Home upgrade?

[vagon]

Hi all,

Been lurking and reading the blog for a while have been reducing my spending diligently and now I finally have (what I hope to be) a non-trivial question to get your thoughts on.

First some background:

Income: dual, no kids @ ~ $130K after tax.

Current expenses:
A rather too high $90K for FY13/14. As this isn't about budgeting I wont go into deep detail unless asked. FYI at a high level this is primarily due to travel, dining out and drinks. We have taken measures to reduce this and are on track to a ~20K drop and I'll be aiming for more.

Assets: ~600K Apartment, ~20K shares

Liabilities: ~120K mortgage, ~ 17K LoC

Decision
My wife and I are ready to have kids in the near future and as such would like to upgrade from our apartment to a 3BR house. We have been looking around and in the areas we want the prices are all around 1mm. I'd like to aim for retirement in ~10yrs and barring emergencies can expect my income to rise to a level that should off-set if not exceed my wife being on maternity leave etc.

Is this over-stretching?

Here are my own pros/cons for the houses in that price range:

Feature	Pro	Con
Transport	Close to public transport, parents.	Actual time lost to being further out is negligible
Mortgage	We've paid similar levels down on lower income/higher spend in 5 years	Its likely to be a ~700K cloud over our heads
ROI	Historic price growth, not affected by downturns	Could potentially achieve greater returns renting and investing the difference
Ownership	Stable environment to raise kids, can DIY for returns	Cost of maintenance, lack of diversification given levels of debt
Cash flow	Cost decreases over time as mortgage paid off	Opportunity cost as rent cash flows immediately lower

[zolotiyeruki]

Are you looking to keep the apartment and rent it out, or sell it and roll the equity into your new home?  How much time do you have before it is paid off?  Is there another alternative that would give you a bit more space without doubling the cost of your housing?

[rmendpara]

Most houses, if well maintained and in a good location, will maintain their value over time. A primary household is not an investment. A primary house is a hedge against rising rent.

Based on your net $130k income, and $20k assets, you can't afford a $1 million house. This sounds like roughly a $200k annual gross income, so you're thinking 5x income is reasonable? No. I don't know how else to explain this. The only remotely possible exception is if you live in Manhattan or SF (probably can't find $1m there anyway) or Boston or wherever else RE is pricey. Even then, this house/income ratio should scare you!

As far as retirement in 10 years, I'm not sure how you plan on achieving this. You have a spending problem (assuming you want to retire eventually). You owe $17k on a line of credit? That's absurd given how much you make. Looks like you have a NW of around $483k (600 + 20 - 120 - 17), which is not bad assuming you are in your early 30s... but should be much better given your income. Plus, it's all in your primary residence which, again, isn't really an investment. It's a place to live, store of value, and hedge against rising rent.

Buying a home is a solid decision, but at this multiple of income, will require some serious cutbacks in your spending quite a bit ($800k loan @ 4%, 30 yrs, will be ~$3.8k/mo before taxes, insurance, HOA fees, and utilities... probably close to $5-6k total). It will be more manageable if you sell your current home and use the proceeds for the new purchase. Other option is to keep your home, rent it out, and take out a mortgage for the new one. Regardless, you'll have to come up with $200k cash in the near future.

Good luck with whatever you decide.

[vagon]

Thanks guys.

@zolotiyeruki

"Are you looking to keep the apartment?"	Sell the apartment, I already feel over invested in real estate just from the primary place of residence.
"How much time do you have before it is paid off?"	We could pay the apartment off in 2-3 years, all else being equal, but that would probably mean delaying kids. Current cost of Mortgage /yr is ~11K
"Is there another alternative...?"	Without going interstate the only option is renting, we could rent in the same ~1mm - 1.2mm housing range for ~700-1000 p/wk.

@rmendpara

"Most houses, <are not investments>"	I agree, especially given inflation - thanks for setting me straight probably confirmation bias on my part.
"this house/income ratio should scare you!"	Absolutely it scares, hence why I appreciate your help on the matter. I live in Sydney, Australia which is slightly more expensive than Boston or NYC according to Numbeo, but I'm sure that Numbeo's numbers do not correlate to the same lifestyle as MMM would advocate.
"You have a spending problem"	Agreed, we've already taken steps to reduce it but in the interest of being honest I thought I'd provide that info to give an indication of my history.
"You owe $17k on a line of credit? That's absurd given how much you make."	I'm open to closing this down, I have it purely for taxation reasons. Australian tax law means I have to keep debt from my primary place of interest separate from my deductable investment debt. I could pay this investment debt off immediately, but this would make my share investments less worthwhile and reduce my (meagre) diversification. The idea behind this is something called "debt recycling" I use the tax back from the deductible debt along with dividends and pay that into my non-deductible mortgage. Capital gains are a bonus.
"Looks like you have a NW of around..."	Yep its about $480K. I am 30 and my wife is 28.

