How Much House Should I Buy?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
freddie
Posts: 920
Joined: Sat Feb 08, 2014 10:06 pm

Re: How Much House Should I Buy?

Post by freddie »

WorkToLive wrote:Not to beat a dead horse, but you need to think hard about your plans for future children. Childcare is expensive, some decide public schooling is not right for their child (we do AMI Montessori), some women want to be home for the first few years, groceries go through the roof, vacations aren't cheap, activities are expensive (we spend $800/month for our one child to do piano, ballet, summer camps, etc.), college savings looms, not to mention a desire for early retirement. If you multiply that all by 2 or 3 or 4 kids, you are talking about some serious cash outlay, especially if you go to one income. I am glad I kept a reasonable mortgage that gave me the freedom to live the life we want with relative ease. Believe me, I had NO idea how much this all would cost when I got pregnant.

In sum, I think you and your wife need a plan for kids before you decide on the house. Plans can change, but spending time making one will increase the chances you will make good decisions.
They have something like 100k after paying for a 4 million dollar house. I think they can afford childcare:) More seriously this is the type of questions that Bogleheads (and any message board) suck at. It is all personal choices. They can definitely pay for a 4-5 million dollar house out of cash flow and still have enough to retire at 55. Is it going to be a good choice? Impossible to say. 20% house drop and a layoff makes it look dump. 5% salary increases and 6% appreciation makes it look cheap in 20 years.

My best advice is to take a piece of paper and run some numbers and see what your live looks like in ~15 years with different choices. Being a 45 year old with a 3 million dollar house (todays dollars) and 4 million in the bank (i.e. you can retire given you expenses) might be more appealing than have a 4 million dollar house and 2.5 million dollars in the bank (you have another 5 years of working in front of you). And then figure out how much worse your quality of life would be with a 3 million place instead of a 4 million and decide how much you want to gamble. Same thing with waiting a couple years. You will know more, houses might cost more (and property taxes would be higher forever) but you might also have given up 3 years of living the dream. If you thought that carried interest was going to show up in the next 12 months, I might think about procrastinating for it (another 600k or so is a lot of money) but if we are talking 5+ years, thats a long time to wait.
Longtimelurker
Posts: 471
Joined: Fri Dec 13, 2013 7:23 am

Re: How Much House Should I Buy?

Post by Longtimelurker »

LFKB wrote: Thanks for the advice. Waiting if certainly an option we are considering. We are happy with our rental situation, and below market rent due to rents increasing since we leased two years ago about 20-30% but our landlord not implementing a rent increase (which has surprised us). The things that would make us happy about owning a home would be having a yard and some outdoor space and a pool, as well as more room in the future when we do have kids. The main motivation to moving soon would be capitalizing on low rates. If we wait three years, we are afraid we could be in a situation where rates are in the 6-7% range and home prices have gone up another 30% and since we can afford it now, we are considering it.
1: You are in finance. You should understand the negative correlation between housing values and interest rates. You want to buy when interest rates are high if you have the income to pay off early. Studies find that for a doubling in rates, housing prices decline 15-17% on average with a 2-3 year lag.

2: $3m financed at 4.5% over 30 years = $15,201 payment. @ 7% = $19,959. @7% after a 30% increase in house price (assumes same $1m downpayment) = $27,943. Housing always follows incomes and affordability over the long run. Do you believe this to be a sustainable scenario?
Stay the course. If you can't resist greed, and fear is proven to be 2x as strong, you are doomed as an investor.
Grt2bOutdoors
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Location: New York

Re: How Much House Should I Buy?

Post by Grt2bOutdoors »

HornedToad wrote:
Grt2bOutdoors wrote:
No - you are banking on the bonus to leverage up and purchase the place you will be living in. If you can't repay, the bank will seize the property and you could lose all of your down payment. A million is serious money to have at risk. Remember, it took you 3+ years to accumulate it.
In any rational scenario this would never happen. The OP would sell the house, possibly at a loss if it was in a hurry to sell and also pay the realtor commission. They wouldn't just default on a house with a million dollars in equity.
Was the market rational or irrational during 2008 and 2009? If you have no assets outside of equity in the home and no rational purchasers, would your scenario work? He's about to plunk down $1MM in cold hard cash, all of it as a down payment. If the home was purchased for $3MM, OP loses job, puts the home for sale and it sells for $2MM - bank is owed $2MM since OP is gunning for an I/O (interest only mortgage) leaving principal loan still intact. After costs, OP walks with zero or is slightly negative. To me, that's more than a loss - that is a foreclosure on your money when you lose it all.

The OP asked us because he wanted a devils advocate, so here we are saying be judicious when it comes to personal leverage. The bank will give him an outrageous mortgage if he desires, but just because they offer the candy, doesn't mean you should accept it.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: How Much House Should I Buy?

