I think a lot of these items are bad advice. Above, you asked for someone to explain their disagreements, so I will.
geerhardusvos wrote: ↑Sun Sep 06, 2020 11:50 am
1. If you live on either of the coasts (HCOLA) in the USA, you should probably rent
. If you live in the middle of the country in LCOLA, then you should consider buying. These are generalities that are often true, but not always true. Owning can be great if you can afford it and if it makes sense for your area and income level and desired lifestyle. These are personal decisions; some people like owning some like renting. But there is likely a more clear ideal financial choice for your situation if you dig into it and have an open mind.
As you pointed out, this is a generality, and because you didn't explain the reasoning, you're not giving the advisee the ability to make a decision more specific to their own situation. It is also not timeless advice. The areas where buying makes sense can change significantly over a decade.
I also think that probably at most 25% of people living on the "coast" actually live in areas where it is financially better for a long-term resident to rent. The Bay Area and urban New York City are possible examples. But when I lived in suburban New Jersey, it was definitely a "buy" kind of place, and looking at prices right now, I think it still is. There is a lot
of coast outside the very expensive cities.
Better advice would look something like: You should probably buy if the price-to-rent ratio is lower than X. You should probably rent if the price-to-rent ratio is higher than Y. This is easier to apply in a variety of situations, but even this is dependent on mortgage rates and opportunity costs, so it has an expiration date.
Ultimately, I think people should just use the New York Times buy vs rent calculator.
2. You should only buy if you plan to stay longer than 10 years. If you are a resident, new employee, new to an area, just starting out, etc... just rent, pay off debt, keep investing in your three fund portfolio, and if things are stable down the road and you find the place you want to stay a long time, then consider buying. But don't spend too much (see next step).
Again, this is poor advice because you didn't explain the reasoning.
I would argue that if
buying is a good idea at all, 10 years is an excessively long period to require. By buying for the short term, you pay transaction costs to avoid a short position in housing. The transaction costs in urban and suburban areas are, let's say, 10% (though in most places, this is an overestimate). The costs of being short housing are probably at least 2%/year (otherwise it wouldn't really be a "buy" area at all). This would argue for a 5-year holding period (10% cost spread over 5 years) even in marginal "buy" areas.
3. You should only spend 2-3X your annual gross income on a house. This means that if you make $100k gross as a family, you can afford a $200-300k house. This is regardless of if you are paying for the house with cash, home equity, or borrowing. It's about your long term ability to sustain your standard of living. It's about not having too much of your net worth wrapped up in a house (I recommend targeting home equity being <25% of your long term net worth in your primary residence - so if you plan to retire with $2M, you have a ~$500k house paid off as an example). We want our assets to pay us, and minimize consumption items that don’t pay us, and if we are living in our house, it is just another consumption item. If you want to spend more than that, you're probably over extending yourself unless you got an inheritance or are getting help to buy the house. Even then, it's recommended to stick to 2-3X your gross income (you can use pre or post tax income, I use post-tax). If you plan to have kids or if you are married and one of you will stop working, then you should consider your gross income only the one that will be sustained in the long term. Don't account for short term income. If you make $500k/year, yes, you can probably afford the $1.5M house! If you really really want to spend 3.5-4X on a house, many many people do this, but know that they are likely overbuying and taking on more risk than they need to. Just be aware of the trade offs of plowing money into your house instead of the stock market (this can be a significant trade off over long periods of time). So in answer to the question proposed at the top of the OP, no, if you make $150,000 per year, you cannot afford a $850,000 house. Will you go bankrupt? Probably not. But unless the value to you significantly exceeds the trade-offs, then you are doing yourself a disservice.
There's so much wrong here.
First of all, once again no justification is provided, so this is poor advice. And why 3x and not 3.1x or 2.9x? There is no evidence that you did any kind of computation or analysis to come up with the "3x" number. Why, then, should I believe it? Why 25% of net worth rather than 26% or 30% or even 60%? What concrete bad thing would happen if my house was 60% of my net worth when I retired?
Second, there is a lot of space between 2x income and 3x income. (Having a lower limit is rather silly anyway. If you want to live in a house that's worth 50% of your income, there is nothing wrong with that.) Overly broad advice is not actionable.
Third, the advice is based mainly on income. It is therefore not helpful to people in many common situations, such as those who are retired or have received an inheritance. 25% of net worth is also not appropriate advice for many of these people. You should provide people with a framework for analyzing these decisions, rather than just throwing numbers at them.
Fourth, interest rates matter, because they affect the cost of capital and opportunity costs. Your rule ignores this, so it can't be right in general.
Fifth, the way you pay for the house (cash vs. mortgage) matters too. You present this as a risk management strategy ("If you really really want to spend 3.5-4X on a house, many many people do this, but know that they are likely overbuying and taking on more risk than they need to") so let's consider risk. Your risk is obviously greater when you have leverage. Therefore, if you care about risk management, the degree of leverage should be considered when purchasing. Your rule ignores this, so it can't be right in general.
