CA - buy or rent (socal) - 1st child on the way

[bryan995]

Looking for some input on evaluating the potential tax benefits of owning compared to renting in CA.
It looks like in CA homeowners can deduct interest from both federal and state?  If so, awesome!

About us:
    DINKs, ~240K gross, itemized taxes in 2016
    Currently renting a 1bed/1bath 'luxury' unit for $2100/mo. 
    1st child due in Sept

Average 1bed/1bath in this area are ~$1800, the extra ~$300/mo was worth it to us (new construction, gym, classes etc)
Commutes are 1 mile and 10 miles, no traffic, great area, great schools.

Yes - we could move further away to save on rent ($1500 for 1bed/1bath) but this would add considerably to our commutes and bring traffic into play (>30mins each).

We both plan to continue to work after the baby arrives, but do not want to over-commit to a massive monthly housing payment should our plans change.  Hoping to make the numbers work with only 1 working adult.

Given the child on the way, we are looking to move to a slightly larger space (to allow visitors, baby room etc).

Option 1:
Rent 2bed/2bath, 1mile/10mile commute (no traffic), $2300/mo
    (no tax benefits)

Option 2:
Rent (luxury) 2bed/2bath, 1mile/10mile commute (no traffic), $2700/mo
    (no tax benefits)

Option 3:
Buy 3bed/2bath home ($800k), 10mile/20mile commute (no traffic), $4000/mo
    P&I = $3000/mo [$2075interest/$925principal] - $640,000 mortgage / 4% interest / 30yr fixed
    PT = $700/mo (property tax)
    HOA/Insurance = $300/mo

    $2075MI + $700RET = $2775/mo tax deduction 
    $2775*12=$33000 deduction

    ~30% federal tax + ~9.3% state tax = ~39.3 tax
    $33000*0.393 = $12969/12 = $1080 tax savings / mo.

    $4000 - $1080 = $2920/mo effective monthly housing cost.
    + adding ~$900/mo in principal...

Option 1: $2300/mo
Option 2: $2700/mo
Option 3: $2920/mo (+$900/mo principal - $maintenance)

Obviously we are leaning towards option #3.. :)
Does the above seem correct?
What would you do in our situation (or what have you done?) ?

[joonifloofeefloo]

I would stay where you are, put the baby in your room with you, and have you or guests sleep in the living room :)

[bryan995]

Ha, trying convincing my wife! I've even suggested staying put, and re-purposing the lovely 28sqft walk-in closet we have as a private on-suite baby room.

Not totally ruled out just yet, but if the tax-incentive is as lucrative as I think it is then it seems worthwhile to become a home owner and stop renting.

[jac941]

Houses are a lot of work and babies are a lot of work. I would advise against adding both to your life at the same time. We did and it was a pretty stressful transition. Also, what you want in a house will change once you have the baby -- your priorities change in ways you might not expect. Stuff you find appealing now might seem horrific with a toddler or preschooler in the house.

I would advise you to stay in the 1 br until it actually feels too small for your family. Also, no space for guests to stay is a bonus in my opinion. Especially when you have a newborn. Visitors just have to find a hotel while they're around. It is far cheaper to rent the occasional hotel room than add square footage you don't need most of the time to your place.

[Tuskalusa]

I agree with the other posters who advise renting. While you're awesome case study captures the basics of the home purchase deal, there are often lots of hidden costs associated with moving (repairs, updates, moving costs, increased utilities, etc.). We moved when our child was one, and the escalating costs took me by surprise.

Add the housing costs to daycare, and you've really changed the picture.

That being said, I'd advocate for renting a 2-bedroom place. Having a second bedroom for baby and their stuff will make for an easier transition. Having some luxuries nearby like the gym and classes will be a nice break. (Not very mustacian, but I'm a fan of being able to work out easily.) The short commute is awesome!

Good luck!  You've got some exciting times ahead of you!

[Bruinguy]

I may have missed it, but does your analysis include property taxes?  Maintenance?

[bryan995]

Yes, I included property taxes above (abbreviated as RET - real estate tax), Ill change to this PT (property tax) :)

I did leave out maintenance costs (and PMI - would put down 20%).  But I suppose I should bring maintenance costs into play (call it ~$1000/mo).

Just comparing the effective monthly costs does not seem 100% fair, as with owning, there is also (~$900/mo) going towards principal - money one will hopefully see again.  Yes we should count the transactions costs of buying/selling but I feel as if the monthly principal gain needs to have its place above, or no?

