Sunday, July 19, 2015

Is your house robbing you?

Ah home! There's no place else like it on earth.  It’s your own little piece of heaven on this place we call earth.  You can decorate, have parties, relax in it, and create wonderful memories lasting a lifetime. The idea of home brings thoughts of joy, wonderment, and the yearning to always be there. The saying is “There’s no place like home.” But is your home really that nice to you? What if your home was actually a bloodsucking, evil, nefarious place turning you into it’s servant for life?  Imagine instead of lovely flowers on the tables, and custom drapes on the window, it actually represented your tin cup with prison bars over the windows.  That’s what your house is really doing for you.  How could that possibly be?  Well if people have learned anything from the last recession is that a home can become a financial morass wiping out years of your hard earned savings in a heartbeat. Leaving you cold on the street with none of the comforts it previously provided.  

How could this pillar of American society be a source of our actual financial destruction? Well there’s a lot of reasons, and they don’t stem from the recent recession. If anything that’s helped change societal views of our home. For the majority of people the basic home buying checklist is as follows

  1. Watch HGTV and proclaim you must have everything you see other people buying.
  2. Find a real estate agent and start checking the listings.
  3. Get mortgage pre-approval.
  4. Look at 5 homes. Who really has time to do anymore than that since you’re likely too busy driving far distances making yourself poorer!
  5. Buy the spacious, updated, expensive home at the top end of your price range.
  6. Decorate the shit out of it with Restoration Hardware and Crate & Barrel furnishings.
  7. Handcuff yourself for the next 30 years to pay for it all.

If this doesn’t seem like a logical sequence then congratulate yourself for seeing the insanity!  Major things I see wrong is why the heck you’re doing #1, and barely putting any effort into #4. This is how the list should start.

  1. Carefully consider exactly how much space you really NEED, not WANT.
  2. Analyze rent-vs-buy in your targeted neighborhood. Make sure it’s close to where you plan to work. If not refer back to why driving makes you poor.
  3. Get mortgage pre-approval and compare loan costs from two separate banks. If you need assistance with the analysis send MAD Consulting an email. Understand borrowing means you actually can’t afford your home. Also never borrow the maximum amount.  Think about how you will pay for it all if you end up with a job paying less money, or your spouse quits working in order to raise the children.
  4. Find a smart and trustworthy real estate agent if you decide to use one. Remember you can buy a home without an agent if you desire in the for sale by owner market.
  5. Look at lots of homes before you even really consider buying one. Trust me, another one will be put up for sale everyday so you won’t miss out on the “opportunity of a lifetime.” It usually takes 30 minutes to look at a property. I bet most people spend more time trying on pairs of shoes before they purchase new ones. Does spending the same amount of time on a $70 and $250,000 purchase sound like a wise idea?  I didn’t think so.
  6. Consider buying ANY home if the price is good, and structure is sound! Learn to understand how the real estate is valued in that neighborhood. Also you can renovate it yourself (very rewarding), or use a reputable construction company for custom updating.  
  7. Vow to never watch glorified home buying television shows again & enjoy the luxury of not being financially handcuffed to your home!

When I bought my first piece of real estate I ended up looking at over 200 condos, single-family homes, and multi-family buildings.  It ended up being a great lesson. At the end of it I realized in the beginning I had no idea of what I was looking at, and no particular way to judge the quality and value of a house.  I’m glad it worked out the way it did.  With a lot of luck, time, and analysis I ended up with an undervalued multi-family property that will pay for itself many times over in the long run. It also drove me to develop my own analysis techniques to gauge the viability of a property. That was mostly a direct result of my first real estate agent not being very helpful in that area particularly.  So if you can find a smart agent you’ll be much better off than most people.

But back to the real issues of how your house is making you poor.  If you follow the standard American way you end up buying a home that is 2,600 square feet! if you’re not sure how big that is let me tell you, IT'S HUGE! If the average cost of heating a home with natural gas is $0.55sq/ft then your 2,600 square foot home will cost you $1,430 a year*. I won’t go into AC systems for brevity’s sake, but it’s well documented a bigger home costs more to cool in the summer. For our simple example let us assume the last 5 years you’ve used the average amount of heat in your 2,600 sq/ft home. That’s $7,150 less in your pocket.  If you had bought a smaller, still nicely sized 1,700 square foot home you would have spent only $4,675 the last 5 years. Let’s project your 5 year savings of $2,475 and assume you invested it all today returning you a historical average of 8% for 10 years.  There’d be an extra $5,464 in  your pocket.  Might not seem like much, but we haven’t even started looking at other areas, plus this doesn’t include your A/C bill which would add significantly to your costs. Also don’t forget other utility/municipal services such as water, sewage, waste removal, and taxes  which can add significant yearly costs.

How about the cost to decorate your home?  We all want our home to look like the pictures in magazines for good reason.  They look beautiful, it impresses your family & friends, and it can provide a sense of happiness which I don’t mean to discount.  Some quick google searches will show a lot of interior decorators stating you will spend 25% of the value of your home furnishing it. Let’s be conservative and assume it’s actually 22.5% since interior decorators are motivated to have you spend a lot of money.  So nothing scientific in our 2.5% reduction. If your average 2,600sq/ft home costs $272,900 then you’re looking at spending(272,900*22.5%) $61,402.  Now obviously most people will do rooms one at a time or multiple rooms partially over a few years. We can now estimate a cost per square foot to decorate your home($61,402/2600) at $23.61sq/ft.  If you had purchased a 1,700sq/ft home you’d instead be looking at paying only $40,137 to furnish your home. The lesson should be don’t make Pottery Barn & Pier 1 rich, make yourself rich.

Let's assume we have Person A and Person B both buying homes. Person A bought the big home and spent the typical amount($61,402) while person B bought the smaller home and spent the lesser amount($40,137). Person B would have $21,265 more in their pockets at the end of the day.  If we compound it over 10 years at 8% Person B ends up with $46,953 more in their pocket for buying a smaller home. Now lets add in their savings for buying a smaller home which based on the above housing size and price numbers would have cost $178,434.  Person B now has an extra $94,466 of savings available. Together Person B has saved $21,265 + $94,466 = $115,731, and compound it over 10 years at 8% return during that time.  I hope you’re ready for this.  Person B has an extra $255,538 in their pockets after 10 years. Add in the saved heating costs $2,475+$21,265+$94,466= $118,206 and you’d have $261,003** in your pocket.  Or basically enough money to buy that original 2,600sq/ft home. In our analysis we didn’t include other costs which would have made this number even higher. I bet Person B will have a lot less stress in their lives over Person A who is sucked into working long hours while spending no time with family to pay for their larger house.

Now a prudent person would take that $261,003 and do just one thing. Buy that 2,600sq/ft house as a rental property and make even more money.  At MAD Consulting, we can help you take this massive pile of money you saved and invest it in the right property. Have you always wanted to invest in rental real estate?  We specialize in analyzing multi-family, single-family homes, and condos for investment properties.  Also, we can help you determine if the house you plan on buying for your family is the right size for you, cost effective, and not draining your bank account. That’s something the bankers and real estate agent could care less about helping you with.  

*Calculated using 80% efficiency natural gas furnace(2200 sqft/$1215=$0.55 cost per sq/ft) from  Adjust your numbers accordingly if you have a different heat source or more efficient furnace.  

**All estimated investment returns calculated at 8% return rate with interest paid quarterly.

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