Post by sscritic »

LFKB wrote:A few clarifications and responses to various posters:

This is the best neighborhood with great school districts. It's the most expensive and has been the most resilient historically, hence the extremely high prices.
People in Brentwood send their kids to Harvard-Westlake or Crossroads. People in Santa Monica do the same. People with your income use private schools, not public schools in my experience (actually, my experience is with people lower on the income scale, and their kids went to HW and Crossroads - different personalities).

http://www.hw.com
http://www.xrds.org/
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

Grt2bOutdoors wrote:
HornedToad wrote:
Grt2bOutdoors wrote:
No - you are banking on the bonus to leverage up and purchase the place you will be living in. If you can't repay, the bank will seize the property and you could lose all of your down payment. A million is serious money to have at risk. Remember, it took you 3+ years to accumulate it.
In any rational scenario this would never happen. The OP would sell the house, possibly at a loss if it was in a hurry to sell and also pay the realtor commission. They wouldn't just default on a house with a million dollars in equity.
Was the market rational or irrational during 2008 and 2009? If you have no assets outside of equity in the home and no rational purchasers, would your scenario work? He's about to plunk down $1MM in cold hard cash, all of it as a down payment. If the home was purchased for $3MM, OP loses job, puts the home for sale and it sells for $2MM - bank is owed $2MM since OP is gunning for an I/O (interest only mortgage) leaving principal loan still intact. After costs, OP walks with zero or is slightly negative. To me, that's more than a loss - that is a foreclosure on your money when you lose it all.

The OP asked us because he wanted a devils advocate, so here we are saying be judicious when it comes to personal leverage. The bank will give him an outrageous mortgage if he desires, but just because they offer the candy, doesn't mean you should accept it.
The downpayment on a $3M house at 75% LTV is $750k (not $1 million), we would have about $450k in reserves after this. By year end, those reserves will be around $700k (we have pretty good visibility into the rest of the year). So yes, with $700k in reserves, we could both lose our jobs for some time and still be fine under your scenario. I understand your playing devil's advocate and that was much of what I was looking for by starting this thread, it just seems like you're being too extreme (it's more extreme than 2008 and 2009 and it still works fine for us). I am trying to find the healthy balance of conservatism while also finding a home I can be in for years to come.
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

Longtimelurker wrote:
LFKB wrote: Thanks for the advice. Waiting if certainly an option we are considering. We are happy with our rental situation, and below market rent due to rents increasing since we leased two years ago about 20-30% but our landlord not implementing a rent increase (which has surprised us). The things that would make us happy about owning a home would be having a yard and some outdoor space and a pool, as well as more room in the future when we do have kids. The main motivation to moving soon would be capitalizing on low rates. If we wait three years, we are afraid we could be in a situation where rates are in the 6-7% range and home prices have gone up another 30% and since we can afford it now, we are considering it.
1: You are in finance. You should understand the negative correlation between housing values and interest rates. You want to buy when interest rates are high if you have the income to pay off early. Studies find that for a doubling in rates, housing prices decline 15-17% on average with a 2-3 year lag.

2: $3m financed at 4.5% over 30 years = $15,201 payment. @ 7% = $19,959. @7% after a 30% increase in house price (assumes same $1m downpayment) = $27,943. Housing always follows incomes and affordability over the long run. Do you believe this to be a sustainable scenario?
I certainly understand the correlation but it doesn't always play out that way. Interest rate can rise with housing prices, especially in niche, highly desirable markets like the ones we are looking at. There will always be millionaires who want to live on the westside of LA. It's probably not sustainable for interest rates to rise to 7% and home prices to increase 30% nationally, but it could happen within specific markets.
Grt2bOutdoors
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Location: New York

Re: How Much House Should I Buy?

Post by Grt2bOutdoors »

LFKB wrote:
Grt2bOutdoors wrote:
HornedToad wrote:
Grt2bOutdoors wrote:
No - you are banking on the bonus to leverage up and purchase the place you will be living in. If you can't repay, the bank will seize the property and you could lose all of your down payment. A million is serious money to have at risk. Remember, it took you 3+ years to accumulate it.
In any rational scenario this would never happen. The OP would sell the house, possibly at a loss if it was in a hurry to sell and also pay the realtor commission. They wouldn't just default on a house with a million dollars in equity.
Was the market rational or irrational during 2008 and 2009? If you have no assets outside of equity in the home and no rational purchasers, would your scenario work? He's about to plunk down $1MM in cold hard cash, all of it as a down payment. If the home was purchased for $3MM, OP loses job, puts the home for sale and it sells for $2MM - bank is owed $2MM since OP is gunning for an I/O (interest only mortgage) leaving principal loan still intact. After costs, OP walks with zero or is slightly negative. To me, that's more than a loss - that is a foreclosure on your money when you lose it all.

The OP asked us because he wanted a devils advocate, so here we are saying be judicious when it comes to personal leverage. The bank will give him an outrageous mortgage if he desires, but just because they offer the candy, doesn't mean you should accept it.
The downpayment on a $3M house at 75% LTV is $750k (not $1 million), we would have about $450k in reserves after this. By year end, those reserves will be around $700k (we have pretty good visibility into the rest of the year). So yes, with $700k in reserves, we could both lose our jobs for some time and still be fine under your scenario. I understand your playing devil's advocate and that was much of what I was looking for by starting this thread, it just seems like you're being too extreme (it's more extreme than 2008 and 2009 and it still works fine for us). I am trying to find the healthy balance of conservatism while also finding a home I can be in for years to come.
On that note, I recommend you keep reaching for the stars - buy a $4MM house instead. I missed the part about buying a "forever" home.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
wilked
Posts: 2441
Joined: Thu Mar 24, 2011 1:50 pm

Re: How Much House Should I Buy?

