The Money Mustache Community
Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: Kaplin261 on August 05, 2016, 12:02:02 PM

Fictional story,I'm not buying a home this is for research and learning. I want to figure out what it costs to actually own a home for 15 years(Personal home). I'm not getting into any real estate investments so I don't care about tieing up equity. Interest rates are at 3.5% and I will need 20% down. Household income is $170k. All repairs and upgrades would be done by homeowner. Both homes would appreciate at standard 3%. We would use a realtor to sell the home at the end giving a 6% commision.
Does a $200 per sqft home that is 2000 sqft ($400,000) actually cost more than a home that is $50 per sqft and 2000 sqft ($100,000) if i'm going to sell it in 15 years?

Historically, real estate in the US appreciates in line with inflation. There are big ups and downs, and different local markets act very differently (ie, compare Detroit and San Francisco in the 1950s and again today...) but overall, you will likely do much better with the cheap house and the $300k invested (in almost anything) over that time period.
It is very easy to figure this out on a spreadsheet, of course. Most people here would consider your home an expense rather than an investment. When you sell it, you will still (hopefully!) need a place to live, so that money is going to get used to buy another house (which will presumably have appreciated as well and hence cost you more in 15 years) or rent.
Walt

Assuming the homes both appreciate by the same percentage(it would be speculation to assume otherwise)  The $100k home will be better for the stash. You will spend more on interest on the higher mortgage, also on upkeep  a more expensive home will likely require more expensive repairs, etc... when things wear out.

http://www.pragcap.com/robertshillerdontinvestinhousing/
I spent most of my adult life, about three decades, building houses. I agree with Mr. Shiller. The concept of a single family home as an investment is an illusion. A spectacularly well marketed illusion, that has become a "fact", according to the average American. Sadly, for the vast majority of SFH owners, they are cash sucking machines. Short of buying gold from Glenn Beck, you would have a hard time finding any "investment" with a lower return. As you might guess, I vote for the smallest, most modest dwelling you can handle.

Historically, real estate in the US appreciates in line with inflation. There are big ups and downs, and different local markets act very differently (ie, compare Detroit and San Francisco in the 1950s and again today...) but overall, you will likely do much better with the cheap house and the $300k invested (in almost anything) over that time period.
It is very easy to figure this out on a spreadsheet, of course. Most people here would consider your home an expense rather than an investment. When you sell it, you will still (hopefully!) need a place to live, so that money is going to get used to buy another house (which will presumably have appreciated as well and hence cost you more in 15 years) or rent.
Walt
In the scenario i presented I'm not paying cash for either home, just a 20% downpayment. There would not be a $300k sum of cash difference that would be invested. $20k and $80k would be the upfront cash.
$100,000 Home
30 year mortgage with 20% down= $359 monthly payment
0.7% annual tax = $58 monthly payment
insurance = ?? dont have that info at the moment
Income tax right off $2,800 from the mortgage interest
$400,000 Home
30 year mortgage with 20% down= $1,437 monthly payment
0.7% annual tax = $232 monthly payment
insurance = ?? don't have that info at the moment
Income tax right off $10,800 from the mortgage interest

If you want a fancy place you need to buy one that is likely to appreciate more than average. My dad live on a lake and years ago he realized that the property there appreciated more than local nonwaterfront property, because of the limited supply. He purchased neighboring properties while they were still affordable & they are worth 10X that 20 years later. Every McMansion that gets built nearby the property keeps appreciating, and the demand keeps growing.
I think you need to look for an advantage like that to go for a fancy place.

Historically, real estate in the US appreciates in line with inflation. There are big ups and downs, and different local markets act very differently (ie, compare Detroit and San Francisco in the 1950s and again today...) but overall, you will likely do much better with the cheap house and the $300k invested (in almost anything) over that time period.
It is very easy to figure this out on a spreadsheet, of course. Most people here would consider your home an expense rather than an investment. When you sell it, you will still (hopefully!) need a place to live, so that money is going to get used to buy another house (which will presumably have appreciated as well and hence cost you more in 15 years) or rent.
Walt
In the scenario i presented I'm not paying cash for either home, just a 20% downpayment. There would not be a $300k sum of cash difference that would be invested. $20k and $80k would be the upfront cash.
$100,000 Home
30 year mortgage with 20% down= $359 monthly payment
0.7% annual tax = $58 monthly payment
insurance = ?? dont have that info at the moment
Income tax right off $2,800 from the mortgage interest
$400,000 Home
30 year mortgage with 20% down= $1,437 monthly payment
0.7% annual tax = $232 monthly payment
insurance = ?? don't have that info at the moment
Income tax right off $10,800 from the mortgage interest
Go do a spreadsheet. The difference will still be enormous investing the money vs. borrowing/paying interest on it.
Now, you might want/need a bigger or nicer house. That's fine. It's just not an investment.
W