Sixth, this makes no sense at all: "it's recommended to stick to 2-3X your gross income (you can use pre or post tax income, I use post-tax)" For one thing, gross income generally means pre-tax income. But let's suppose you have some other meaning in mind. You're saying it doesn't matter whether you use pre-tax or post-tax income. How can your rule possibly
be correct if it doesn't matter whether you use pre-tax or post-tax income to calculate the number? Consider that family earning $150K. Suppose they are in Colorado (a state I picked at random) and contribute $20,000 to their 401(k)s. This couple will pay $30,000 in total income taxes. If you use post-tax income in the rule, they can afford no more than a $360,000 house. If you use pre-tax income, they can afford no more than a $450,000 house. These conclusions are incompatible.
Finally, if we must
have a rule based on a flat multiple of income, I think 3x is unreasonably low. Here's how I would justify that:
* Mortgage interest and principal assuming no down payment: 6% of home value per year
* Property tax: 2% per year
* Maintenance and insurance: 2% per year
All of these are likely overestimates for most people. Even so, the total spending comes to 10% of home value per year. If the house is 3x your income, this spending amounts to 30% of your income. Even if this is a percentage of pre-tax income, it is by no means a risky level of spending. There is at least some room for people to spend more without seriously risking their financial future. It is counterproductive to tell people that anything above 3x is too risky when that's not true. If they figure that out, they will ignore your advice.
4. You should not underestimate the total cost of owning a house. Time, maintenance, risk (see natural disasters), taxes, etc. all add up very quickly and are a larger toll than most people account for. Bigger house means more maintenance. More expensive area means higher maintenance cost for labor. If you are doing the labor yourself, you are giving up your most valuable asset, your time. Be clear with yourself about the costs and opportunity costs. Opportunity costs which include the ability to invest more aggressively, especially while you are young, instead of saving for a down payment on a house or instead of the cost of owning and maintaining. These decisions can be worth hundreds of thousands of dollars if you are willing to see the opportunity costs. If we frame the question around which option, renting or owning, will allow us to build long-term wealth, I think it starts a healthy conversation and shifts the conversation more about long-term value and wealth accumulation. There are many cases renting smooths the monthly expenses and allows for more consistent investing into the stock market (where are you will get the biggest returns). I can’t stress enough, the earlier you can invest in the stock market, the better. Saving up for and buying a house has too often gotten in the way of investing early for young accumulators. Just be clear about the trade-offs and your goals!
I agree with everything here. The only problem is it's not actionable advice. I think maintenance on my house is likely to be 1.5% of the home value per year. Am I right, or wrong? Knowing that most people underestimate maintenance does not help me know the answer to that question.
This section could be improved by helping people estimate their costs, rather than just telling them not to underestimate them.
5. Town-homes, condos, apartments, etc. are usually not as good of investments as single family homes (see HOAs, etc.). They tend not to appreciate as much and they are less desired. This depends on your area (see #1 above). Seek to spend only 1-2X annual income on non SFH properties. These can often need less maintenance however, so consider the trade-offs. Having a pool or a gym can be very attractive for certain lifestyles, so there are some benefits of this type of home, as well as downsides.
I'll skip commenting on this one because I have never considered buying a part of a building, and I honestly have no idea about the long-term value.
6. Renting is NOT throwing away money
. Renting can be a better and more prudent financial option depending on your math and income. Don't let family or friends pressure you to buy just because "it's what grownups do." There are plenty of wealthy grownups (and people in every economic level) who rent for life
. And just FYI, "making money in real estate" doesn't actually mean it was a good investment
. Owning can be the right choice to depending on your analysis, and if it is, owning can be a great choice in many markets!
No disagreement here, though again I don't think it's really actionable advice.
2. If you can rent out your house for 1% of the purchase price, then you're in good shape. If you bought the house for $200k, you should rent it out for $2k/month. If you are less than this, it's very likely not a good investment to rent it out and you should sell your house instead of renting it out. This has nothing to do with appreciation, but everything to do with what you paid for the house. If you bought a house in 1992 for $120k in Portland and now it's worth $800k, you would still seek to rent it out for 1% of purchase price or more. In this scenario, you're in good shape since you can probably rent this house out for $2.8k/month in Portland. But if you don't want the headache, selling is a great (and usually the most ideal) option. Rental investments can be really good, but you have to do your math, know your areas, and it's a business. It's not truly passive income in almost all cases. You can find many real estate investment blogs (Bigger Pockets is a good place to start) if you want more information.
This stands out to me as the worst part of your post, because there is no rational basis for this advice. Except in California, where property taxes are tightly locked to the initial purchase price, there is no logical connection between the price paid for a house and the rental rate that makes it worth renting out a house rather than selling it. You rightly called attention to opportunity costs above, so I don't understand why you're suddenly ignoring them here. A house worth $800,000 that rents for $2,800/month should be sold. That is a gross rental yield of 4.2%, insufficient to be a good investment when you consider other opportunities for what to do with the $800,000. The fact that you paid $120,000 is irrelevant. This house should be sold (or 1031-exchanged for a better investment property, if taxes are prohibitive).
Indeed, taking your argument to a not-even-that-extreme level, if you paid $120,000 for a house in Portland that is now worth $800,000, you say that renting it out for 1% of purchase price is OK. So I should be willing to rent this house out for $1,200 per month. This is a gross rental yield of 1.8%. Property taxes alone are 1%. You are almost certainly making a negative rate of return on this investment.
The bottom line is that the purchase price should be ignored in these computations, except for tax purposes or in California (and even in those cases, use the appropriate figures: the basis or the assessment, respectively).