Does this information change your perspectives at all? Does renting become a more obvious play?

Thanks again.

<Edit: formatting and added some info>

[former player]

Are you putting anything into pensions?  Any assets other than $20,000 in shares?  If you are relying solely on equity in your principal home to fund your retirement, it ups the risks of putting all your finances into it.

Re housing, you currently have $463,000 equity with a mortgage of $137,000 (including the line of equity) and after selling that and buying a $1m house are looking at $463,000 equity with a mortgage of $537,000, which is just over four times your annual income.  What percentage of your net income would you be paying in housing costs after the move?

I'm used to house prices in London. We haven't seen big drops in value for a long time, have seen very significant capital increases (property in the UK has historically been a very good investment, for a number of reasons) and are pretty used to a four times salary multiple for mortgages.  That is a very different perspective from most of the USA, where there is a seemingly endless supply of housing and limited capital appreciation outside a few specific cities.  I suspect that for purposes of comparison Sydney is closer to London than most of the USA.

You are young (30 and 28).  You have very good incomes which are stable and potentially increasing (depending on whether and how much your wife wants to work after having kids).  You already have a substantial net worth.  You spend a lot in relation to your earnings, but are looking at changing that.  You want kids in the near future.

My view is that your $1m house is financially doable.  Short term, it increases your risks (exposure to the Sydney property market) and reduces potential income (from investing elsewhere).  Long term you have somewhere to bring up your kids for the next 10 or 20 years, and potentially live in for life, but will not have optimised your finances for financial independence and early retirement.  So buying this house is less a financial calculation than a fork in the road moment for you: do you want to bring the kids up in a cheaper home (not necessarily your current condo) and get to FIRE pretty quickly or buy the $1m house and take the slower route to FIRE?  You could delay the decision for a bit, if you wanted.  It'll probably take you a year to have a baby and most of another year before it starts walking, and before its walking a baby is really not going to know the difference between a condo and a family house.

[vagon]

Hi player, thanks for replying.

"Are you putting anything into pensions?"	Yes, I put 12% of everything into super which is the Aussie equivalent of a  UK private pension or US 401K. I believe there's about ~40K in there right now and my wife has something comparable too
"What percentage of your net income would you be paying in housing costs?"	Reducing spending by about $30K/yr should be achievable this year. We already save about $55K/yr so we could put lets say a conservative $75K to work against the house or by investing. Costs in that should be stable in the long term as we would no longer have to pay strata to the apartment's body corporate, but would have to put in money for maintenance/improvements.
"a baby is really not going to know the difference between a condo and a family house."	That's a very good point.

Really good to have the UK perspective here, thanks again.

[gimp]

I love your formatting, not something I've ever seen before.

I think you should count your 'super' net worth; an extra $80k there is noticeable. Not today, but in the future.

If you have a 2-bedroom apartment, I don't think a baby or small child will know the difference between that and a house for at least a couple years. Now, in a one-bed, that'd be very tough.

Cutting your spending is, as you know and as everyone said, a priority. Even if you cut spending, though, it'd be tough to buy the house and retire within ten years; you'd certainly have the proper net worth but it would be locked into an illiquid, non-cash-bearing asset.

Here's a question: have you considered renting out the apartment you currently have? How much would that fetch a month? At $600k it's unlikely to be a good idea, but maybe something to look into.

[vagon]

Hi gimp,

"I love your formatting"	Thanks! I tried with the default quote option and it was pretty clunky so I switched to tables. I should write up a quick how-to because tables might be a bit confusing to emulate for people unfamiliar with html and I'd like to give back to the forum even if its only a little.
"the proper net worth...would be locked into an illiquid, non-cash-bearing asset."	Yes, this is something I'm definitely concerned about. I've already looked into a vanguard managed fund (ETFs have too high a transaction cost for regular savings) which would provide diversification. The issue is any return from an investment at my tax rate (45%) would have to be pretty high to be worth it. E.g. on 5% mortgage I'd need around a 9% return. Then again I could pay more into super, which (in order to encourage savings) is only taxed at 15%, but is subject to higher fund management fees, less control and less liquidiity.
"have you considered renting out the apartment you currently have?"	Yes, but it probably doesn't make sense if we also buy for obscure Australian tax reasons. It is certainly a consideration if we rent instead though.
"How much would that fetch a month?"	In the current market about $550p/wk so lets say $2200 a month. Given the places we're looking to but are around $800 to rent, the net loss would leave housing costs about $2K/yr above what we pay on our mortgage now.

