So you’re looking for a big expensive house to upgrade your life. Perhaps the months of lockdowns you experienced is making you want to live it up a little. I get it! Owning a larger, nicer house will make living through a second lockdown much more bearable.
However, I want to provide a warning that a big expensive house can ruin your life and derail you on your path to financial freedom. Let me share one of my experiences almost buying an expensive house back in 2018 and the numbers.
As a dad, I’d like my parents and in-laws to come visit more, which is why it’d be nice to have a ground floor level portion of the house dedicated just to them. This would make it more comfortable for all of us.
Given I write from home, it’d be nice to have a house large enough so that I can’t hear my boy squealing with joy or crying in frustration. Trying to create while hearing him is one of my toughest challenges because once I hear him, I just want to drop everything and go to him.
Finally, I have some FOMO that if I don’t buy this house now in one of the best neighborhoods in San Francisco, I might never be able to get in. This is my ego talking more than anything else.
Found The Perfect House
I’ve found the perfect house in Presidio Heights, one of the most prime neighborhoods in my city. It has four bedrooms, four and a half bathrooms, an awesome attic that would be used as a playroom, and a ground floor suite for my parents or in-laws. My commute to the tennis club would be cut down from 15 minutes to only five minutes a well.
Here are some pictures:
Pretty nice house right? It’s roughly 3,200 square feet, or 1,300 square feet larger than our existing three bedroom, two bathroom house. Not extravagant, but nice.
Here’s the problem. The asking price is……………. $4,395,000! Nooooooo.
Believe it or not, buying a single-family home in Presidio Heights for under $5 million today is considered reasonable. But when I do the math on how much it would cost to own a $4.5 million home, it kind of hurts my stomach.
The Cost Of Owning A Regular $4.5 Million House
It’s important to always do the math before making any big purchase. Here’s the math to own this beautiful house with a $2 million downpayment just because I thought it might be nice to live in Presidio Heights instead of Golden Gate Heights.
If I bought this house, my all-in monthly housing expense would more than triple to $18,605 while I would no longer be able to earn any potential income or returns from $2 million currently spread out across municipal bonds, stocks, and real estate crowdfunding in lower cost areas of the country.
The $2 million downpayment is guaranteed to earn $62,000 a year in state tax-free income if it was invested entirely in a 10-year government bond. Hence, one could easily argue that the total annual cost of owning this house a year is not $223,254, but actually $223,254 + $62,000 = $285,254.
Although the mortgage would eventually go away, the 1.23% property tax rate is for life. I cannot get over how egregious it is to pay $55,350 a year in property tax forever. You can rent a nice two bedroom, two bathroom, lightly remodeled condo in a nice part of San Francisco for $4,613 a month. Further, the property tax amount will keep on going up by about 2% a year because the city automatically assesses the value of your house up by 2% a year.
The Cost Adds Up!
After 20 years of ownership, you will likely have paid roughly $1,200,000 in property taxes alone. That is just absurd.
To add insult to injury, due to the $10,000 SALT deduction cap, I can no longer deduct the entire property tax amount. The SALT deduction cap includes state income taxes as well. Therefore, I’d be losing out on at least another $10,000 in tax refunds, despite the rise in the standard deduction to $24,000 for married filers.
Note: If you want to calculate how much capital you need at a 4% rate of return to cover your housing costs, simply add up all your housing costs, divide by 0.04% and multiply by 1.4X to account for taxes.
Never Getting Out Of The Rat Race
Buying a big expensive house would put me in massive debt.
It’s clear to me that for me, buying this house or this type of house is not worth it. I would need to amass almost $8,000,000 in capital just to cover my housing costs if I wanted to stay unemployed. Even after paying off the mortgage, I would still need $2,500,000 in capital returning 4% to pay for the ongoing $5,938 a month in after-tax unavoidable costs of owning such a home.
I can only imagine the family who ends up buying this home will have to work for a very long time with a very high income to afford this type of lifestyle. We’re talking $500,000 – $1,000,000 a year in required income to be able to afford the house and everything else that comes with raising a family. These type of jobs can be very stressful, especially if you actually need that much money to survive.
Nobody buys a house this size if they don’t have at least two kids. Further, each kid will probably also be going to private school at a cost of $35,000 – $50,000 each. If a downturn ever comes, these $500K+ jobs go away quickly. Then your stress goes through the roof as an albatross hangs around your neck.
If you needed to sell in a down market, you’d not only lose money on principal value of your home, you’d also have to pay at least 5% in realtor commissions and transfer taxes = $225,000.