Historically, real estate in the US appreciates in line with inflation. There are big ups and downs, and different local markets act very differently (ie, compare Detroit and San Francisco in the 1950s and again today...) but overall, you will likely do much better with the cheap house and the $300k invested (in almost anything) over that time period.
It is very easy to figure this out on a spreadsheet, of course. Most people here would consider your home an expense rather than an investment. When you sell it, you will still (hopefully!) need a place to live, so that money is going to get used to buy another house (which will presumably have appreciated as well and hence cost you more in 15 years) or rent.
Walt
In the scenario i presented I'm not paying cash for either home, just a 20% downpayment. There would not be a $300k sum of cash difference that would be invested. $20k and $80k would be the upfront cash.
$100,000 Home
30 year mortgage with 20% down= $359 monthly payment
0.7% annual tax = $58 monthly payment
insurance = ?? dont have that info at the moment
Income tax right off $2,800 from the mortgage interest
$400,000 Home
30 year mortgage with 20% down= $1,437 monthly payment
0.7% annual tax = $232 monthly payment
insurance = ?? don't have that info at the moment
Income tax right off $10,800 from the mortgage interest
Go do a spreadsheet. The difference will still be enormous investing the money vs. borrowing/paying interest on it.
Now, you might want/need a bigger or nicer house. That's fine. It's just not an investment.
W
Borrowing money at 3.5% is about the same as inflation 3%. So the interest occurred on loan long term is not that much if your home matches inflation at 3%+

You didn't go run the numbers, did you.
Facepalm.
Good luck.
W

You didn't go run the numbers, did you.
Facepalm.
Good luck.
W
I just ran some numbers on 10 years not 15, because that is easier.
$100,000 Home
30 year mortgage with 20% down= $359 monthly payment
0.7% annual tax = $58 monthly payment
insurance = ?? dont have that info at the moment
Income tax right off $2,800 from the mortgage interest
Home Value after 10 years $134,935
$400,000 Home
30 year mortgage with 20% down= $1,437 monthly payment
0.7% annual tax = $232 monthly payment
insurance = ?? don't have that info at the moment
Income tax right off $10,800 from the mortgage interest
Home Value after 10 years $539,741
Math for $100,000 home
359+58=417x177=$73,809  34,935= $38,874
Math for $400,000 home
1437+232=1669x177=$295,413  $139,741=155,672
I still need to calculate money saved on income tax from home loan interest. And a old $100k home is going to cost a lot in maintance vs a new $400k home

Where I live appreciation is higher than inflation over the long term, houses appreciate faster than condos and better areas are the first to rise and last to drop. Look at the long term stats for your area. You also need to factor in the lost opportunity costs on your down payment and monthly payment differentia. And then risk. If you have to sell in a down cycle you'll lose more with a more expensive place. Where I live houses in good locations cost more and they've had a higher return. If I had to do it over again I'd buy even higher. I know some markets on the west coast in the us are like this too  like Seattle, Oregon, San Francisco...