Cheers

[nora]

I couldn't work out if you are quite putting the $25000 a year into super on not, that might be worth it before overpaying your mortgage.

The other thing which another person pointed out already is the delaying thing. I know it's tempting to have the house all ready before you have children, but you don't need a three bedroom home now so wait until you do, (like when your third child turns one) and save yourself a packet for the next ten years. You could be retired before you change your home! What if you can't have children?

[vagon]

Hi Nora,

I'm not doing the full $25,000 in super as I've been a bit dubious about management fees and the locked away nature of super, I am doing more than the require ~9% though.

You make a very good point on simply expecting children, there's a real (and hopefully never realised) risk of complications.

Thanks for your input.

[urbanista]

That's exactly what we did: bought a house in Melbourne because we planned for the kids. Lots of regrets later.

I would be fine with $1M house with roughly $500K mortgage in Sydney. With 50% LVR, you are doing much better than most of the people.

However, look at this:
- Are you sure you can maintain your income at 130K after the baby is born? Your wife might want to stay home above the 1 maternity leave. She may not want it now, but it is common to have a complete change of heart after the baby is born. Are you able to sustain your lifestyle and pay new mortgage with one one of you working?

- Insurance, maintenance and utilities are considerably higher for the house than an apartment. We actually paying about $200 per month more, and already spent about $10K in house maintenance. Mind you, the house was in a very good condition when we bought it. Still, some $$ here and there, it really adds up.

- Personally, my biggest regret was that by buying a house, we locked into a 1 hour commute to the CBD. Before baby, 1 hour commute each way was tolerable. After a baby, it became really, really bad. I had to switch jobs to a local one as I could not take it any more. DH still does it and it sucks. I have limit my career prospects to work locally as someone has to do child care drop-off/pick-ups and cook dinner. It would have been way easier if we lived in a smaller place closer to the CBD.

- Increased chores: more space to clean, decorate, and  the worst of it all is garden maintenance. Boy, does the garden keep DH busy! Lawn moving, tree cutting, watering: about 3-5 hours weekly on average. DH enjoys that, but do you? Also, because DH does this work, he has less time to help with chores inside the house, so 90% the house work falls on me. Every Sunday morning, while cleaning three bathrooms instead of one, I wish I had my small low maintenance rental unit back! Where gardening was done by landlord, and cleaning inside by DH.

We moved where we are only because the in-laws are over the corner and they help with child care, which is very important to us. The area has no small units or apartments though, so we decided we might as well buy a large house to "grow" into it.

Would I do it again? No.

[vagon]

Thanks urbanista, as you say we are in a very similar position to yours so this post is very helpful.

"Are you able to sustain your lifestyle and pay new mortgage with one one of you working?"	No, its unlikely that we would be able to on one salary. This is also a good reason to drastically reduce spending, as insurance that she will want to stay at home. We have both agreed that at least part time would be good, but as you say perspectives change pretty quickly after kids I'm sure.
"Insurance, maintenance and utilities are considerably higher for the house than an apartment"	This is very useful info to have, I'll factor that in.
"Personally, my biggest regret was that by buying a house, we locked into a 1 hour commute to the CBD"	That is actually remarkably similar to the distance we will be locking in on a bus in peak hour. I looked at it from the perspective of it only costing us about $7K extra in time per year for a $200-300K difference in house prices.
"Increased chores"	I am similar to your DH, I enjoy landscaping/gardening and used to do a significantly larger lawn while living at the parents (granted many, many years ago) so I'm actually looking forward to working out there. I'm not sure inside house work would increase hugely as we would be looking to only add one bedroom and not several bathrooms like yourself, but granted there would be a increase in size across all rooms. Would it be as much of an issue if you had a 3br 1 bath house?
"We moved where we are only because the in-laws are over the corner and they help with child care, which is very important to us."	This is a big factor for us too. What are your thoughts on kids in apartments though? How long is it doable?

Cheers

[urbanista]

If your apartment has lifts (or located on a ground level), you can absolutely have a baby in the apartment. I have a European background, my parents raised me and my sister in a 1-bed/1-bath, 50sqm, 5th level, no lifts apartment. My childhood was very happy. It was tough on my parents though, so I would not recommend this. But all of my European friends start family in 2-bed apartments, both in Melbourne and Sydney. They usually move out to a larger place only after a second child is born. If your apartment has lifts you may even prefer it to a house initially: you might want to look after your 2-months old baby on a Saturday morning in order to give your wife an opportunity to catch up on sleep, instead of moving lawns. 

