Don’t buy a home on active duty

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A reader writes:

“My spouse and I don’t have a house to use as a tax shelter. We are transferring to a new duty station on the coast for 22 months and I am seriously thinking about buying a house there. Why throw away money on rent when we can buy and have a mortgage of about half of our housing allowance? It’s in a military area so it wouldn’t be hard to rent out when we leave. Problem is, my spouse has no desire to buy a house again after the two we sold during the housing recession. It was pretty ugly and stressful. Suggestions?”

This seems like an attractive way to pursue financial independence, but you’re hearing common high-pressure sales tactics from the real estate industry. The reality (and the math) rarely support the hyperbole. Even worse, you’re leveraging a large financial risk with a limited upside and a deep downside– on borrowed money.

I recommend that military servicemembers rent while they’re on active duty. Let’s walk through the different scenarios to see whether you reach the same conclusion. You might be hard-wired for the landlord life, but most people would prefer to avoid the labor and stress.

In a typical military renter scenario, you’d transfer to the coast. You’d spend just a few days learning about a new neighborhood, sign a lease (or a base housing agreement), pay a deposit, and move in. Then you can move on with the rest of the new duty station, unpacking your household goods, getting the kids in school, and returning life to some sort of normal.

In your ownership situation you’d transfer to the coast, spend just a few days learning a little about a new neighborhood, sign a purchase agreement, apply for a mortgage, pay thousands of dollars in transaction fees, and spend several hours reviewing and signing documents. Then you still have to deal with the rest of the transfer tasks while caring for your new home. The property would historically appreciate at about the rate of inflation (except when a hurricane hits). You’d only profit from the ownership if you were highly leveraged (nearly 100% mortgaged), escaped damage from natural disasters or accidents, and did most of the work yourself.

Image of renting a bigger red house or buying a smaller green house

Visual analogy of rent vs buy

While you’re living in the home, a mortgage payment could be less than the market’s rental rates. As a short-term tenant you might feel that you’re throwing money away (even though you get to keep whatever housing allowance you don’t spend). However as an owner you’re subject to more expenses: property taxes, property insurance, homeowner association fees, maintenance, and repairs. Every property is different but your housing allowance is projected to cover only 99% of your rent and utility expenses. Unless you bought the home with a large down payment, now you’re spending more than your military housing allowance. It’s not designed to pay you for ownership.

When you transfer (less than two years later) you’d have to manage a rental from a distance. You’d hope that your new tenant produces cash flow while the local market generates more property appreciation.

Your first landlord challenge will be moving out of the house and returning it to flawless move-in condition, which you’d have to do whether you’re a renter or an owner. But then you’d have to either stay in the area to market the rental and screen new tenants, or you’d pay a property manager (or a realtor) a fee to put new tenants into the property for you. In the meantime your family would have to move to the new duty station and get settled in again. Buying a house has cost you extra labor on both the transfer in and transfer out, and (unlike renting) it hasn’t put any actual cash in your pocket yet.

While you’re living in the house you might spend the same amount of money on a mortgage or on rent, so the ownership expense might seem sensible. However when you moved out and became a landlord then you’d have to pay the mortgage (and all your other homeowner expenses) from the tenant’s rent– or else you’d have to pay the mortgage from your personal savings.

You’d have to cover the mortgage during the month that it might take to get a new tenant into the property. Even when you find the world’s best tenants you’ll still spend 1-2 months of time and money on the costs of getting them into the property and getting them back out at the end of the lease. If you’d simply been a renter then you would have dropped the key off with the landlord, haggled over your deposit, and moved to your new duty station without any further expenses at the old duty station.

As a landlord you might be able to manage the property yourself with a local contractor on call for repairs, or you might want to use a property manager. It’s hard enough to coordinate this when you’re hundreds of miles away– what if you’re stationed in Guam or Germany?  The real estate “experts” frequently tell you about the successes while glossing over the failures, and you’ve already seen a little of that homeowner’s stress from the Great Recession. Transferring to a new duty station is hard enough without worrying about those issues.