Post by wilked »

LFKB wrote: I certainly understand the correlation but it doesn't always play out that way. Interest rate can rise with housing prices, especially in niche, highly desirable markets like the ones we are looking at. There will always be millionaires who want to live on the westside of LA. It's probably not sustainable for interest rates to rise to 7% and home prices to increase 30% nationally, but it could happen within specific markets.
For the record, this is what people say that are trying to talk themselves into something.

If interest rates rise housing prices are most likely to decline (and at the least stagnate). You will be much better off socking away that $50-100K differential for the time-being, keep renting for a few years, and put yourself in a position where you can put 50% down on one of these places once kids come into the picture. I can promise you that your bargaining position will be much better (ability to waive financing contingency is very valuable)
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

Grt2bOutdoors wrote:
LFKB wrote:
Grt2bOutdoors wrote:
HornedToad wrote:
Grt2bOutdoors wrote:
No - you are banking on the bonus to leverage up and purchase the place you will be living in. If you can't repay, the bank will seize the property and you could lose all of your down payment. A million is serious money to have at risk. Remember, it took you 3+ years to accumulate it.
In any rational scenario this would never happen. The OP would sell the house, possibly at a loss if it was in a hurry to sell and also pay the realtor commission. They wouldn't just default on a house with a million dollars in equity.
Was the market rational or irrational during 2008 and 2009? If you have no assets outside of equity in the home and no rational purchasers, would your scenario work? He's about to plunk down $1MM in cold hard cash, all of it as a down payment. If the home was purchased for $3MM, OP loses job, puts the home for sale and it sells for $2MM - bank is owed $2MM since OP is gunning for an I/O (interest only mortgage) leaving principal loan still intact. After costs, OP walks with zero or is slightly negative. To me, that's more than a loss - that is a foreclosure on your money when you lose it all.

The OP asked us because he wanted a devils advocate, so here we are saying be judicious when it comes to personal leverage. The bank will give him an outrageous mortgage if he desires, but just because they offer the candy, doesn't mean you should accept it.
The downpayment on a $3M house at 75% LTV is $750k (not $1 million), we would have about $450k in reserves after this. By year end, those reserves will be around $700k (we have pretty good visibility into the rest of the year). So yes, with $700k in reserves, we could both lose our jobs for some time and still be fine under your scenario. I understand your playing devil's advocate and that was much of what I was looking for by starting this thread, it just seems like you're being too extreme (it's more extreme than 2008 and 2009 and it still works fine for us). I am trying to find the healthy balance of conservatism while also finding a home I can be in for years to come.
On that note, I recommend you keep reaching for the stars - buy a $4MM house instead. I missed the part about buying a "forever" home.
I assume this post is sarcastic but it's always impossible to tell on here :)
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

wilked wrote:
LFKB wrote: I certainly understand the correlation but it doesn't always play out that way. Interest rate can rise with housing prices, especially in niche, highly desirable markets like the ones we are looking at. There will always be millionaires who want to live on the westside of LA. It's probably not sustainable for interest rates to rise to 7% and home prices to increase 30% nationally, but it could happen within specific markets.
For the record, this is what people say that are trying to talk themselves into something.

If interest rates rise housing prices are most likely to decline (and at the least stagnate). You will be much better off socking away that $50-100K differential for the time-being, keep renting for a few years, and put yourself in a position where you can put 50% down on one of these places once kids come into the picture. I can promise you that your bargaining position will be much better (ability to waive financing contingency is very valuable)
I see rates rising and prices remaining flat as the most likely scenario over the next 2-3 years in the areas we're looking. But who knows, anything could happen. Anyways, to me it makes more sense to lock in the low interest rate while available. What we do know is that rates can't go much lower than they are today but we don't know is how much higher they can go and whether home prices will go up or down, so may as well lock in the one variable that is in an ideal situation. To me it makes more sense to do a 7 year IO loan and pay down principal with excess cash (thus reducing interest payment), rather than save up more for a downpayment but potentially at a much higher interest rate.

The difference between 4% and 7% interest on a 30 year fixed at 75% LTV is an additional $1.5M of interest expense over the full life of the loan.
bloom2708
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Re: How Much House Should I Buy?

Post by bloom2708 »

I would rent or buy a small house with cash, work for 12 years and save $700k+ per year. Retire at 40 and enjoy life.

You have the equivalent of of an NBA contract salary. I would not want to lock in a 15 or 30 year monster mortgage payment. But you certainly can afford most any house you want.