Look, my main message to you is this: have a baby first and re-evaluate. If you still want that 3-bed/1bath, $1M worth house with 1 hour commute, you can always buy it later. You have already missed on the property boom in Sydney, so there is no rush now. There is a good chance though that you would want something quite different after the baby is born, though.  That's what happened to us anyway.

[vagon]

Really appreciate the time urbanista, thanks

[agent_clone]

Apartment living is pretty standard in many parts of the world (e.g. Singapore, Hong Kong, Japan, many places in Europe).  There was also some radio program I was listening to that was saying that kids living in apartments tend to be more independent because they tend to be allowed out on their own more (I believe this was an Australian study).

If you want the kids to run around, thats what parks are for!  As urbanista is suggesting, re-evaluate after you have kids and save money in the mean time.  Personally I would be interested to see what happens with the Sydney market once interest rates go up, and some of those overcapitilised investors start feeling the pinch.

For those commenting on retirement accounts, I consider that while superannuation may be good for a standard age retirement, for early retirement it is essentially useless as, except for dire circumstances (i.e. financial hardship or terminal illness), you can't access it until preservation age (for the OP currently 60).  Also for the OP's age who knows what fiddling they will do with it over the next 30 years (the preservation age is likely to go up for one)...

[historienne]

That is actually remarkably similar to the distance we will be locking in on a bus in peak hour. I looked at it from the perspective of it only costing us about $7K extra in time per year for a $200-300K difference in house prices.

The thing is, when you have a small child, that time is going to be worth way more to you than the wages you give up for it.  I have an hour long commute that I do, on average, two days a week.  On those days, I leave the house before my daughter wakes up and get back an hour before she goes to bed.  I would really, really not want to be doing that five days a week (and I don't think my husband would be very happy about picking up the slack, either).   Same goes for weekends of lawncare - we do have a house and like gardening, but it is a pain in the butt to be doing with an infant.   We bought the house over the apartment because we were renting and it made financial sense to buy, and we figured we would want the house when we have more/older kids.  But if we already owned an apartment, I would have vastly preferred to stay in it as long as possible.

[vagon]

"I consider that while superannuation may be good for a standard age retirement, for early retirement it is essentially useless"	My thoughts exactly. What are your thoughts on dropping 10 or so years expenses into it though as the tax benefits are really huge with the expectation we'll get to use them eventually?
"if we already owned an apartment, I would have vastly preferred to stay in it as long as possible."	This is a recurring theme I'm hearing, I'm trying to figure out how this configuration would work in our current 2br - it could be a good way to remove some unused clutter at the same time, but would cause some headaches moving the quiet study to a noisy living room. I'm assuming with a kid that noise is coming anyhow though so this is probably a moot point.

[Primm]

+1 to the "wait until you actually have kids" vote.

My rationale is slightly different though. I'm coming from the perspective of one who works in NICU, and deals a lot with fertility-impaired couples.

You may not be able to have children. If you can't, and you bought a bigger house solely for the purpose of fitting in those children, I can't even begin to imagine the strain that would put on you and your partner's mental health.

The other reason? Multiples. Babies don't just come in single packages, you know. Sometimes, even without fertility treatment, there are two, or three, or more... ;)

[urbanista]

Another thing you need to think about (or rather your wife should think about) is there is a huge probability that her job will change when she comes back to it in 1 year time after having a baby. Majority of women that I know, who returned to work after a baby, had issues at work and had to either quit or get a new job or somehow went under a huge amount of career related stress. I was very close to quitting my job due to stress, and the last thing I would want is a big mortgage over my head in that already tough time of my life. Now, that my baby is almost 2.5 y.o., sleeps through the night and is happily settled into a child care, I can handle more stress and take professional/financial risks again.

[urbanista]

I'm trying to figure out how this configuration would work in our current 2br - it could be a good way to remove some unused clutter at the same time, but would cause some headaches moving the quiet study to a noisy living room. I'm assuming with a kid that noise is coming anyhow though so this is probably a moot point.

Your ideas of "quiet" and "noisy" might change when the baby arrives lol

[greaper007]

Sorry to thread jack, but I'm so glad I don't live in Sydney...$1million for a house on a $200k salary, wow.     And I don't think the OP is being unreasonable, that's what people do in a lot of really expensive areas.

[vagon]

No problem greaper, I am acutely aware of it. Scary thing is we're lot better off than a lot of people too because we have a fair bit of equity in our apartment. Don't get me wrong I love Sydney and our friends and family are all from here, but hearing some US people get 100K+ salaries each and housing only costs $300K really puts a dampener on the lifestyle.