Using real estate to build wealth: here are three ways your home can increase your net worth - Real Estate - Cover Story

Black Enterprise, March, 2004 by Matthew S. Scott, Carl Unegbu, Aissatou Sidime

Richard Flateau, president of the Bedford-Stuyvesant Real Estate Board in Brooklyn, New York, says the simplest approach to trading up is to first build up substantial equity in the home, and then use the equity as a down payment on the more expensive property. "You have to have enough equity to cover the down payment and closing costs of the bigger property--say 15% to 20% of the total cost of the larger property," he says.

In some cases, homeowners can move into a larger home without having to dramatically increase their income. "Most people's incomes tend to be higher when they trade up, but not always," says Flateau. "If the price of the new property is a lot higher, then you probably need more income, but if you put more money down, it may be different." In fact, a higher down payment on the larger property allows you to finance the exact amount of mortgage loan you can afford.

Take Myrtle and Reginald Campbell. They wanted to trade up from the 1,475-square-foot, four-bedroom home they bought in San Antonio, Texas, for $72,000, to a larger home that they decided to build themselves. Their new 1,959-square-foot, three-bedroom home cost $174,000, including land and construction, more than twice what their first house cost them, but they didn't skip a beat.

Myrtle, 43, an insurance claims representative, and Reginald, 43, a courier for Overnight Transportation, sold their smaller home for $88,000 last September, $16,000 over the original cost of the home. They used the proceeds from the sale to pay the $10,000 deposit plus closing costs on their new home in Schertz, Texas. The Campbells' great credit scores and household income of $90,000 allowed them to finance $166,000 of the $174,000 purchase price at an interest rate of 5.99%. The $1,300 mortgage payment is comfortably affordable for a couple with their income level.

"We always wanted a bigger house," says Reginald. But the size of the home is not the only benefit the Campbells enjoy. "I knew that taxes were cheaper being outside of Bexar County [the home of San Antonio]. Insurance is cheaper too. And I wanted my daughter to experience a new environment," he says.

There are other ways to trade up. McDaniel says a more sophisticated swap of smaller and larger properties is done with a "Section 1031 exchange." In this kind of exchange, the real estate owner can avoid tax liability from a property sale by purchasing another property within a six-month window using the escrowed proceeds from the first sale. Another way to trade up is through a trust deed exchange. For people who have paid their mortgages in full, they can exchange the smaller property for a larger one, with the difference in the values of the two properties being liquidated through periodic payments per the terms of the trust deed.

By trading up, Flateau says, the real estate owner can take control of a larger asset, which has the potential to lead to greater wealth. He notes that going from co-ops and condos to two- or three-family homes is more typical in trade up transactions in places like New York than in other markets. He also says there are tax advantages to trading up, such as the exemption from capital gains tax on the proceeds of the sale of the smaller home.