Maybe back into a number. Figure out what 25% of your net take home pay is. Figure out what amount of mortgage that would buy. Conservative, but you'd have the ability to power save.
Longtimelurker
Posts: 471
Joined: Fri Dec 13, 2013 7:23 am

Re: How Much House Should I Buy?

Post by Longtimelurker »

LFKB wrote:
Longtimelurker wrote:
I certainly understand the correlation but it doesn't always play out that way. Interest rate can rise with housing prices, especially in niche, highly desirable markets like the ones we are looking at. There will always be millionaires who want to live on the westside of LA. It's probably not sustainable for interest rates to rise to 7% and home prices to increase 30% nationally, but it could happen within specific markets.
Sounds like you are set on a course of action. Frankly you could not pay me to live in LA. But to each their own. Good luck to you.
Stay the course. If you can't resist greed, and fear is proven to be 2x as strong, you are doomed as an investor.
freddie
Posts: 920
Joined: Sat Feb 08, 2014 10:06 pm

Re: How Much House Should I Buy?

Post by freddie »

wilked wrote:
LFKB wrote: I certainly understand the correlation but it doesn't always play out that way. Interest rate can rise with housing prices, especially in niche, highly desirable markets like the ones we are looking at. There will always be millionaires who want to live on the westside of LA. It's probably not sustainable for interest rates to rise to 7% and home prices to increase 30% nationally, but it could happen within specific markets.
For the record, this is what people say that are trying to talk themselves into something.

If interest rates rise housing prices are most likely to decline (and at the least stagnate). You will be much better off socking away that $50-100K differential for the time-being, keep renting for a few years, and put yourself in a position where you can put 50% down on one of these places once kids come into the picture. I can promise you that your bargaining position will be much better (ability to waive financing contingency is very valuable)
If you have 1 million dollars, save 100k/yr(or even 200k) and earn 5% (taxes are a real crimp on returns), how many years will take you to get to 50% of a 4 million dollar house appreciating at 7%/yr(i.e. effectively tax free)? How much more will your property taxes per year for life be by buying a 6 million dollar house instead of a 4 million (about 10-15k/yr is my rough guess)?

Someday costal CA real estate will stop appreciating at insane rates. I am not smart enough to tell you if it will be in 1 month or 30 years. I can tell you that 15 years ago people were talking about how insane prices were and how they were unsustainable. Markets can remain "irrational" a lot longer than your willing to wait.
wilked
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Re: How Much House Should I Buy?

Post by wilked »

If you will be aggressively paying down the principal, why discuss 30 year payback dollars?

Postponing the purchase has real savings, I would say at least $50k/year. All of this other stuff of interest rates might go up to this and housing prices might do that is pie in the sky stuff. Your rent today approaches what you will pay taxes on for the properties you are seeking, for instance. I am not suggesting you shouldn't buy ever, but buying early to 'lock in interest rates' is like buying two additional cars now because you might have kids in the future and they have 5 year interest-free loans at the local dealership. Great rate, but meanwhile you own a depreciating asset, pay to register and insure the vehicles, and you don't need them (not an exact analogy, but not far off either I don't think).

Anyway, I wish you the best, I think your mind is made up but hopefully we have at least shown you a different perspective. Good luck!
freddie
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Re: How Much House Should I Buy?

Post by freddie »

bloom2708 wrote:I would rent or buy a small house with cash, work for 12 years and save $700k+ per year. Retire at 40 and enjoy life.

You have the equivalent of of an NBA contract salary. I would not want to lock in a 15 or 30 year monster mortgage payment. But you certainly can afford most any house you want.

Maybe back into a number. Figure out what 25% of your net take home pay is. Figure out what amount of mortgage that would buy. Conservative, but you'd have the ability to power save.
Or buy the house, work for 7 years, sell it for 8 million and retire at 35 and enjoy life. For better or worse this house is a big crap shoot financially. You get 7%+ appreciation with the leverage and you can generate real wealth (assuming you don't mind retiring someplace else). The reverse can also happen.

BTW it is impossible to save 700k on 750k of salary. Getting much above 350k is just about impossible.
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

wilked wrote:If you will be aggressively paying down the principal, why discuss 30 year payback dollars?

Postponing the purchase has real savings, I would say at least $50k/year. All of this other stuff of interest rates might go up to this and housing prices might do that is pie in the sky stuff. Your rent today approaches what you will pay taxes on for the properties you are seeking, for instance. I am not suggesting you shouldn't buy ever, but buying early to 'lock in interest rates' is like buying two additional cars now because you might have kids in the future and they have 5 year interest-free loans at the local dealership. Great rate, but meanwhile you own a depreciating asset, pay to register and insure the vehicles, and you don't need them (not an exact analogy, but not far off either I don't think).

Anyway, I wish you the best, I think your mind is made up but hopefully we have at least shown you a different perspective. Good luck!
What are the $50k per year in savings you are referring to? If you mean I can put a bigger downpayment down and pay less per year, those aren't really savings. The money could just as easily be invested elsewhere and if it earns greater than 3.3% per year (interst rate I have been quoted at) it would be a net negative to put down a greater dowpayment.

Your car analogy is ridiculous. It's a depreciating asset vs. a home which can be lived in forever and which should appreciate.

