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One of the most deeply-embedded pieces of the “American Dream” is the desire for a large, spacious home with lots of sitting rooms, corners, nooks, and crannies. Large dining rooms and other entertainment spaces! Wrap-around porches! Two- or three-stall garages and one heck of a master suite!
To many of us, a large home is a mark of success. A big house indicate status, and the more space we’re able to call our own, the more successful we look and feel.
But, what if I told you that most of us don’t use even a fraction of that space? That’s not just me talking. A research team affiliated with the University of California studied American families and where they hung out the most inside their homes, how (and where) clutter builds, and the general stress level associated with living big.
The findings were overwhelming: The majority of the space in our homes is wasted.
How We Use Our Homes
As J.D. shared on Saturday, researchers at UCLA conducted a detailed study of 32 dual-income families living in the Los Angeles area, one of the first studies to document so vividly how we interact with the things for which we’ve paid good money. The findings were not pretty. In fact, they helped prove how little we use our big homes for things other than clutter or objects that hold little intrinsic value.
From the press release:
The researchers doggedly videotaped the activities of family members, tracked their every move with position-locating devices and documented their homes, yards and activities with reams and reams of photographs. They asked family members to narrate videotaped tours of their homes and took measurements at regular intervals of stress hormones via saliva samples.
When I originally wrote about the study, I took special note of where families spent the large majority of their time. In the following UCLA-published diagram of one family that was studied, we can easily observe a truth that’s probably common among so many of us: We tend to congregate around two primary areas of the home: food preparation/eating and television.
While this diagram only represents a single family, the results of the study suggest that this family is very typical of most of those studied, and the majority of traditional homes.
Take note of the different areas of this home, especially the dining room. The dining room saw extremely little activity from this family. The porch was almost never used. The study found that 68% of the family’s time was largely spent in the kitchen/nook as well as the family room, typically near the television.
The large majority of the time, this family spends their waking hours congregating around areas of food preparation and consumption. The rest, they’re plopped down on the couch watching the boob tube or on the computer.
As J.D. mentioned on Saturday, the study also found that clutter, enabled by such huge homes, fueled stressful emotions for many of the family members — especially mothers. And amazingly, only 25% of garages could be used to store cars. The remaining 75% were jam packed with so much stuff that cars simply couldn’t fit. Cars were relegated to the driveway or street.
Furthermore, families hardly used their yards, devoted money to renovating little-used areas of the home (like master suites) instead of fixing obvious problems, and relied on heating up frozen meals instead of using large and luxurious kitchens to cook.
Of course, not every family will exhibit these behaviors in their homes. Some will use their yards or porches, or dining rooms. However, most families don’t use large areas of their homes — which means they’ve essentially wasted money on space they do not need.
The results of this study reflect my experience perfectly. Years ago, I lived in a 1600-square-foot home and spent 99% of my waking hours in the kitchen and family room. The remaining rooms — like my small office/den and two extra bedrooms — were closed off. One bedroom turned into my hidden cavern for the accumulation of boxes and plastic shopping bags. The other held a spare bed that almost never got used.
Why People Want Big Homes
Why do we want huge homes instead of living smaller? Why do we make the choice to drop additional coinage for space that most of us don’t use?
I believe there are two primary reasons:
We link “bigger” with “success”. It’s all too common to feel like our big homes represent our success or status in life. The bigger our home, the more successful we appear to our friends and family. How many times have you heard people at work talking about how many square feet they have? It’s a brag item! New homes today are 1000 square feet larger than they were in the 1970s. According to the U.S. Census Bureau, the median single-family home built in 2016 was over 2400 square feet.
We want room to grow — temporarily.Many of us enjoy entertaining groups of people at our homes. Others want a dining room for big family dinners. But wait, how about that spare bedroom? After all, the three or four times that your in-laws come to visit demands additional sleeping quarters in a dedicated room that probably isn’t used for much the rest of the year.
Let’s talk a little about that last point, since there’s a sort of logic to it. I get why you might sometimes want extra space in your home. But here’s the problem with buying extra space for need temporarily: That additional space is always there. We’re buying additional space in our homes that we pay for 100% of the time but seldom actually use. We like having the space, but what is that space doing to us? Is it worth the cost?
In the video below, two of J.D.’s friends give him a tour of their tiny house. As you can see, it’s perfectly possible to be fulfilled and content — to live the American Dream — in a very small space.
Tammy and Logan's Tiny House - YouTube
Big Home, Big Headaches
Larger homes and yards not only require large mortgages and tax payments, but also more maintenance. If you aren’t spending your own precious time mowing the lawn or fixing your roof shingles, you’re paying someone else good money to do so. These costs can become cripplingly expensive, especially with super large houses (McMansions).
Larger homes require more security, too. The more space we have, the greater the need to protect it with fencing, cameras and Internet-connected security systems.