My spouse and I have bought & sold four times on active duty, and twice we’ve been long-distance landlords. We made a little money once and lost much more money twice. The net result is that we’ve lost more money (and time) as owners than as renters. I’m not a fan of landlording but I can appreciate the benefits of diversifying my investments and building equity. Being a long-distance landlord is no fun at all– especially when the local real estate market is “temporarily” depressed, new tenants are hard to find at any price, and their rent is only 70% of your mortgage payment. We’re still landlords today on one place, and it took over eight years to achieve positive cashflow. When I reflect back on our decade of landlording during active duty, the stress levels were off the charts.

House as a tax shelter” is another way to say “paying a dollar of interest on debt to deduct 15 cents on my tax return. Somehow we’re supposed to feel good about getting a 15-cent discount while still spending 85 cents? In the 1980s, with mortgage rates at double-digit percentages and high tax rates, this approach might have generated 20 or even 30 cents of deductions for every dollar of mortgage interest. However you’re still spending large sums of money just to cut a little off your taxes.

You might not even be able to deduct that first dollar of mortgage interest. At today’s tax rates you’d have to exceed the standard tax deduction by paying at least $6200 (single taxpayer) or $12,400 (married filing jointly) of interest and other itemized deductions. Otherwise you get to take the standard deduction on your tax return whether you’re paying mortgage interest or not. Paying $12,400 of mortgage interest in a tax year implies that you have a 4% fixed-rate 30-year mortgage of over $300K. As a landlord you can deduct additional expenses and depreciation from your rental income, but again you end up spending money to offset your income. If the property lacks cash flow then you lose even more money just to be able to reduce your taxable income a little.

Don’t get me started on the taxes of selling a rental property. I’ll just mention that the federal depreciation recapture tax rate is 25% and (unlike an owner-occupied home) you can’t simply roll the profits (if any) into your new home. There’s a whole industry built around the tax concept of a Section 1031 exchange, and most landlords lack an exit strategy.

Instead of losing money to deduct a little of it on a tax return, I think it’s far better to rent a home and invest any unused housing allowance in stock index mutual funds or lifecycle retirement funds. In the long term of 5-10 years, the funds will grow faster than real estate– and with zero effort (or worry) from you. There’s less financial risk, zero leverage, and you won’t have to deal with tenants or hurricanes.

I recommend that you rent while you’re on active duty and consider buying only after you’re finished with active duty. Even after active duty you still have the average American’s risk of moving to a new home every seven years.

As you near the end of your active-duty time then you can save up cash for a down payment, spend months on market research in your chosen area (with no time pressure), and buy a cheaper fixer-upper in your favorite neighborhood. You’ll get an extra discount by buying during the winter when there are fewer buyers (and the sellers are motivated). You’ll save thousands of dollars with your value shopping, and it’ll make up for decades of “missed” ownership opportunities. Better yet, you’ll avoid years of financial risk and landlording stress.

 

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[mybooktable author=”doug-nordman”]

 

Related articles:
Book Review: “Rent Vs Own”
Real Estate: Rent Or Buy?
So You Want To Be A Landlord



WHAT I DO: I help you reach financial independence. For free.

I retired in 2002 after 20 years in the Navy’s submarine force. I wrote “The Military Guide to Financial Independence and Retirement” to share the stories of over 50 other financially independent servicemembers, veterans, and families. All of my writing revenue is donated to military-friendly charities.

19 Comments
  1. Reply
    Dave February 26, 2015 at 5:25 PM

    just to give an up to date perspective. I bought our current house in the DC area in 2012, retired last year. Used a VA loan, house was $400K @ 3% 30 year mortgage, monthly payment $1975 (BAH was $3030 for the 2 years I was on active duty). We are going to retire for good and are renting it out. I put it on AHRN a week ago listed at $2900 and the house already rented for a 3 year tour. The breakdown looks like this: $10,800/yr gross; probably $9500 in profit. Another $9120 toward principal pay down. Compared to living on base, I saved about $25K in BAH money while on active duty.If you add in the mortgage and prop. tax deduction and principal pay down; that’s several more thousand and that’s in just under three years.

