Author Topic: Where does "if you're not going to live there for >5 years, don't buy" come from  (Read 5818 times)

Kriegsspiel

  • Guest
I think the title says it all.  Is it just the fact that closing costs are high and the timeline is too short that you might have to sell at a loss?

gdborton

  • Bristles
  • ***
  • Posts: 254
  • Age: 30
  • Location: Muncie, Indiana
    • Gary Borton
There are a lot of factors that play into this. Realtor fees, appraisal costs, down payment amortization, etc... the benefit of owning your house grows over time.  The first few years you'll be lucky to save any money over renting.  Then you run the risk of selling for a loss when you move, or not selling at all and being stuck with two housing payments.

DaftShadow

  • 5 O'Clock Shadow
  • *
  • Posts: 25
That's part of it.  Another big one you're not accounting for is interest on your loan.  In the first 1-3 years, you haven't paid back any of the principal yet, so almost your entire monthly payment is interest expense. 

That being said, whether or not the rule holds up depends on the mathematics of your specific market.  If you have a relatively cheap housing market with expensive rental rates (more common than you might think) then the closing costs could be entirely covered by the interest deduction you earn the first year, and make the entire deal worth your while!  Everything depends on your specific situation...  Even more valuable if you plan to fix the place up using sweat equity. 

Here is a great interactive graphic that NYTimes put out, which helps you dig into this analysis at the initial level:  http://www.nytimes.com/interactive/business/buy-rent-calculator.html

~ DaftShadow

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28239
  • Age: -999
  • Location: Seattle, WA
Yup, basically.  Closing costs and realtor's fees and such eat up monies, such that even if you're saving over renting it takes a few years to earn that back.

Like most rules of thumb, it's worth knowing for general cases, and running the numbers for specific ones.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Matt K

  • Bristles
  • ***
  • Posts: 332
  • Location: Canada
    • Krull Photography
Don't forget opportunity costs.

If you allocated X money to living, and renting cost Y, you can/should invest the difference between X and Y.

When I decided to buy, I did a pretty complicated spreadsheet that would let me set all sorts of assumptions - appreciation on the house, returns in the market, etc. What I found was that if I was going to live in my house vs keep renting a 2 bdrm in a high rise, the balance didn't tip until 7 years.

chopperdave

  • 5 O'Clock Shadow
  • *
  • Posts: 13
I've never sold real estate, but I've heard it is a VERY expensive proposition.

When XYL and I bought a house and moved out of the apartment, we bought one that we plan to live in until we die.  Does it ever make sense to buy one if you're planning to own it for less time than that?

I do accept that our neighborhood could turn into a place that we don't want to live in, and we will deal with that if it happens, but to PLAN to move out of a place purchased as a home sounds kind of crazy to me.

Matt K

  • Bristles
  • ***
  • Posts: 332
  • Location: Canada
    • Krull Photography
I've never sold real estate, but I've heard it is a VERY expensive proposition.

When XYL and I bought a house and moved out of the apartment, we bought one that we plan to live in until we die.  Does it ever make sense to buy one if you're planning to own it for less time than that?

I do accept that our neighborhood could turn into a place that we don't want to live in, and we will deal with that if it happens, but to PLAN to move out of a place purchased as a home sounds kind of crazy to me.

I'd say it makes a lot of sense - life changes. Say you are young, in good financial straights, and want to own a home (you have a lot more options when you own the house - garden, renovations, etc). You aren't sure if you are going to have children or not, but you don't want to saddle yourself with more house than you need. So you buy a three bedroom house. This house is a fine size (maybe a bit big) for now, and gives room to grow if you have a child. Depending on the layout of the house, with two children it could get tight (maybe you have a strong want or need for an in-house office). With three children of school age, it is just too small. So you buy small now, but know you may want to move to larger in the future as life changes.

Similarly, when you are young, you probably want to live in the city, near work and friends. When you get older (FI), you want to move farther out of town to where it is cheaper to live, and you can have some land to do something with (a workshop, large garden whatever). In this case, you are planning on owning two homes in your life.

TomTX

  • Magnum Stache
  • ******
  • Posts: 3768
  • Location: Texas
In the typical process of selling a house through a Realtor, there will be 8-12% of the value of the property siphoned off. It's an incredible racket.

Lets say you're buying a $100,000 house. At the closing table, you put $100,000 on the table on a traditional 20% down purchase. Before that money gets to the seller on the other side of the table, this happens:

$100,000 is the pile of money you put on the table.

$6,000 gets scooped out by the Realtor(s)
$500-$1000 gets scooped out by the Title company
$800-$2,000 gets scooped out by the bank for using their money for most of the pile you put on the table.
$500-$2,000 gets scooped out by various inspections, a lawyer and fees.

