. That would not be a good thing on a million dollar home!
Read my full article on The Appreciation Myth
If you buy a property at an assignment and realize it didn’t appreciate much, you made need to rent it out instead of selling it. Maybe your plan was keeping it as a rental anyway.
Rental properties in HCOL areas almost never work out!
Well, we know the first reason is because of the appreciation myth. It’s also because the numbers don’t work!
Let’s talk about the 1% rule. It’s the most basic and important rule in real estate investing.
The 1% Rule – A house should be able to rent for at least 1% of the acquisition price. This is purchase price plus fixing it up.
Example. If you buy a house for $80,000, and spend $20,000 fixing it up, your acquisition price is $100,000. That means in order to pass the 1% rule, this house should be able to rent out for 1% of the price, or $1,000 a month. If it can rent for this or higher, it would potentially be a good rental. It would have a good return on investment (ROI).
With the 1% rule, the return on investment (ROI) is roughly 6%. If you don’t pass this test, your rental is making less than that.
For more info about the 1% rule and other rules read my article on How Much Money Will I Make From my Rental Property?
Passing the 1% rule is almost impossible in HCOL areas. The houses are too expensive, and rents too low. It’s a poor place to have your money tied up. In many cases, you may be better off renting, and saving up towards a future downpayment.
Example. Let’s use Hawaii again. Finding a house for $900,000 is pretty likely. According to the 1% rule, you’d have to get $9000 for rent to make that a decent rental property.
Surprise, surprise, you can’t even get half that. Maybe $4000. It doesn’t even come close to passing the 1% rule.
It’s a horrible investment. If you buy this property and move away making it a rental, you are making little money or even losing money each month. If you decide to sell after a few years in Hawaii, you might not have enough appreciation in that short time frame to sell without a loss. Buying is a losing strategy.
Also remember, just because your rent covers your mortgage doesn’t mean you are making money. There are lots of expenses in a home that are paid after the mortgage payment!
But I get great tax benefits!
The tax benefits of owning a house are largely overblown. Suffice it to say, it can make a crappy investment slightly less crappy, but it doesn’t turn a bad investment into a good one! Make sure the house you are buying is a good investment before considering taxes.
Buying a Property at Each Duty Station
This is a big one.
Everybody either knows somebody or has heard of that mythical military figure who has made it big and hit the jackpot by purchasing a property at every duty station, turned them into rentals when they moved, and retired with several rental properties that cash flow well and have appreciated massively in value.
Now they jet to the Bahamas on private planes and party on yachts eating caviar and sipping pina coladas all day.
Maybe that’s an exaggeration, but you get the picture.
Buying a house at each duty station is a horrible idea.
The chances that strategy will work for you are 1 in 100. The other 99 have you losing money.
There are three problems with this strategy. Cash flow, appreciation, and management.
This is the same problem we saw above in HCOL areas. Some cities are much better for rentals than others. To take that even further, once you’re in a city, some neighborhoods will make much better rentals than others.
If you buy a house in a neighborhood that is new or newer, has very good schools, and is considered upper-class or higher, these neighborhoods usually end up not meeting the 1% rule. My advice is, you can live there, but don’t buy there. It will make a poor investment.
I’ll use myself as an example here.
When I was in Montgomery, Alabama for an assignment, I knew the neighborhood I wanted to live in. It was a gated community with a clubhouse and pool, newer houses, low-crime, great schools. The houses could be purchased for about $179,000, but could only be rented for about $1300. They didn’t pass the 1% rule. I rented there.
In the same city, however, I was able to purchase a house in a more middle-class neighborhood for $60,000 that rented for $800 a month. I bought this house, but not to live in, purely as an investment.
Actually, I own 20 houses in Montgomery. If you want to know more about that, read my Complete Guide to Real Estate Investing
You can’t just buy a house at every station you end up in the military. Whether or not it makes sense to buy a home while in the military depends on if that house will make a good rental when you move away. If it doesn’t pass the 1% rule, it probably won’t. I would suggest renting instead.
Same problem as in HCOL areas. You’ve seen in the media or heard friends talk about the huge money they made from appreciation. You need to consider these as unique cases. This may or may not happen to you in the location and over the time frame you own your homes. Most people I know have seen far more modest appreciation over the long term. Don’t count on large appreciation. If I happens, great.
I have 20 rental properties and they are all in the same city. I have one management company that handles them all. It took me a long time and a lot of work to get a great management company that I trust. I know lots of unhappy military landlords that have serious problems with their management companies. I also know many who are trying to manage properties themselves and doing a horrible job.
Getting property management right in one city is hard enough. If you think you’re going to get it right in five, six, or seven different cities, you’re dreaming. Finding good contractors, real estate agents, and management companies are rare things. Spreading yourself out that thin doesn’t work very well, IMHO. I think it’s best to concentrate your portfolios in as few locations as possible.
Want to know more about property management? 5 Secrets to Finding the Best Property Manager
So there you have it. Two deadly real estate mistakes I see all the time in the military. Buying in HCOL areas, and buying at every assignment. I hope you can avoid it.
Of course, some people will feel like buying is always better than renting, because renting is throwing money away. This is not the case. In many situations, renting can be financially smarter than buying.
Read my page on buying vs renting
Anyone disagree that buying in HCOL areas or buying at every assignment is a mistake?
I want to hear your comments!
Rich on Money