I certainly haven't made up my mind but appreciate the feedback.
surfstar
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Re: How Much House Should I Buy?

Post by surfstar »

bloom2708 wrote:I would rent or buy a small house with cash, work for 12 years and save $700k+ per year. Retire at 40 and enjoy life.
THIS x $million

:sharebeer
bigred77
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Re: How Much House Should I Buy?

Post by bigred77 »

A couple more comments after thinking about this more:

1.) Mortgage underwriters may not consider your bonus when calculating income (regardless of what the brokers tell you). When my wife and I got a mortgage last year they would only consider our base salaries when determining Debt Service to income ratios. They would not even consider my equity awards that were already given and vest on a time schedule much less my cash bonus.

2.) Property Taxes and insurance alone on a $3M house are going to be more than your paying right now in rent, nevermind the mortgage servicing.

3.) No matter where you live, it just a little extreme for 28 yr olds to around buying $3M dollar homes. If you think of your mortgage as a negative bond, your asset allocation is going to be something insane like this:

Cash: 45%
Equities: 15%
Bonds: -160%
Single Family Home in LA: 200%

4.) I would really advise you to just wait. Keep gettin them checks while the gettin is good. Take some more extravagent vacations, rent a nicer apt, and stockpile cash for when it makes more sense to buy a house. Wait till you have kids at least.
wilked
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Re: How Much House Should I Buy?

Post by wilked »

LFKB wrote: Your car analogy is ridiculous. It's a depreciating asset vs. a home which can be lived in forever and which should appreciate.
The house is definitely a depreciating asset. You may think it should appreciate, but history disagrees, in spite of recent run-ups... Google inflation-adjusted housing prices, there are tons of links out there

If your taxes on your house = current rent, I can assure you there are significant savings to be had by renting. A very graphical way to look at it is here
http://www.nytimes.com/interactive/2014 ... .html?_r=0
Grt2bOutdoors
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Location: New York

Re: How Much House Should I Buy?

Post by Grt2bOutdoors »

bigred77 wrote:A couple more comments after thinking about this more:

1.) Mortgage underwriters may not consider your bonus when calculating income (regardless of what the brokers tell you). When my wife and I got a mortgage last year they would only consider our base salaries when determining Debt Service to income ratios. They would not even consider my equity awards that were already given and vest on a time schedule much less my cash bonus.

2.) Property Taxes and insurance alone on a $3M house are going to be more than your paying right now in rent, nevermind the mortgage servicing.

3.) No matter where you live, it just a little extreme for 28 yr olds to around buying $3M dollar homes. If you think of your mortgage as a negative bond, your asset allocation is going to be something insane like this:

Cash: 45%
Equities: 15%
Bonds: -160%
Single Family Home in LA: 200%

4.) I would really advise you to just wait. Keep gettin them checks while the gettin is good. Take some more extravagent vacations, rent a nicer apt, and stockpile cash for when it makes more sense to buy a house. Wait till you have kids at least.
Another +1. Item 1 is exactly what we've been saying in a round about way. A bank will only consider wage income and guaranteed income such as an annuity backed by a legal contract to pay from a verifiable source. Carried interest and target bonus amounts means bup-kus! There was another thread on here recently that asked what commercial bank view as liquid assets for collateral - let me paraphrase what I said on that thread for the OP - cash, cash and more cash! So yes, your downpayment amount is good, your wage income is good, the amount of leverage you want to take - is not so good. Of course, you will find a lender willing to lend it to you for a Price! You have to decide if that price is acceptable vs. a lower amount of free cash flow each month.

As to the other post - read between the lines. If you stretch for $4MM, don't be surprised if that rubber band snaps back at you.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
Topic Author
LFKB
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Re: How Much House Should I Buy?

Post by LFKB »

wilked wrote:
LFKB wrote: Your car analogy is ridiculous. It's a depreciating asset vs. a home which can be lived in forever and which should appreciate.
The house is definitely a depreciating asset. You may think it should appreciate, but history disagrees, in spite of recent run-ups... Google inflation-adjusted housing prices, there are tons of links out there

If your taxes on your house = current rent, I can assure you there are significant savings to be had by renting. A very graphical way to look at it is here
http://www.nytimes.com/interactive/2014 ... .html?_r=0
I googled inflation adjusted housing prices, they have appreciated in real terms, albeit at a slow rate. Comparing a house to a car which depreciates 30% when driven off the lot and has a useful life of probably 7-10 years is a bit ridiculous in my opinion. I never said I am anticipating significant appreciation in the home, but comparing it to a car depreciation isn't reasonable.

I played with the rent vs. buy calculator. It says I would need to rent a similar place for ~$7,000 a month to make renting a better deal, which is likely not doable.
Grt2bOutdoors
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Re: How Much House Should I Buy?