    At first, I try to take the military aspect out of the general equation and focus on the numbers and other qualitative factors: margin between mortgage and rental market price (often times BAH rates), maintenance costs, turnover, vacancy rate, demographics, network of maintenance professional and property managers etc. In a lot of cases, you can do what normal property investors would kill for. Leverage properties at 100% at incredibly low interest rates. the interest rate for a principal residence is almost always lower than on an investment property. If you move from somewhere in the midwest, to DC to Hawaii or Alaska for example, you could potentially buy three houses with VA loans over time/nothing down (you can have multiple properties financed with VA loans simultaneously) at incredibly low interest rates and have them all generating cash flow buy the time you separate or retire. If you’re comfortable with risk and do the research, this could certainly mean the different between a mandatory bridge career and true early retirement. don’t underestimate the potential, but don’t go into it haphazardly either and patience is certainly a must.

    • Reply
      Doug Nordman February 27, 2015 at 12:06 AM

      Thanks, Dave! DC has certainly been a growth area over the last 30 years, but Hawaii got hammered by military downsizing between 1990-2000. It can be a big financial risk.

      Considering the frequent moves and the debt leverage of real estate, a diversified portfolio of low-expense passively-managed index funds offers a much less-risky and lower-stress way to accumulate wealth. But the key is diversification, and real estate can be a great diversifier.

  2. Reply
    Friar1610 February 26, 2015 at 12:21 PM

    Interesting discussion. I’ve been retired almost 20 years. I owned 4 houses during my 28 year Navy career. (I bought the last one while I was on active duty and lived in it 8 years post-Navy.) I made money on all but one. I broke even on that one. (In two cases I had the good luck to be transferred and sell just before a housing meltdown – 1989 and 2005.)

    BUT, times were different then. House prices were rapidly accelerating. EVERYBODY expected to buy a house for a 3 year tour, sell it and make a few bucks and do it all over again at the next duty station. People who hit Hawaii at just the right time made a killing. The DC area was almost as good. Norfolk and San Diego were pretty good.

    If I were on active duty now, I would only buy in an area where 2 or 3 of these factors were present:
    – I had a good chance of back-to-back tours at different commands
    – I was all but sure I would return to for a tour later in my career
    – There was a vibrant (military) rental market
    – I would have a high probability of wanting to retire.

    Otherwise, renting seems to be the way to go these days. Even with my relative good luck during the “old days” I spent quite a few sleepless nights as my transfer date loomed and I still had a house on the market. Just moving out of a rental or base quarters and turning the keys over to someone else is very attractive in many ways.

    • Reply
      Doug Nordman February 27, 2015 at 12:08 AM

      Good to see you here, Friar, and thanks for your comments!

      You make excellent points from your long-term experience.

  3. Reply
    Doug Nordman February 14, 2015 at 8:44 PM

    Thanks, Ty, that’s interesting info on the glut of housing at military bases.

  4. Reply
    Ty February 14, 2015 at 6:12 AM

    I have been there. In twenty years of service(still in) I have bought homes and realized that the math doesn’t work, even after you consider the various write offs etc. A look at an amortization table will make it clear that it takes a long time to realize any significant equity unless you are in a very hot market. Add in Realtor fees and the potential upside is even further away. I am consistently surprised by the number of service members who are saddled with properties from former duty stations that they cannot unload or achieve rents that cover the mortgage. I would venture to say there have been more losers than winners when it comes to service members owning a house over that last ten years. From a FI tool perspective, owning is a bad idea unless you are posted somewhere you will be for an extended period(10 years..) As a side note. There is a glut of housing on many installations. The last decade has seen a lot new family housing put in. This has left a lot of the older units being offered at “market rates” to DA civilians, retirees AND soldiers. My family resides in a unit built in the 80’s. Its not as large as the newer housing, but its well maintained and suits our needs. The result is $1000 in saved BAH each month(mid-Atlantic region housing allowances). Additional savings are gained through no power, water, trash collections expenses. The yards are maintained by the installation. When something goes wrong we call maintenance and they are there within the day. Hard to beat.
    Will we buy again? Yes, when we finally retire and at that point the house will be owned mortgage free.