~Modified effective costs:

Option 1: $2300/mo
Option 2: $2700/mo
Option 3: $3020/mo ($4000allin -$1080taxbenefit -$900principal +$1000maintenance)

The effective cost of owning only seems to be few extra hundred dollars a month.
(it is also a bigger space, 3bed/2bath - rent for a 3bed/2bath would be >$3000)

We are not necessarily looking to rent the cheapest place around, but looking for the best value.  It would also be nice to gain some free equity in the form of home appreciation - the SoCal markets seems perfect for this ... for now ...

[Laura33]

Well, I think you have a little apples and oranges comparison built in, because you are comparing the cost of the farther-out house to the cost of the close-in apartment, not the cost of the farther-out apartment.  So factor in commute time and the extra costs of what looks like 40 miles per day commuting.

You are right that you are getting your principal back at some point, but in the interim it is still cash that has to come out of your pocket every month.  So I would suggest doing this as a cash flow analysis, given your other increased costs (e.g., childcare) and possible decreased income (mat leave, possible part-time, etc.).  You don't want to spend so much on housing that you can't save toward your retirement as well (shouldn't be a problem on your income, but you never know).

Finally, on the tax benefit, you need to look at the delta between what you would save from buying (and itemizing) and what you would owe as is (using the standard deduction).  I think married couples who do not itemize already get a standard deduction between $12-13K; if you itemize, you lose this and replace it with your individual deductions (principal, RE taxes, charity, etc.).  Obviously, this isn't an issue if you already itemize.  But if you have been taking the standard deduction, the net benefit to you is really more like $20-21K (your "new" $33K minus the $12-13 you're already getting to deduct but won't any more).

Obviously, none of this addresses "my wife wants a house."  :-)

[Dicey]

Where are you planning to buy for 640k in CA?

[bryan995]

Well, I think you have a little apples and oranges comparison built in, because you are comparing the cost of the farther-out house to the cost of the close-in apartment, not the cost of the farther-out apartment.  So factor in commute time and the extra costs of what looks like 40 miles per day commuting.

You are right that you are getting your principal back at some point, but in the interim it is still cash that has to come out of your pocket every month.  So I would suggest doing this as a cash flow analysis, given your other increased costs (e.g., childcare) and possible decreased income (mat leave, possible part-time, etc.).  You don't want to spend so much on housing that you can't save toward your retirement as well (shouldn't be a problem on your income, but you never know).

Finally, on the tax benefit, you need to look at the delta between what you would save from buying (and itemizing) and what you would owe as is (using the standard deduction).  I think married couples who do not itemize already get a standard deduction between $12-13K; if you itemize, you lose this and replace it with your individual deductions (principal, RE taxes, charity, etc.).  Obviously, this isn't an issue if you already itemize.  But if you have been taking the standard deduction, the net benefit to you is really more like $20-21K (your "new" $33K minus the $12-13 you're already getting to deduct but won't any more).

Obviously, none of this addresses "my wife wants a house."  :-)

Agreed on the A&O comparison given the housing locations.
Technically we could buy in the same location we are now, for the same price, only for a slightly older home, 1960s vs 2000s (in the 10/20mile area).   This is not totally off the table.

Yes right now I am running the numbers assuming 401k, backdoor-roth-IRA all being maxed, and will continue to be.  We've been successfully living off one salary for 6 months now (I know, easy given our income) and pushing the other directly into down-payment savings (~$4500/mo living expenses).  Will run some numbers that take into account lost income or adding in daycare costs.

Yes, because we already itemize we should be able to capitalize on the entirety of the mortgage interest + property tax deduction. Given our high tax bracket this deduction is amplified.

The "my pregnant wife wants a house" issue still stands :)

Where are you planning to buy for 640k in CA?

It would be 640K + 160Kdownpayment so ~800K home.  Something like this in socal.
http://www.sdlookup.com/MLS-170019467-13560_Elderberry_Way_San_Diego_CA_92130

p.s. thank you all for the replies - appreciate it!

[Laura33]

(I know, easy given our income)

Hey, don't sell yourself short -- there are a lot of people who live in less-ridiculously-expensive parts of the country who still manage to blow through what you make and more.  :-)

[bigotepequeno]

Hey there! I'm anticipating a move to the La Jolla area myself and have been looking at condos in the $550k to $600k range and it occurs that that might be another option for you. You'd still be at 1,000 to 1,200 square feet, but it might be a way to split the difference between renting and owning--especially if you the house you're looking at has an HOA anyway. Just a thought from a pretty green mustachian. 

[Bruinguy]

I agree with the idea that you consider the $900 principal reduction as "investment" money in your budget.  I personally would not reduce my housing cost by that amount in this analysis and would believe that there was a substantial difference in cost than the other options in this analysis.  I'm not saying I wouldn't go with 3, but if I did go with 3, I would view the difference as the cost of being happy, if that was what made me (or my wife) happy. 

