How to calculate the return on investment on your primary residence? I have a pet peeve when others talk about their real estate in this real estate crazy city called Vancouver. Even I am guilty of it sometime, thinking that increase in property value is something to write home about. Especially when Vancouver has become Canada’s first city of millionaires, where the average net worth in 2015 was $1.036 million. My pet peeve is when people don’t calculate the return or profit on their home sale accurately. When they overestimate the return on investment on the primary residence.
It irks me when someone says: I bought this house in 1992 for only $250,000, now in 2018, it’s $1,250,000. I made $1 million!
One has to brush aside the glitz and glam and crunch numbers to determine the real number. In order to accurate calculate how much you’ve really made, technically there are a number of other costs that should be calculated into that value, and it would be prudent to compare this number to a benchmark stock index.
Let’s take for example a house bought for $270,000 with a $190,000 mortgage on a 25 year amortization schedule and a 2.84% mortgage rate, 5 years ago. Let’s say you sold the house for $500,000 this year. At first, when you calculate it hastily, it sounds like you made $230,000, but if you look closely it’s much less than this.
I would recommend you sit down, maybe grab a glass of wine, because this is kind of painful and will bring your beer goggled real estate ‘gains’ vision back down to reality to the cost of owning.
Table of Contents
To Calculate the Return on Investment on Your Primary Residence:
Here are the other numbers you need to calculate the ROI on your primary residence.
mortgage interest and mortgage penalty costs
If you have a mortgage, you pay mortgage interest to the bank for borrowing their money. It can be a lot of interest that you aren’t aware of because of the amortization schedule. For example, on a $190,000 mortgage with a rate of 2.84% on a 25 year amortization schedule, the interest cost is about $5400 for year one. In year two, it is $5200, year three $5000, year four, $4850 and so on.
The total amount of mortgage interest paid after five years is about $28,500. That’s a lot right?! Already it feels like the ‘gain’ from the home sale isn’t that much!
This number has to be deducted from your selling cost in order to reflect the cost of borrowing for your home.
If your mortgage is even higher than this (and many in Vancouver are much much higher than this, I have a friend with a $1 million mortgage), your interest costs are even higher, obviously!
In addition, if you have a closed mortgage, you will have to factor in the mortgage penalty costs if you were to pay off your mortgage balance early. Usually the mortgage penalty is about 3 months of interest, Rate Hub has a mortgage penalty calculator.
Home insurance costs are another factor.
maintenance, assessment, or renovation costs
If you live in a condo you pay maintenance fees you should calculate how much you’ve paid over the years. If you paid any sort of special assessment for your strata you should also include this too.
If you live in a house or a condo and you upgraded the appliances and spent $3250 upgrading the kitchen appliances and $3600 updating the bathroom, you should put this in your calculation. Let’s say you had to repair the roof for $13,800 too three years ago.
Already, that’s another $20650 taken off the top.
If you are home owner, you pay property taxes. People who rent don’t have to pay property taxes. Property taxes go ‘poof’ unfortunately. Let’s say for the past five years, your property taxes were about $500 a year. Over five years, that’s $2500.
There goes another $2500 for property taxes.
Here’s how to pay your property taxes with a credit card to lessen the sting.
real estate sale costs
Real estate costs are a b*tch unfortunately. In British Columbia, on the first $100,000 it is 7% commission split between the buying and selling real estate agent, and 2.5% split between the buying and selling agent on the remaining balance. Plus 5% GST. So on a $500,000 house, the total commission amount is $17,850.
Of course, if you use discount real estate brokerages or negotiate with your realtor, you may be able to bring this down. For example, discount realtor brokerage One Percent Realty may lessen the selling realtor fee but possibly not the buying realtor fee unfortunately.
It’s painful I know, but now we must subtract $17,850 from the $500,000 sale price.
opening and closing costs
Notary or lawyer fees vary but can be about $2000 for closing costs.
Don’t forget about the opening costs when you bought the house five years ago, let’s put in another $2000.
The hemorrhaging of ‘profits’ is slowing down, and we subtract another $4000 from the sale price.
Here are some of the closing costs when selling a home in BC.
capital gains taxes (if any)
In Canada, on your primary residence, you don’t have to pay any capital gains taxes or taxes on the sale of your home (which might get me on a huge rant of why the speculators are flipping properties in Vancouver and making it so unaffordable, but let’s not get started, shall we?). If it is not your primary residence you will have to pay taxes.
What’s the total?
Adding all of these numbers up, you get almost $74,000.
$500,000 – $190,000= $230,000 (the number that most people think is the return on investment)
$230,000- $74,000= $156,000 over 5 years on a $80,000 investment (the down payment).
Using this return on investment calculator by Calculator.net, the annualized return on ‘investment’ was 14.29% over 5 years.
Finally You Compare This Number to a Benchmark Index
Compare the number above to the S&P500 the 5 year annualized returns from the last five years which was 13.46%.
So if you were to rent and have $80,000 to invest or to plunk down into a down payment, you would come out similarly as putting your money down into a home. However, there are lots of variables and assumptions to this. Of course if you have $80,000 to invest in the market that means you also have money to pay for rent too. In addition there are variables to this calculation and this is a rough guideline. For example, if you have HIGHER mortgage debt that means higher mortgage interest costs even if you have secured the same ‘great’ rate of 2.84%– for example a $570,000 mortgage is about $15000 for the first five years using the calculator. And it depends on when in the real estate cycle you are. Also depends when in the stock market cycle you are.
In addition, one could argue that the amount of mortgage interest paid to live in your own home is like paying ‘rent’.
It really depends on whether your home is considered an ‘investment’ but personally I would be wary of calling it this because of the impending real estate crash in Canada.
It will come, eventually (right?).
For real estate crowdfunding idea in Canada, click here.
How do you calculate the return on investment on your primary residence?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.