Dream home vs invest – What should I do?

I get asked all the time: “Should I buy my dream home … or should I invest?”

There are two ways to answer this question:

• With numbers (what’s the return on investment?)
• With emotion (what’s the right choice for my family?)

In this article, I’ll answer this question both ways. That way, you can make the decision that’s right for you.

Before we get into it, you should know that here at Opes we keep the lights on through New Build investment property.

So, there is an incentive for me to say: “Buy the investment property, every time”. But I’m not going to do that.

Not everyone should keep buying investment property; sometimes buying that dream home is the right move.

So in this article, I’ll explain the pros and cons as honestly as possible. Then I’ll take a step back so you can make the best decision for you.

Case study – Couples at odds: Dream home or invest?

Here is an email I received from Sam and Alex – they’re a couple of investors.

Sam said: “We have a nice home we live in. We’ve also got two rental properties. I’m super happy with where we live, but my spouse wants to live in a bigger house.

“Our house is almost paid off, we own our own business – I want to know what the difference would be for us if we:

• Sell our house and buy that big new house, or
• Should we renovate our current home and buy an investment property instead.”

This is an interesting (and common) one.

So should they buy a bigger home to live in, or should they renovate and buy an investment property instead?

What’s the better return on investment?

Right, let’s look at the numbers.

Option #1 – Buy the bigger home

Let’s look at Option #1, which is selling their home and buying a bigger property.

Sam reckons that if they sell and buy a bigger home, they’ll need to spend an extra $1 million. They’ll get a mortgage for that extra $1 million.

The benefits of this option is that they’ll own a more valuable asset (the house). This house will likely increase in value. On top of that, Sam and Alex will also pay off some of that $1 million of debt.

If you add it all up, I estimate that they’ll get around $1.4 million worth of returns over the next 15 years.

But … dream homes cost real money. And Sam says they’ll have to borrow that extra $1 million.

That mortgage will likely cost almost $1 million over the next 15 years; $640,000 of that goes to paying the bank interest, while the rest is paying down the mortgage.

So, let’s just look at the numbers from buying a bigger house.

If they get $1.4 million out and they put about $1.2 million in. That means their return on investment is around 20% if they upgrade to their dream home.

Option #2 – Renovate and buy an investment property

Now, let’s look at the return if Sam renovates and buys an investment property.

To keep this fair, let’s assume Sam is still going to spend $1 million.

So, in this scenario let’s say he spends:

• $150k renovating the family home
• $850k on an investment property

We usually work to a 2:1 return on renovation money. So, if Sam spends $150k on renovations, his house could go up in value by $300,000. That’s called instant equity.

Now the couple have upgraded their home, it’s worth more. It’s a more valuable asset. That means they get more money from capital growth.

In this scenario, they also spend $850k on an investment property. That means they get rental income to help pay some of the mortgage costs and they also have another asset that is potentially going up in value.

When you add this all up, this option gives total estimated returns of around $1.6 million. That’s an extra $225k compared to buying their dream home.

But the big difference is what they need to invest.

Because they have rental income, Sam and Alex get a higher return. But they put less money in.

They get an estimated 113% return by staying where they are then buying an investment property.

What’s the better financial decision?

From a pure numbers-based perspective, renovating their own home and investing is the better financial decision.

Their estimated return is 113% if they renovate and invest. Compare that to upgrading their own home, which only has a 20% return.

But these kinds of decisions are usually not this clear cut. We also need to consider the emotional side and how Sam and Alex want to live.

What’s the right choice for my family?

That being said, Sam and Alex have to consider what’s going to make both of them happy.

There are pros to owning your dream home too.

For many, buying a dream home is a major personal achievement. We spend so much time dreaming of the perfect house. When we finally make it happen, we feel good that we achieved our goals.

It also represents a place to create more memories with the family. That could be because the new house has more space in the backyard for the kids, or maybe it’s the dream kitchen for entertaining friends.

As you get older, you start to wonder – when am I going to get my dream home? So, there is a sense of personal achievement in doing that.

Life is too short to be miserable. If your dream home is the only thing that’s going to make you happy, then go for it.

If your partner wants the dream home then maybe that’s a joint decision you need to make.

But on the other hand, the dream home can also stop you from making your other dreams a reality.

Buying your dream home doesn’t just mean a bigger mortgage repayment right now. It can often mean being poorer later on in life because the big mortgage stopped you from investing.

Sam and Alex may have so much debt that the bank won’t let them buy an investment property. The risk is that you get to retirement, or want to stop working early, but you can’t. You might not have enough assets to do that.

What’s the right decision for me?

There is a trade-off. Sacrifice now, or later.

Pass on the bigger house now, but have a higher passive income in retirement.

Or go for the dream home now, but retire with less money.

In this scenario, the numbers say that investing is the right financial decision. And generally, that’s my advice for Kiwis who don’t have many assets (apart from their home).

Once you’ve got some assets, then go for the dream home.

But Sam and Alex are in a different position to most New Zealanders. They’ve done well. They own their own home, they’ve got 2 rental properties, and they have a business.

They have some assets, so if they want to reward themselves with a bigger house, they can probably afford to do it.

But if they came to me without any assets, I’d probably say: “You can’t afford $1 million for your own home. You need to invest first.”

But remember, sometimes decisions aren’t just about numbers. Maybe the right answer is a bigger house for your family, or a place closer to work.

In the end, you’ve got to do what’s right for you.