  5. Reply
    Romeo Jeremiah January 24, 2015 at 4:58 PM

    This makes sense Doug, until you walk away with $40k two years after living in a home. 🙂 Active duty members just have to buy smartly and shift their thinking. Money is made when you buy, not when you sell. The problem, though, is that most folks don’t know how to valuate a bargain.

    • Reply
      Doug Nordman January 25, 2015 at 9:47 AM

      Thanks, Romeo! I think you’ve already shown that you’re one of the few servicemembers who’s hardwired to make money in real estate. However the vast majority are not ready to deal with the hassles of ownership (and the possibility of landlording from long distances).

  6. Reply
    Peter Gregory January 6, 2015 at 9:15 AM

    Outside of one’s relative health, the most precious commodity one has to work with is not a domicile, rent or own, or a stock or bond. It is time. It is that which we cannot conserve and once gone is passed forever. For any military retiree, separated, active, time is your most valuable asset. I retired at 52, ancient for this line of work, the vast majority will be onto a second act by 42-45, some younger. Regardless of age one one only has XX amount of years to get from A to Z for financial freedom and autonomy, from working for a paycheck to work only if one desires. In the board scope of things, in general, people who are financially independent and successful, secure, do they own stuff and things, or do they rent them? I think in all economic cycles and patterns those who own will always be in a better position than those who rent, and applies to real estate. Money and its benefits will always pass from the renter to owner, debtor to the granter of credit, that iron of economics has yet to be repealed. And the sooner one gets that matter behind them, so much the better in terms of time.

  7. Reply
    Fred Atwater January 6, 2015 at 1:37 AM

    The math on 100% leverage via a VA loan may not work out when it comes time to rent out the house. All of our houses thru my 24 year AF career were bought with 20-30% down, we still own them and rent them out to other military folks. We bought the houses with the knowledge of the local rental rates and worked cash flow back from there. The 30% down number is a really sweet-spot when paired with a 30 yr 3-4% mortgage when it comes time to rent out the house. Essentially, the 30% down on say a $200k house is $60k which yields about $6k annual profit after PITI and mx/vacancy reserves. $60k is pretty easy to save over a 3-4 year period (same as each PCS). $6k/yr on a $60k investment is a 10% year after year ROI (cash on cash). We have had the houses long enough now that they are being paid off (early, too) which means a RAISE for us in the thousands of dollars per month. It just takes a lot of patience, discipline, time, an occasional struggle, and vision. Good luck!

    • Reply
      Doug Nordman January 7, 2015 at 5:43 AM

      Good points, Fred.

      I think the key to owning a home on active duty is being ready to turn it into a rental, and having the market analysis/finances in place to do that before buying it.

      Entrepreneurial landlords have that mindset. The vast majority of servicemembers do not, and end up being “accidental landlords” with negative cashflow.

  8. Reply
    JP January 4, 2015 at 7:21 AM

    There are complicating factors around homeownership. If you want to live in a house, buying it is the easy way to go. If you want to live in an apartment, renting it is the easy way to go. But renting a house is often a headache. House landlords aren’t generally as good at responding to fix the things that need fixing as the full-time employees who manage apartment rentals. Sometimes you have to pay for a more desirable lifestyle.

  9. Reply
    Dave January 2, 2015 at 4:38 AM

    I pretty much have to agree with Doug on most of his points. I will say though that I’ve done it a few times–bought, landlorded from afar and done ok. If you are going to do it, know what tools are available to you such as AHRN, USAA tenant screening service, military by owner etc. A newer home leveraged with a 100% VA loan if bought at a reasonable price can be a nice hedge especially if you have a reasonable chance at getting re-assigned to a post again (and/or have a network of friends and colleagues that may be on the same rotation). I know a few folks who bought houses in DC in the 90’s, only to be reassigned there in late 2000’s so they had locked in low real estate prices and while they were gone, had good military tenants renting their places and when they returned, they were receiving $3000+ BAH payments on $1000 mortgages. For three years, they were essentially making $1500-$2000/month tax free profits on their investments by living in their own homes and not on base.