What happens when you invest the $60K difference in down payments in an index fund, over your ten year time frame? Typically it would double,and more. Now factor the $2530K spent on resale fees for the bigger place, when you liquidate. Next, assuming you end up with a shiny new place for your $400K, how much are you going to have to spend to get it back to that condition when you sell it? You would be lucky to not have to at least replace a significant amount of the floor coverings, and put a coat of paint on the interior. Wouldn't be surprised to hear the realtor recommend $1520K in cosmetics at that point to make it competitive with the market, which in a low cost area of VA. puts you in high dollar territory. Finally, I live in the midAtlantic, about half a days drive north. I have actually been house shopping in your city and the surrounding area. I have also seen desirable neighborhoods in my region, with good schools, and a stable safe environment, that took 2530 years to see the kind of appreciate you are factoring. When I quoted Shiller, I did so out of experience. His data is not an outlier, there are others that reached the same conclusion after compiling the last century of values in the states. Overall home values have been basically stagnant in that period, and do not come close to keeping pace with inflation. If you buy a well vetted, modest $100k place, and keep the $60K split invested, you are much more likely to come out significantly further ahead in 10, 15 or thirty years.
EDIT: Totoro brings up an excellent point that I missed. I would love to see one of the numbers geeks here do a workup on the lost opportunity cost of your additional monthly payment, spread over a 10,15 and 30 year time frame. Nothing fancy, just looking at long term historical performance of a low fee, total market index fund, and how your net worth looks after depositing $1100 a month into it, over that time. I would guess that this would pretty much kill any justification for overspending on the mythical housing "investment".

I can't believe I'm still replying to this, but: you need to model the investment returns from the extra money you have sitting around each month in the cheap house. Easiest thing to do would be just assume something like 7% inflationadjusted returns (historical stock market average) to get a rough idea.
Assuming you have an extra $10,000 a year to invest living in the cheaper house, a rough estimate is that at the end of the 30 years, you'll have an extra $830,000 (your tax bracket being unknown, I just assumed 15% here).
Also, FWIW, you don't simply subtract all your mortgage interest from your taxes. Assuming you are itemizing, you deduct that amount times your tax rate. So at 20% tax bracket, you'd save about $2000 a year on your $10k worth of interest.
Walt

I can't believe I'm still replying to this, but: you need to model the investment returns from the extra money you have sitting around each month in the cheap house. Easiest thing to do would be just assume something like 7% inflationadjusted returns (historical stock market average) to get a rough idea.
Assuming you have an extra $10,000 a year to invest living in the cheaper house, a rough estimate is that at the end of the 30 years, you'll have an extra $830,000 (your tax bracket being unknown, I just assumed 15% here).
Also, FWIW, you don't simply subtract all your mortgage interest from your taxes. Assuming you are itemizing, you deduct that amount times your tax rate. So at 20% tax bracket, you'd save about $2000 a year on your $10k worth of interest.
Walt
that was the point of the 177. I remember reading a MMM article that said a pretty accurate and easy way to calculate what a monthly payment could be if you invested into something that earned 7% is to multiply it by 177 and you will have 10 years worth of monthly payments earning 7%.
So 417x177=$73,809 would be what those payments could of been if you invested into 7% investment. Then deduct what the home appreciated for, in my scenario we are using the standard 3% so deduct 34,935 from 73,809= $38,874
Again there other factors I have not added to this, like alternatives for the 20% downpayment. Tax savings for someone in the 27% bracket or higher. Loan fees for getting a loan is about $10,000 whether your getting a $100k or $400k home.
In 30 years that $400,000 home would be worth $982,736.88

Right, but the 177 rule is already accounting for inflation. Your house price calc is not. Fix that and your math looks a lot different, because the value of the house *basically* stays constant (according to the data we have, that would be your best guess) when inflation is included, whereas the stock investments are going up 7% a year under the same conditions.
Even if you had a 0% mortgage the stocks would win by a large amount in this scenario.
Again, you might want or need a bigger house. Nothing wrong with that, I have a giant stupid McMansion. But there's no reasonable logic by which buying more house than you need is a good decision for investing/FIRE reasons.
W

Right, but the 177 rule is already accounting for inflation. Your house price calc is not. Fix that and your math looks a lot different, because the value of the house *basically* stays constant (according to the data we have, that would be your best guess) when inflation is included, whereas the stock investments are going up 7% a year under the same conditions.
Even if you had a 0% mortgage the stocks would win by a large amount in this scenario.
Again, you might want or need a bigger house. Nothing wrong with that, I have a giant stupid McMansion. But there's no reasonable logic by which buying more house than you need is a good decision for investing/FIRE reasons.
W
The 177 is only monthly payment at 7%. It has nothing to do with with adding in 3% for inflation.
If I make a monthly payment of $417 for ten years at the end of those ten years if my account earned on average 7% I would have $73,809. Maybe some one else can chime in and correct me if I'm wrong.