Big homes also need to be filled with furniture. Beds, couches, loveseats. Pianos. Pool tables. Most of us don’t let unused rooms sit idly by without anything in them. They need something, so we buy additional stuff to put in there.
In general, the larger the home the bigger the risk. If owners of big homes lose their jobs, their homes don’t suddenly get cheaper. Mortgages are as relentless as they are monotonous, easily wiping away a large majority of our take-home pay.
Here’s the truth: The American Dream shouldn’t compel you to buy a home that you cannot afford or maintain. (Or to drive a car you cannot handle or to watch televisions that are just too big for our walls and pocketbooks.)
More does not automatically equal better. More simply means more.
Downsizing to 200 Square Feet
Naturally, larger families require larger homes. We all have different needs, comfort levels, and desires. The point of this article isn’t to prove that larger spaces are always bad. Such a conclusion is much too simplistic and entirely inaccurate.
Instead, this article is designed to spur thought and self-reflection. Regardless of the space that you call home, are you fully utilizing that space or is it overcome with clutter? Do you feel stressed when cleaning or maintaining your home? Do you use the large majority each and every week?
As the UCLA study found, we tend to overbuy, believing the misguided wisdom of buying “as big of a house as you can afford”. Forget that advice. Instead, buy as much house as you need. Then, feel confident that you aren’t overextending yourself or weakening your financial position through your rent or mortgage.
To conclude, I want to share how I’ve move past the idea that I need a large home.
For those unfamiliar with my story, I’m a 36-year old early retiree who travels the country in a 200-square-foot Airstream with my wife and two rescued dogs. Both my wife and I sold our homes (each around 1,600 square feet), along with the majority of our possessions, and bought an Airstream that we use to travel the country full-time.
Downsizing has been amazing for several reasons:
Life is much simpler with fewer possessions.
It takes about 10 minutes to vacuum the entire house (well!).
We can clean the whole outside of our home in about 30 minutes.
We can park this thing virtually anywhere (legally permitted, of course!) and change our scenery at a moment’s notice.
Even in a small space, we still have a separate bedroom, bathroom, shower, two sinks, a desk, couch and kitchen with stove, oven and microwave; we also have a refrigerator and freezer, an air conditioner and solar power
The full-time RV life isn’t for everyone, and it’s not my intent to convince you otherwise. Instead, use my story as a testament to the fact that large homes are very much a choice. Few of us need the space we buy. I certainly didn’t need a 1600-square-foot home before I sold it to move into the Airstream. There are many different ways to live.
Don’t let the American Dream take over your life…or your wallet.
J.D.’s footnote: By now, regular readers know how much I agree with Steve’s perspective. My girlfriend and I recently lived in an RV for fifteen months ourselves. The experience taught us that we do not need a large space to live. We believe somewhere around 1000 square feet is perfect for us and our zoo. Last summer, we downsized to 1235 square feet, and even this place has space that goes unused.
Long-time readers are familiar with my decade-long war on Stuff. I was raised in a cluttered home. From a young age, I was a collector. (Some might even say a hoarder!) After Kris and I got married, I began to acquire adult-level quantities of Stuff. When we moved to a larger house, I found ways to acquire even more Stuff. I owned thousands of books, thousands of comic books, hundreds of compact discs, and scads of other crap.
Eventually, I’d had enough. A decade ago, I began the s-l-o-w process of de-cluttering.
While I still bring new Stuff into the house — Kim would tell you I bring too much Stuff home — I’m not nearly so acquisitive as I used to be. In fact, for the past decade I’ve purged far more than I’ve acquired. And that process continues, week by week, month by month, year by year.
The Cluttered Lives of the American Middle Class
Turns out, I’m not the only one fighting this battle. Many Americans struggle with clutter. This is one reason for the popularity of the simplicity movement. When I visit my friends who live in tiny houses, they rejoice at the lack of Stuff in their lives. And it’s why books like Marie Kondo’s The Life-Changing Magic of Tidying Up become popular bestsellers. (That book is great, by the way. Here’s my review from my personal site.)
A while ago, I stumbled on a video that documents the work of a group of anthropologists from UCLA. These researchers visited the homes of 32 typical American families. They wanted to look at how people interacted with their environments, at how they used space. They also wanted to look at how dual-income, middle-class families related to their material possessions. They systematically documented the Stuff people own, where they keep it, and how they use it.
A Cluttered Life: Middle-Class Abundance - YouTube
“Contemporary U.S. households have more possessions per household than any society in global history,” says Jeanne E. Arnold. That’s both shocking and unsurprising all at once.
Her colleague Anthony Graesch notes that our homes reflect this material abundance. “Hyper-consumerism is evident in many spaces,” he says, “like garages, corners of home offices, and even sometimes in the corners of living rooms and bedrooms.”
Graesch continues: “We have lots of Stuff. We have many mechanisms by which we accumulate possessions in our home, but we have few rituals or mechanisms or processes for unloading these objects, for getting rid of them.” All of this stuff causes stress. It carries very real physical and emotional tolls.