Post by Grt2bOutdoors »

wilked wrote:
LFKB wrote: Your car analogy is ridiculous. It's a depreciating asset vs. a home which can be lived in forever and which should appreciate.
The house is definitely a depreciating asset. You may think it should appreciate, but history disagrees, in spite of recent run-ups... Google inflation-adjusted housing prices, there are tons of links out there

If your taxes on your house = current rent, I can assure you there are significant savings to be had by renting. A very graphical way to look at it is here
http://www.nytimes.com/interactive/2014 ... .html?_r=0
Yup! Wait til the OP needs to update the home to keep up with the Joneses - cha-ching! Location, Location, Location! - and that goes for the contractors as well, who will charge you much more than say if they were to venture into East LA. Because where the money is, is where the highest costs for everything will be billed. So it's $3MM just to get in the door, followed by $75K in painting, window treatments, lawn care. Next year, you need a new paved driveway - cha-ching! Earthquake insurance? Cha-ching! Housekeeping? - cha-ching! Membership in the local country club or pool club? - Cha-ching! Add it all up...before you know it, your cash kitty has gone down some more.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

Grt2bOutdoors wrote:
bigred77 wrote:A couple more comments after thinking about this more:

1.) Mortgage underwriters may not consider your bonus when calculating income (regardless of what the brokers tell you). When my wife and I got a mortgage last year they would only consider our base salaries when determining Debt Service to income ratios. They would not even consider my equity awards that were already given and vest on a time schedule much less my cash bonus.

2.) Property Taxes and insurance alone on a $3M house are going to be more than your paying right now in rent, nevermind the mortgage servicing.

3.) No matter where you live, it just a little extreme for 28 yr olds to around buying $3M dollar homes. If you think of your mortgage as a negative bond, your asset allocation is going to be something insane like this:

Cash: 45%
Equities: 15%
Bonds: -160%
Single Family Home in LA: 200%

4.) I would really advise you to just wait. Keep gettin them checks while the gettin is good. Take some more extravagent vacations, rent a nicer apt, and stockpile cash for when it makes more sense to buy a house. Wait till you have kids at least.
Another +1. Item 1 is exactly what we've been saying in a round about way. A bank will only consider wage income and guaranteed income such as an annuity backed by a legal contract to pay from a verifiable source. Carried interest and target bonus amounts means bup-kus! There was another thread on here recently that asked what commercial bank view as liquid assets for collateral - let me paraphrase what I said on that thread for the OP - cash, cash and more cash! So yes, your downpayment amount is good, your wage income is good, the amount of leverage you want to take - is not so good. Of course, you will find a lender willing to lend it to you for a Price! You have to decide if that price is acceptable vs. a lower amount of free cash flow each month.

As to the other post - read between the lines. If you stretch for $4MM, don't be surprised if that rubber band snaps back at you.
We've only spoken with one lender and she is including our bonuses in her calculations but not my carried interest (which is understandable), so for us, the bonus doesn't amount to bup-kus.

I assumed you were being sarcastic but we wouldn't buy a $4M home anyways.
Grt2bOutdoors
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Location: New York

Re: How Much House Should I Buy?

Post by Grt2bOutdoors »

Does the underwriter make the final determination if your mortgage gets approved? Typically, you have an underwriter who reports to someone who in turn reports to someone else. There is more than one person who signs off on a 7 figure loan.
Is the lender keeping the loan on their books or looking to offload it in the secondary market? If they are looking to offload it, they may have to meet FNMA or FHLMC or some other lenders standards, or maybe they're going with a FHA (though I don't believe they underwrite such high limits). Don't count your chickens until they've hatched. Like I said earlier, there is plenty of money to be lent if the price is right.

Good Luck to you, let us know how it turns out.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
Nebster
Posts: 118
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Re: How Much House Should I Buy?

Post by Nebster »

Portfolio lenders will definitely allow the bonus income (and other W2 income in general), if it can be shown that it is historically reliable. Some apply a discount factor to that portion. The ones I have worked with would also take into account stock-based comp, future stock-based comp (unvested grants), history of grant issuance, alternate collateral trapped in tax-advantaged positions, and so on.

As long as the LTV is low enough, most of the risk to the lender is sucked out of the equation anyway.

I've already voted for OP sticking towards the cheaper end of the spectrum, so I'm not advocating for something else. But OP should definitely be able to get the loan from the right creative financier. (Whether he will get a seller to be willing to go into contract with him is a different question, also covered earlier.)
dimdum
Posts: 218
Joined: Fri Mar 04, 2011 1:50 pm

Re: How Much House Should I Buy?

Post by dimdum »

Based on your income, saving and industry I would say go for it. Although I would say go for lower 2.5-3.0m range rather than higher.
I would also recommend putting the minimum payment needed (25%) rather than putting more. And going for 5-7 yr ARM to minimize your payment.

Let's look at worst case scenario:

Recession hit, One of you loses job, housing mkt starts tanking. If it had held its value in past it will hopefully held in future.
At worst case you may have to sell a house at 10% loss or you need to weather the storm (if you can afford mortgage then).

Based on your saving and income, that about .75 yr (300K) of wages lost in worst case.
Topic Author
LFKB
Posts: 1264
Joined: Mon Dec 24, 2012 6:06 pm

Re: How Much House Should I Buy?