I'm just baffled now. Where are you getting the $417 number? The difference in mortgage/tax payments in your example is in the ballpark of $1100 once your itemized deduction for the interest is factored in. I'm ignoring maintenance.
You're using a 30 year mortgage here, so assuming you invest an extra $13k/year in the cheaper house at 7%, after 30 years you have (inflation adjusted):
$400,000 paid off house and $0 investments, total $400,000.
$100,000 paid off house and $925,000 in investments (I assumed 27% tax bracket), total $1,025,000.
If you also invest the $60k difference in downpayments you're at $1,193,000 in investments with the cheap house, total $1,293,000.
W

I'm just baffled now. Where are you getting the $417 number? The difference in mortgage/tax payments in your example is in the ballpark of $1100 once your itemized deduction for the interest is factored in. I'm ignoring maintenance.
You're using a 30 year mortgage here, so assuming you invest an extra $13k/year in the cheaper house at 7%, after 30 years you have (inflation adjusted):
$400,000 paid off house and $0 investments, total $400,000.
$100,000 paid off house and $925,000 in investments (I assumed 27% tax bracket), total $1,025,000.
If you also invest the $60k difference in downpayments you're at $1,193,000 in investments with the cheap house, total $1,293,000.
W
$417 is the monthly mortgage and taxes on the $100,000 home.

Ok, so we're *comparing* the cheap house to the expensive one, correct?
Take the difference in monthly costs, assume you'll invest that, and figure out the difference over whatever time period you want. I just did 30 years because you're using a 30 year mortgage for the monthly numbers. You could use an amortization calculator to figure out what your principal balance would be after 10 or 20 or whatever years.
After 30 years, the $100k house person has a cool million bucks to retire on (and a pretty crappy house). The $400k house person has a pretty nice house (albeit 30 years older now) and zero. Very simplified example with a lot of assumptions, but that's basically the story.
W

Ok, so we're *comparing* the cheap house to the expensive one, correct?
Take the difference in monthly costs, assume you'll invest that, and figure out the difference over whatever time period you want. I just did 30 years because you're using a 30 year mortgage for the monthly numbers. You could use an amortization calculator to figure out what your principal balance would be after 10 or 20 or whatever years.
After 30 years, the $100k house person has a cool million bucks to retire on (and a pretty crappy house). The $400k house person has a pretty nice house (albeit 30 years older now) and zero. Very simplified example with a lot of assumptions, but that's basically the story.
W
Great way of looking at it W
But that Millon would only be worth $700k in today's money?

The calculation I did is as follows:
Assumptions:
Ignoring Taxes and Insurance because it's so variable (cheap house obviously benefits from this a LOT)
No adjustments for inflation
3% value increases on house values every year
30 year 3.5% mortgage
Down payment difference invested at beginning of first year
Difference in mortgage payments invested at end of each year
10% average market return in investment account
Sell both houses after 15 years (180 payments)
House 1:
Value = $155,796.74
Mortgage Principle Left = 50,251.02
Cost Difference Investment Account = $661,529.33
Net Worth After Sale = $767,075.05
House 2:
Value = $623,186.97
Mortgage Principle Left = 201,004.07
Cost Difference Investment Account = $0.0
Net Worth After Sale= $422,182.90
Difference = $344,892.16
Other Scenarios:
Difference with 7% return on investments = $173,883.28
Difference with 5% return on investments = $87,161.13
Difference with 3% return on investments = $17,369.46
Difference if you held money as cash = $62,651.17

Great way of looking at it W
But that Millon would only be worth $700k in today's money?
No, that's inflation adjusted.
W

Why would you assume 3% appreciation in the house price, 10% market returns, and no inflation?
If you want to throw out inflation, make the house return zero, and market 7%.
http://www.fool.com/investing/general/2015/09/13/sorrybutyourhomeisabadlongterminvestment.aspx
W

Why would you assume 3% appreciation in the house price, 10% market returns, and no inflation?
If you want to throw out inflation, make the house return zero, and market 7%.
http://www.fool.com/investing/general/2015/09/13/sorrybutyourhomeisabadlongterminvestment.aspx
W
Literally makes no difference... 2 different ways of saying the same thing... I like to think in physical dollars... how many dollars will I have
Also it's harder to represent "holding as cash" if you do inflation adjustment because then I would have to calculate negative return on that cash sitting there.