$90,000 is what the seller actually picks up off the table (plus or minus. Varies a lot.)

This means that when you buy that $100,000 house - you're actually starting $10,000 in the hole If the mortgage is above 80% (and many are) the numbers will be even worse.

Can Mustachian ways cut down this number? Absolutely. The easiest thing is to buy it for cash - but you will still be very hard-pressed to get the "hole" smaller than $5,000 unless you end up selling it yourself and cutting the Realtors out of the equation.

kit

  • 5 O'Clock Shadow
  • *
  • Posts: 23
  • Location: Sydney
Another thing to consider is that (for the USA) if you do make money on the house, you are subject to a very high short-term capital gains rate (< 1 year), a 20% Long term capital gains tax rate (1-5 years), or an 18% 5-year capital gains rate. Source: http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States

JJ

  • Stubble
  • **
  • Posts: 117
  • Location: On the road, Australia
    • A Philosopher and A Businessman
And if you are buying in Australia you have this nightmare called "Stamp Duty" - as in "stamp on your head and rob you blind" duty which can run to 5% or more.  So closing costs on a $500k house (yes - houses are expensive here):

To buy
House price : $500,000
Legals         :     $1,500
Bank Fees   :     $1,000
Inspections :     $   800
Stamp Duty:   $20,000
Total:            $523,300

To sell a $500K house
Legals        :   $1,500
Agent Fees : $15,000 [3% is common at this price point, 5% is common for lower value deals]
Advertising :   $5,000 [big scam here - agents charge you full price to place newspaper ads then get substantial rebates from the newspapers which they keep]
Bank Fees  :   $1,000
Total          :  $22,500

So the round trip to buy and sell a $500K house is around $45K - 9%.

You can trim the agents fees by selling yourself.  This isn't a good idea if it is your own home due to the emotional attachment.  It also isn't a good idea if you have limited negotiation skills.  However, not many agents have good negotiating skills in my experience.  We were very, very picky hiring our agents and out of 4 sales we had 2 good guys, one legend and one total dud. We had to lead the last guy by the nose through the whole negotiation process and got another 13% above what he was pushing us hard to accept.

So there are a couple of lessons in all this.  First, property transaction costs do represent a sizeable chunk of the value of a property so do your numbers and plan to hold for a while (rule of thumb comment from arebelspy holds).  Second, a poorly sold property bleeds as much or more value than the transaction costs so make sure you invest time and effort into preparing the property for sale, finding a competent agent, marketing it properly and negotiating well.  One moment of weakness in a negotiation on a $100k property could easily be worth $5k.  Some psychological defect in humans makes big numbers appear small in this context and it is easy to give too much away if you aren't concentrating or you go too fast.  Also, you aren't just negotiating with the buyer - you are negotiating with the agent in this situation.  They want to get the property sold, take their commission and move on to the next one.  Pushing for a higher price slows down their deal rate and they make less money so there is a natural conflict of interest.

BTW - one reason to buy rather than rent, even if you are in it for a short time, is to add value through DIY rehabbing etc.  If you enjoy that kind of thing then it's fun to do it on your own place and you can do quite ok financially if you plan it out right.

BTW #2 - I chuckled a little when I saw the "very high capital gains tax rate" comment.  39.6% is high, but top marginal rate for short term capital gains (and normal income) in our part of the world is 46.5%.  But then we do have good health care ;).  And education.

 

Kriegsspiel

  • Guest
Thanks for the advice all.  I think I'm going to forego buying here.  I found an apartment about a mile from work, library, groceries, and the gym, for $460 a month.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1088
Another thing to consider is that (for the USA) if you do make money on the house, you are subject to a very high short-term capital gains rate (< 1 year), a 20% Long term capital gains tax rate (1-5 years), or an 18% 5-year capital gains rate. Source: http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States

Actually, no, at least in the context of a house that you're going to live in (which seems to be what the OP was asking about).  Up to $250,000 (500,000 for a couple) of gain is untaxed if you lived in the house for 2 of the past 5 years.  See "primary residence" in your own link.

happy

  • Walrus Stache
  • *******
  • Posts: 5766
  • Location: NSW Australia
I am so with you JJ.  And 500k is entry point for a family home in many places: since sales tax and realtor commission are % the numbers just get bigger. According to the tenants of  MMM my house, which I not yet had 3 years, is too big and too far from my job and I should  trade down but when I run the numbers taking into consideration the moving costs, the advantage of doing this is really no where near as good as I first thought. Trust me when I do do it, it will be highly strategically planned to avoid ever selling the next one again. My parents have lived in the one house for 50 years... no doubt saving hundred of thousands of dollars in moving costs over the period.