A Deja Vu Feeling
Me wanting to buy this house feels exactly like how I felt buying my Lake Tahoe Property in 2007. The real estate market had just started to slow, and I thought I was getting a steal buying the 2/2 condo for $718,000 since the owners bought the property for $810,000 in 2006.
I was earning the most amount of money I had ever made in my life at the time, and I erroneously extrapolated that earnings power forward for 10 years. Of course, the financial crisis hit, and my earnings power along with my property got cut by 40% – 50%.
Right now, Financial Samurai is firing on all cylinders. I haven’t seen a down year since I started the site in 2009. But it’s very possible that Financial Samurai and all my investments could take a beating next year. October’s stock market rout could be a harbinger for slower growth ahead.
What If A Recession Comes?
If I leveraged up to buy this Presidio Heights home and a recession comes, we would lose our lifestyle because one or both of us would have to go back to work in a hurry. All the levity we’ve felt having a reasonably low housing expense would go out the window. The house would start to own us instead of the other way around.
I hope the buyers of this home are prepared for all types of scenarios. Their new house has likely trapped them into a lifetime of continuous work.
When we moved to our current house in 2014, we effectively lowered our housing cost by 40%. I originally looked at the move as just a change in scenery. We were bored of living in our old neighborhood after almost 10 years, but we weren’t ready to relocate to Hawaii.
But it turns out that the downsizing really did wonders to our FIRE lifestyle, especially after I sold our old house in 2017.
At a 3.5% rate of return, the proceeds from our house sale 100% covers our existing housing costs. This means I’m certain my wife and I will never have to go back to work again so long as we REMAIN in our current house.
However, if we buy this $4.4M house, we open ourselves up to massive lifestyle risk. This happened before when I bought my Lake Tahoe vacation property in 2007.
I had just made the most money I had ever made in my life. Because I extrapolated my record earnings into the future, I thought buying a $718,000 Lake Tahoe property after purchasing a $1,520,000 single family home a couple years earlier would be no big thing.
Of course, I ended up making a poor financial decision as the global financial crisis ensued.
Low Housing Cost Is The Key To Financial Freedom
Instead of owning a big expensive house, own something cheaper and more affordable. At least follow my 30/30/3 rule of home buying so you never feel like your house is a burden.
I highly recommend you keep your annual total housing expense to less than 20% of your annual gross income. Over time, you should be able to get your housing expense down to 10% of gross income thanks to largely fixed ownership costs and growing income. Once you do, achieving financial independence becomes much easier.
Go ahead and fantasize about living in a nicer, more expensive property from time to time. After all, visiting open houses is free. Maybe even spend a pretty penny renting a nice place for vacation once a year to get it out of your system.
Then come back to earth once you’ve done the math and realized how much you’ll need to sacrifice in order to own such a property. Once you do, I’m sure you’ll appreciate that what you have is already pretty good.
This $4.5M house in Presidio Heights is the perfect example of Buy Utility, Rent Luxury (BURL). It’s a much better value to rent this house for $12,000 – $14,000 a month, given cap rates in San Francisco are around 2.5%, than to buy the property at current levels and pay all the continued maintenance, taxes, and mortgage interest if there is one.
My cozy home is currently being battle tested with my parents in town. Four adults and a toddler is quite a crowd. But my house is holding up like a champ. No matter how big or how small our house, we tend to get used to the size. Therefore, I’ll be shelving my dream property plans for now until the next stock market correction hits.
Big Expensive House Update 4Q2020
I originally wrote this post on November 1, 2018. Now it’s two years later and we’re in the middle of a pandemic. I’m sure my wife and I would have enjoyed living in this big expensive house, especially now that we have two kids. The attic and outdoors would be nice play areas for our children. And an au pair or guests could live in the room on the ground floor.
On the other hand, putting down $2 million and taking out a $2.5 million mortgage would feel like a lot. In my chart, I used a 4.5% mortgage rate that would result in a $12,500/month mortgage. I could probably refinance today to 2.5% using Credible and bring the monthly payment down to $9,900 a month.
By not owning a big expensive house during the March 2020 meltdown, we were able to invest several hundred thousands dollars into the stock market. We also felt less stressed because we had purchased a single family home with cash a year earlier.
On the other hand, owning a nice home during a pandemic is more valuable than ever before. We’re spending so much time at home now that our home’s intrinsic value has shot way up.
Bottom line, it’s better to comfortably afford your home immediately instead of expect your wealth to grow larger enough to allow you to comfortably afford your home in the future.
We bought a 40% cheaper home with amazing ocean views during the pandemic and really enjoy it. The leftover cash feels great given these times of maximum uncertainty!
Real Estate Investment Alternatives
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.