The calculation I did is as follows:
Assumptions:
Ignoring Taxes and Insurance because it's so variable (cheap house obviously benefits from this a LOT)
No adjustments for inflation
3% value increases on house values every year
30 year 3.5% mortgage
Down payment difference invested at beginning of first year
Difference in mortgage payments invested at end of each year
10% average market return in investment account
Sell both houses after 15 years (180 payments)
House 1:
Value = $155,796.74
Mortgage Principle Left = 50,251.02
Cost Difference Investment Account = $661,529.33
Net Worth After Sale = $767,075.05
House 2:
Value = $623,186.97
Mortgage Principle Left = 201,004.07
Cost Difference Investment Account = $0.0
Net Worth After Sale= $422,182.90
Difference = $344,892.16
Other Scenarios:
Difference with 7% return on investments = $173,883.28
Difference with 5% return on investments = $87,161.13
Difference with 3% return on investments = $17,369.46
Difference if you held money as cash = $62,651.17
Just what I was looking for, THANK YOU!!

Why would you assume 3% appreciation in the house price, 10% market returns, and no inflation?
If you want to throw out inflation, make the house return zero, and market 7%.
http://www.fool.com/investing/general/2015/09/13/sorrybutyourhomeisabadlongterminvestment.aspx
W
Literally makes no difference... 2 different ways of saying the same thing... I like to think in physical dollars... how many dollars will I have
Also it's harder to represent "holding as cash" if you do inflation adjustment because then I would have to calculate negative return on that cash sitting there.
Ah, gotcha.
Regardless, bottom line no matter how you want to do it: your house is a shit investment.
Walt

Just what I was looking for, THANK YOU!!
Your welcome... Obviously this is sort of a rough estimate assuming different things like average market returns and appreciation on house and you need to think about how much money that is after 15 years on inflation but either way there's a huge advantage to smaller house if you invest the difference most of the time.
You will pretty much always get a negative return on any money used to upgrade and buy more expensive house than you need after you consider the extra maintenance/insurance/tax costs.

Why would you assume 3% appreciation in the house price, 10% market returns, and no inflation?
If you want to throw out inflation, make the house return zero, and market 7%.
http://www.fool.com/investing/general/2015/09/13/sorrybutyourhomeisabadlongterminvestment.aspx
W
Literally makes no difference... 2 different ways of saying the same thing... I like to think in physical dollars... how many dollars will I have
Also it's harder to represent "holding as cash" if you do inflation adjustment because then I would have to calculate negative return on that cash sitting there.
Ah, gotcha.
Regardless, bottom line no matter how you want to do it: your house is a shit investment.
Walt
Now that I'm messing around with my spreadsheet looking at doing the inflation adjusted way you also need to depreciate the loan's principle left each year by the inflation rate... it's gets kinda messy the other way you can't just change house to 0% and market to 7%

That's why I just ran them both to zero principal balance/30 years. Laziness.
W

Other Scenarios:
Difference with 7% return on investments = $173,883.28
So with some mustachian skills and buying when the market is cold or some sweat equity . Say I can a get 10% discount on market value on either home. What would the numbers look like then? I'm mostly looking at the 7% returns model because that what my investments look like.

A problem with living in a fancy home is that most of the neighbors tend to buy fancy cars & other expensive toys, and the temptation & envy can be tough to endure at times. You tell yourself that you're smart by being frugal, but the Porsches etc. do look fun... And all their service crews sure look appealing while I'm sweatin' my butt off mowing, painting, or trying to figure out how to fix the cars or an appliance.