Post by LFKB »

Thanks for all the responses. I have a lot more to learn and think about before making a decision, all of which I'll do. We initially were going in at a price point of $2 million with a max of $2.5 million. We are finding that the "value curve" is leading us to a bit higher of a price point and are considering going a bit higher, but in no case we would go over $3 million. I imagine we end up in the $2.4 to $2.75M range, which feels like a lot but we will still have the ability to save a good chunk each year if our incomes stay flat or increase.
absolutFinance
Posts: 165
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Re: How Much House Should I Buy?

Post by absolutFinance »

Pretty interesting thread and interesting situation for the OP. I know others alluded to this but OP, have you and your spouse considered riding out this cash-rich wave at work, saving along the way and then moving/settling down somewhere cheaper at the time when you start your family? Significantly lower cost of living areas that are still great places to live (like Seattle, Portland, Austin, etc) could give you a great balance of getting a fantastic home at a price that entails less financial risk while having access to great schools? I'm skeptical and cynical of the finance industry so perhaps I'm with many commenters here that are bearish in comparison to your future outlook.
TareNeko
Posts: 585
Joined: Wed Aug 14, 2013 1:27 pm

Re: How Much House Should I Buy?

Post by TareNeko »

bigred77 wrote: 2.) Property Taxes and insurance alone on a $3M house are going to be more than your paying right now in rent, nevermind the mortgage servicing.
I think this is enough of a reason not to buy a house in that location.
tphp99
Posts: 374
Joined: Sun Jan 03, 2010 7:47 pm

Re: How Much House Should I Buy?

Post by tphp99 »

OP,

Congrats on a great start/career. You can certainly afford the $2-3M home. You're young and have plenty of time to recover if something "bad" happens.

However, a 3,000 sq ft home might not look so great after a few years. What's next 5,000 sq ft? How about 10,000? Ask me how I know. Luckily, we live in Florida and housing is cheap compared to Cali.

My recommendation: rent a 3,000 sq ft home for a few years and see what you think. How long would you want to live like that? You actually don't know right now. We never thought we'd "out grow" a 5,000 sq ft home - yet here we are, looking for a bigger home after buying our dream home 3 years ago. Again, we live in Florida, paid cash for said home and will pay cash for our next home. It'll feel way less stressful than having a 7 figure mortgage.

I'm all for living it up, but not taking on debt to do so.

Good luck.
Valuethinker
Posts: 49019
Joined: Fri May 11, 2007 11:07 am

Re: How Much House Should I Buy?

Post by Valuethinker »

LFKB wrote:
wilked wrote:
LFKB wrote: Your car analogy is ridiculous. It's a depreciating asset vs. a home which can be lived in forever and which should appreciate.
The house is definitely a depreciating asset. You may think it should appreciate, but history disagrees, in spite of recent run-ups... Google inflation-adjusted housing prices, there are tons of links out there

If your taxes on your house = current rent, I can assure you there are significant savings to be had by renting. A very graphical way to look at it is here
http://www.nytimes.com/interactive/2014 ... .html?_r=0
I googled inflation adjusted housing prices, they have appreciated in real terms, albeit at a slow rate. Comparing a house to a car which depreciates 30% when driven off the lot and has a useful life of probably 7-10 years is a bit ridiculous in my opinion. I never said I am anticipating significant appreciation in the home, but comparing it to a car depreciation isn't reasonable.

I played with the rent vs. buy calculator. It says I would need to rent a similar place for ~$7,000 a month to make renting a better deal, which is likely not doable.
We need to think about this rigorously as possible-- this is finance.

The equity you have in a property is an alternative to imputed rent.

What I think you will find is that rents have risen, but home values have risen in coastal USA a lot faster. Thus the cap rate has declined significantly. This is a combination of:

- zoning controls which make it hard to build more housing in high demand areas (NY/ Boston/ Bay Area/ SoCal)
- a change in overall market interest rates (down)

The first is likely to continue, the second less so (and could reverse). Both Japan and Germany have experienced real falls in housing prices since the early 1990s. The US has less mature demographics (but immigration controls play a role in this) and deflation is arguably less of a risk.

It is very instructive to look at what happened to housing prices 1920s to 1940s. In many parts of the USA they peaked in the 1920s and didn't recover for 20+ years (in real terms). OK so we don't *think* Los Angeles is the next Buffalo or Baltimore (both of which have absolutely amazing architecture) but we cannot be sure of that.

On actual housing prices, Shiller (and others) found that housing prices didn't keep up with inflation, adjusting for quality. See Neil Monnery 'Safe as Houses: 8 centuries of housing prices' for a broader look at the data (but also see Shiller's website at Yale).

However in coastal areas the last 40 years they have comfortably beat inflation (see Edward Gleaser's work).