A last thought, generally, about home ownership.  You didn't discuss how long you plan to own the house, but I bought my first house with the expectation that I would move again in 3-5 years.  In hindsight, I wish I would have waited until I was ready to buy the house I was ready to live in for "ever."  While I would have missed out on potential increases in value during that time, I would not have subjected myself to additional transaction costs, which can eat up a lot of any gain that had been made over the short period of time.  On a $600k house, transaction costs of 6% would be $36k out of your equity when you sell.  Full disclosure, my experience was buying the year after the peak of the recent RE bubble, at 20% discount to the peak prices.  I put 20% down and still had to come out of pocket to pay off the loan and the realtors when I sold it 4 years later.   Hindsight is 20/20 and all.  This may not apply to you, but thought I'd share.

[Abe]

I agree that moving + new kid = hassle. We're moving to LA with a one year old and not looking forward to that transition. Of course it'll be great once we're settled down, but what a hassle in the meantime! Also keep in mind that the mortgage interest goes down every year, so your deduction will too. I'd say a better way to look at your net savings from tax deductions is take the total amount of interest over the life of the mortgage / term of mortgage in months * tax rate. Also remember to account for renovations that may occur (either planned or unplanned!) since it's rare that the house will be move-in ready.

[Dicey]

Funny, the Elderberry property looks very much like a local infill development that was built here in 2000. Similar look, similar original price, similar current value. I'd say it looks reasonable, except for its proximity to the freeway. This is known as an "incurable defect". Buy something further away, with fewer bells and whistles. They can always be added, but an incurable defect is yours forever.

[bryan995]

Hey there! I'm anticipating a move to the La Jolla area myself and have been looking at condos in the $550k to $600k range and it occurs that that might be another option for you. You'd still be at 1,000 to 1,200 square feet, but it might be a way to split the difference between renting and owning--especially if you the house you're looking at has an HOA anyway. Just a thought from a pretty green mustachian.

Absolutely - ideally we could find a home with little to no HOA and no mello-roos.  But should that be difficult, then we may shift our focus back to the condo space.

I agree with the idea that you consider the $900 principal reduction as "investment" money in your budget.  I personally would not reduce my housing cost by that amount in this analysis and would believe that there was a substantial difference in cost than the other options in this analysis.  I'm not saying I wouldn't go with 3, but if I did go with 3, I would view the difference as the cost of being happy, if that was what made me (or my wife) happy. 

Agreed - the $900 is better viewed as a 'forced investment' rather than reduction in housing cost.
We've owned a condo before so are familiar with the responsibilities that come along with home ownership.
Our plan is to stay in this home until we either FIRE (~7 years out) or move elsewhere for better work (coinciding with a big promotion and paid move).
I absolutely understand the waiting until you can buy the "forever" home think, something we've struggled with for some time, and one of the main reasons we are still considering renting for another 2-3 years.  But at some point it seems like we should just take the plunge.  The forever homes that we like are very non-mustachian and are priced accordingly (1.4M+ for beach front/view)! Yikes.

I agree that moving + new kid = hassle. We're moving to LA with a one year old and not looking forward to that transition. Of course it'll be great once we're settled down, but what a hassle in the meantime! Also keep in mind that the mortgage interest goes down every year, so your deduction will too. I'd say a better way to look at your net savings from tax deductions is take the total amount of interest over the life of the mortgage / term of mortgage in months * tax rate. Also remember to account for renovations that may occur (either planned or unplanned!) since it's rare that the house will be move-in ready.

Good advice - thanks!  We mainly want to be 'settled' before school starts with the kid(s), as painful as it may be to move with an infact, it may be unavoidable.  I figure that the amount that the mortage interest deduction goes down each year should be somewhat similar to the amount that rent would increase each year.  Should we buy, then we will have to fight the urge to take on any large rennovations, that can quickly blow up a budget.

Funny, the Elderberry property looks very much like a local infill development that was built here in 2000. Similar look, similar original price, similar current value. I'd say it looks reasonable, except for its proximity to the freeway. This is known as an "incurable defect". Buy something further away, with fewer bells and whistles. They can always be added, but an incurable defect is yours forever.

Great point re. the "incurable defect".  We would pass over that home for that exact reason, plus it is done up a bit too much (high end appliances) and photographs well.  Which means it will be hard to negotiate a fair price on this home.
I'd even pay a quite bit more for a home with a distinct feature, e.g. positioned on hill with a canyon view.  Something that could set it apart when it comes time to sell.

Again - thanks all for the responses thus far!