Other Scenarios:
Difference with 7% return on investments = $173,883.28
So with some mustachian skills and buying when the market is cold or some sweat equity . Say I can a get 10% discount on market value on either home. What would the numbers look like then? I'm mostly looking at the 7% returns model because that what my investments look like.
Negligible difference  you're still talking about $270k stuck in the house rather than invested.
Look, if you want a fancy house, get a damn fancy house. If it makes you happy, then it's worth it. It's going to make it harder to get to FIRE, though, full stop.
W

Other Scenarios:
Difference with 7% return on investments = $173,883.28
So with some mustachian skills and buying when the market is cold or some sweat equity . Say I can a get 10% discount on market value on either home. What would the numbers look like then? I'm mostly looking at the 7% returns model because that what my investments look like.
Negligible difference  you're still talking about $270k stuck in the house rather than invested.
Look, if you want a fancy house, get a damn fancy house. If it makes you happy, then it's worth it. It's going to make it harder to get to FIRE, though, full stop.
W
Walt, at 7% it was $173k difference. So I would imagine if you can get a good deal upfront maybe the number would be somewhere closer to $100k difference.
Also to be considered that $100k home is probably been around and needs TLC. Where as the $400k would be almost new and a roof,hvac,water heater , siding that will last another 20 years.
My old 1980s house had Masonite siding that needed to be replaced and the lowest quote we got to replace siding was $20k. New roof was $6k and a HVAC was another $6k. Had we continued to live there another 15 years all those items would have needed to be replaced. Not to mention all the little things I was fixing on the weekends.
My new home is in in a neighborhood that ranges $350k$500k. We ended up paying $329k and got $7k back in closing costs. The home is 5 years old the carpet was ruined from the previous owners dogs. We replaced it hardwoods at $8k. I also had to paint the home due to walls being scratched up and holes. My home is currently worth $355$365k.
In my situation after going over the numbers my old $200k home is not going to be much less then my new $360k home. The old $200k home wasn't appreciating each year. It was slowly going down do to the neighborhood. I'm also saving money on my electric bill because of the new homes energy effiency . I'm also saving money on my commute.

Awesome. Why did you post this question then? Your *original* post was simply about whether a fancy house or a crappy one was a better way to get to FIRE. The answer to that is "the crappy house". If you want to add a bunch of other variables about commute distance and neighborhood and such, feel free. If we're comparing apples to apples, though, the cheap house wins every time.
I have a feeling this is an attempt to justify your existing choices rather than an actual question, since you keep coming back with caveats and new tweaks to the scenario.
W

Awesome. Why did you post this question then? Your *original* post was simply about whether a fancy house or a crappy one was a better way to get to FIRE. The answer to that is "the crappy house". If you want to add a bunch of other variables about commute distance and neighborhood and such, feel free. If we're comparing apples to apples, though, the cheap house wins every time.
I have a feeling this is an attempt to justify your existing choices rather than an actual question, since you keep coming back with caveats and new tweaks to the scenario.
W
My original question was how much of a difference would it have on your stash. And the answer was $173k

Yep, you got your answer a while ago.
W

I was thinking maybe he meant:
I'm going to spend $80k on my house now. Would I be better off buying a 100k fixer upper or a 400k already fixed house.
The difference there is a little more subtle, but the answer is fairly straightforward.
First, you win on taxes buying the 100k house. All else being equal, buying a house and making it nice on the downlo where the tax man can't see it would be better than paying an upfront cost for looks nice. I drive past a million dollar mansion every day that shows up on the tax rolls as $140k because the original wood siding has never been replaced and the grounds was let go to scrub. The inside is cherry though (owner invited me inside once). Nicest house I've ever been in.
In the second place, you win on actual enjoyment buying the 100k house. Provided you don't hate living in a construction site for a bit and the fixup goes well, getting exactly what you want beats getting exactly what your demographic was most likely to want wins every time. As an example, while hardwood looks great, nothing beats carpet for "I feel like taking a nap in this hallway."
In the third place, you likely lose a bit on ROI buying the 100k house. Sort of. From everything I've read, you don't get the fixup costs back when you go to sell. So if you buy a 100k house, put 20k down, and dump 60k into renovations to make it nicer, you don't end up with a 160k house, you end up with like a 140k house, or 120k house. Usually. All else being equal. Losses from this very likely are outweighed by the lower mortgage payment allowing for more spending on real investments. But it is worth keeping in mind that there's a difference between buying a house at fair value and renovating it to your tastes, and buying a fixer upper at deal prices that has significant issues and fixing it up as a top of the line example and selling above fair value. "Flipping" the house you live in is different than customizing your own house. Nobody but me wants those naked lady toilet flush handles, is what I'm trying to say.
Knowing what you can live with is huge though. I can deal with a modest house. I can't deal with unreliable plumbing. I mean of course I can, because of the awesomeness, but I prefer not to.