    I’ve rented a house in Olympia near lewis/mcchord for 3 years to one military family and just resigned another military family with absolutely no vacancy in between for another 2 years. In all likelihood, the current tenants will stay 3-4 years so at the end, the house should still be in really good shape, it will have 20 years left on the note and considerable equity built up by my and tenants’ BAH over almost 10 years. Total maintenance has cost very little and I take the occasional space A flight out there to visit friends and check on the house.

    A lot of “ifs” and caveats; but it can be done if you know what you’re doing and/or can homestead for a bit.

    • Reply
      Doug Nordman January 2, 2015 at 7:18 PM

      Thanks, Dave, great comments. When it’s good, it’s pretty good. When it’s bad, it’s awful. AHRN has been a particularly useful tool, and far better than Craigslist!

      Every career is different, and every family grows/changes over the years. I’d say that it’s almost impossible for a military family to predict their chances of being reassigned to a post, especially if they’re staying flexible on their service obligation. For example I know one servicemember who spent over 25 years trying to return to a Norfolk duty station to live in their Virginia Beach home.

      We’ve owned a home on Oahu for 25 years, and it’s been rented for 17 of them. We have three huge military bases within 25 minutes. In the 1990s it was renting for much less than the mortgage and for almost a decade was assessed at much less than we paid for it. Today, after 25 years of ownership, it’s renting for much more than the mortgage and assessed at just about the rate of inflation since our purchase price.

      Its cash flow beats CDs, but overall it’s been a mediocre investment. Today its primary value is a potential tax-free gift to the next generation.

      A few servicemembers are hard-wired to be landlords. I feel that they’ll succeed no matter where they buy (or live), but they’re a very small percentage of the population. For the vast majority, the downside risks outweigh the upside rewards.

  10. Reply
    Peter Gregory January 2, 2015 at 2:20 AM

    So much nonsense parading as economic counsel. Having bought and sold 3 homes in Navy hub areas over a 23 year career some comments.

    -A house is a place to live, period. It is not an investment, as a stock or bond, or an ATM. There is a cost associated with having a roof over your head. I think owning beats renting ever time.

    -Plan on owning a home at least 5 years, if you have to PCS, guess what, there are many, many people more than happy to pay rent to live in your home. and they are just like you. If your home is in a good school district relative to the military base, so much the better. I do not think the Navy is leaving Norfolk, San Diego, or closing the Washington Navy Yard anytime soon. You’ll do fine.

    -As with all other things, military careers and services come to an end sooner or later, so where are you going to live and how much equity do you have in your current situation?

    • Reply
      Doug Nordman January 2, 2015 at 7:08 PM

      Peter, your experience is different from that of many readers.

      I’m working with one reader who owns a house in the Norfolk area in a neighborhood that’s gone downhill in just two years since they transferred. After a four-month vacancy, their new tenants are paying $150/month less rent than the mortgage. In other words the landlords have already lost several thousand dollars in rent and will continue to lose $1800/year before fees, maintenance, and repairs. The home was recently assessed at a 20% lower value than when they were living in it… in just a couple of years. When they sell, they’ll have to bring money to the closing.

      Over the long term– at least five years and preferably longer– I think that owning a home is generally better than renting. However it makes little sense to complicate a busy military life with home ownership, especially when that ownership is leveraged with mortgage debt. Upside is great when it happens. However the downside is much worse than the upside, and statistically more likely to happen.

      When a military career comes to an end, I’d hope that a family was saving and investing in assets that would produce a home down payment. That could be CDs for a purchase a few years away, or a short-term bond fund for 5-10 years away, or equities for a purchase that’s more than 10 years away. Wherever they decide to live, they’d have months to learn the neighborhoods and buy a bargain at a substantial discount. That alone would produce equity– and without years of attempting to leverage that equity through mortgage debt. It makes no sense to take outsize risks of losing money at every duty station in hopes of having equity when you hang up the uniform.

      While your constructive comments are always welcome, the sentence “So much nonsense parading as economic counsel” is not constructive. We won’t read any more of that here.

  11. Reply
    annielogue January 1, 2015 at 1:43 PM

    This is great. Homeownership has been oversold to everyone. It makes a lot of sense to own a house outright in retirement, but beyond that, so much depends on one’s specific situation – and a career with a lot of moves isn’t one of the factors in favor.

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