What we can say is that:

- structures depreciate over time. That depreciation may be as much as 1-2% pa. Houses are not worth more as they get older, because you have to spend to keep them up to date (in commercial structures the depreciation rate is 2-3x that). In that sense a house *is* like a car (albeit with a much slower depreciation rate). It is a depreciating consumer durable

(if you go round homes and see some ones that haven't been touched in 30-40 years you'll see what I mean. Old wiring etc. 40 years ago Air Conditioning wasn't universal, and it was on a different level in terms of comfort and convenience even if you had it. Roofs need constant replacement. Driveways and decking. Even in the last 10-15 years it's standard for new homes to have home entertainment systems, fancy kitchens and family rooms etc. that were unknown 20 years ago eg it is common now for a cinema in the basement, temperature controlled wine cellar etc.). My mother's home is in a good area, but the house hasn't been updated since the 70s (except for necessary repairs) and the agents basically say the next buyer will *deduct* the cost of knocking it down from the purchase price. If you buy a $2.5m house more than 10 years since last total renovation, I predict you will spend $250k updating it.)

- land may, or may not, appreciate over time. Given the long run population and economic growth of the USA, the increase in housing prices has been surprisingly low (it's been much higher in the UK but, again, depends on *where*)

So past price appreciation may not be indicative of future price appreciation. Because the cap rate might not fall any further and/or rents might not rise as fast. I would add that a high quality neighbourhood is a 'low beta stock' in this-- the swings are not as large, generally.

Your investment in your house is your equity. The remainder of the purchase price, financed by debt, is a 'negative bond' in a sense, it's an inflation hedge.

My own view is that you are in a highly volatile profession. There are no certainties in private equity (google Candover and its torrid recent past for an example of one of the leading London PE firms for 2 decades, that blew up. Or Hicks Muse. Or Forstman Little). A *lot* of people have earned a lot less carry than they thought they would 10 years ago. Everyone I know who was in your sort of field:

- bought a nice house
- deleveraged as quickly as they could

There's a correlation between your personal income and the behaviour of financial markets. Having debt increases your leverage to that.

Once you have maxxed out tax exempt saving (and I assuming that's a trivial amount to you) then I would focus on debt repayment until you hit a level of debt (1-2x annual income?) that you are comfortable with, and that is on the safe side. Leverage is what you put into companies, not your own personal balance sheet. The only reason to have personal leverage is for liquidity reasons (it's hard to use your house equity as a bank account).

Remember if you have children your income may plummet (wife stops working) and your expenses will probably soar (nannies, private schools etc.).

The exceptions are borrowing to own equity in your firm, or for coinvestment in the fund portfolio (they usually arrange leverage with a bank for execs in that position). There, you have some influence over the outcome of your investing, so there's a case for gearing up to do it.

Note also higher interest rates are generally not good for PE investments (on the leverage side, the economics of deals shifts against you; conversely it may be a sign of a better economy). So you want most of your mortgage to be fixed, not variable, rate.
Valuethinker
Posts: 49019
Joined: Fri May 11, 2007 11:07 am

Re: How Much House Should I Buy?

Post by Valuethinker »

tphp99 wrote:OP,

Congrats on a great start/career. You can certainly afford the $2-3M home. You're young and have plenty of time to recover if something "bad" happens.

However, a 3,000 sq ft home might not look so great after a few years. What's next 5,000 sq ft? How about 10,000? Ask me how I know. Luckily, we live in Florida and housing is cheap compared to Cali.

My recommendation: rent a 3,000 sq ft home for a few years and see what you think. How long would you want to live like that? You actually don't know right now. We never thought we'd "out grow" a 5,000 sq ft home - yet here we are, looking for a bigger home after buying our dream home 3 years ago. Again, we live in Florida, paid cash for said home and will pay cash for our next home. It'll feel way less stressful than having a 7 figure mortgage.

I'm all for living it up, but not taking on debt to do so.

Good luck.
OP lives in Southern California/ LA. I don't even want to think what a 5,000 square foot home would cost in a good neighbourhood of LA.

The analogy I can come up with is London, and the answer is c. £5m (USD 8m say). £1000 psf (USD 1700) would not buy you the best of London (Chelsea or Kensington say-- up to £2000 psf) but would buy you 'nice' London (Fulham, Wandsworth) ie 30-45 minutes to work, good (private) schools etc.

Also house utilities and maintenance costs (and perhaps property taxes) tend to 'scale' with the size of the home.

In some places you do see 'McMansions' or 'teardowns' where the owners are say Asian (or Italian) and you have 3 generations under one roof. Kids often stay with parents until married. That makes sense-- having a huge house. But the rest of them just look like beached whales, and someday they will need a *lot* of work.

(I come at this with a bias. When I was a kid I used to point at big houses and say to my dad 'what a great house'. And he would snort and say 'who cleans all the bathrooms?' He grew up in probably 5,000-6,000 square foot English Victorian country houses with 6-8 bedrooms (the kind where the owners would never turn on the heating, because it was too costly) which were falling apart. When I finally 'upscaled' (to less than 2,000 square feet) I suddenly see his point-- there's always something that needs doing, fixing or cleaning. Always. And the heating bill is awful (Victorian house).

Roofs. Roofs have this innate repair and replacement cycle. There are *always* tiles that need replacement, etc. I lie awake at night listening to the rain and thinking about the roof.
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