One interesting finding? Clutter bothers women more than men. This might be because the responsibility for cleaning the clutter generally falls to women.
“The United States has 3.1% of the world’s children but consumes 40% of the world’s toys,” notes Arnold. In households with children — or, in my case, puppies — the toys can take over the home. Children’s toys and objects spill out of their bedrooms into living areas, kitchens, and bathrooms. The push to become consumers, to value Stuff, starts at an early age.
Why do modern kids have so many toys? It may be because there are so many playthings available so cheaply. There’s more Stuff available for kids than there was fifty years ago, and that Stuff costs less. Plus, priorities seem to have shifted. Modern parents see spending on kids as a priority; parents fifty years ago did not.
Food as Clutter
It’s not just kids, of course. Adults have their own brand of clutter.
For example, many families are guilty of stockpiling. They buy food in bulk, then stack their cupboards and fridges and pantries and garages to the gills. Naturally, most of these are “convenience foods”. (Fresh food wouldn’t keep if bought in bulk like this.)
Researcher Elinor Ochs observes, “If you brought someone from Rome or from a town in Sweden, and you showed them the size of the refrigerator in the kitchen, and then walked them to the garage and they saw the size of the refrigerator in the garage, they would be pretty astonished. The refrigerator, then, becomes something to think about culturally. Why do we have these big refrigerators? And what does that say about food in our society?”
Note: This was something that Kim and I thought about a lot on our RV trip across the U.S. During our fifteen months on the road, we had limited space for food storage. There was a small-ish frige in the motorhome and a few cabinets for non-perishables. At home, we tend to buy food for a week (or more) at a time. And we’re guilty of stockpiling some stuff too. (Don’t ask me how much ketchup I have in the cupboard!) On the road, this was fundamentally impossible. We bought only what we needed for the immediate future. This forced us to be better at meal planning, and it made us much more aware of the kinds of foods we were buying.
The easy availability of convenience foods has some interesting effects on how families relate to each other. Longer ago, the household sat down to eat the same thing at the same time. That’s not true anymore. Nowadays, each person tends to eat what they want, when they want.
“Families have bought into the idea that use of these foods will somehow save time,” Graesch says. But researchers have found that families only save about twelve minutes per meal when they use convenience foods. And at what cost?
During their research, the UCLA anthropologists looked at how families used the space in their homes. Unsurprisingly (to me), the kitchen tends to be the hub, the command center of the household.
“Everything transpires in kitchens,” Graesch says. “Activities are organized, schedules are co-ordinated, plans are made for the next day, meals are cooked, kids are doing homework in kitchen spaces. It’s very, very intensively used. A lot of the material culture in kitchens speaks to this logistical center in everyday family lives.”
The refrigerator door is often a center for family artifacts. It’s a place for family history and culture and nostalgia. But, says Arnold, “There seems to be a kind of a correlation between how much Stuff is on the refrigerator panel door and how much stuff is in the broader home.”
Bathrooms, too, can become important places to plan and prepare for the day. They’re staging areas where we get ready to go out into the world.
With all of the chaos in other parts of the home, many parents work hard to make the master bedroom a sort of quiet retreat, a space isolated from the rest of the house. People value their master bedrooms so much, in fact, that they’ll spend to remodel them into the oasis they desire instead of funneling their funds to remove actual bottlenecks (like bathrooms) or to optimize the spaces where the family spends most of its time.
In some ways, the master bedroom has become a symbolic space. It’s a place of refuge.
The Bottom Line
Is clutter a uniquely American problem? I don’t know. I doubt it. But I also suspect that because of our sheer material abundance, more of us struggle with clutter than folks in other countries. (I’d love to hear anecdotes or see stats on this subject, actually. Anyone have those?)
However, I do know that it this is another area where we can take charge of our lives. As I purge Stuff from my life, I gain a greater sense of satisfaction. I feel like I’m in more control of my environment — and myself.
Do you struggle with clutter? Is your home packed to the gills with Stuff? What steps have you taken to get rid of some of this crap? Or have you? (Maybe it doesn’t bother you?)
Today’s article is from Chad Carson, who writes about real estate investing (and other money matters) at Coach Carson. I’ve always been intrigued by real estate investing but overwhelmed by how much info available. I asked Chad if he’d be willing to write an article that would help me (and other GRS readers) understand the basics of real estate investing. This is the result.
I got started in real estate investing right after college. Because a young adult can basically sleep in a car if he has to (my 1998 Toyota Camry with cloth seats was comfortable), I had little to lose by launching a business. Unfortunately, as a Biology major, I also knew very little about business or real estate. But I did know how to hustle and to learn. That helped.
Slowly, I learned to find good deals and to resell them for a small markup of profit (a.k.a. wholesaling). I also learned to buy, fix, and flip houses for a bigger profit (a.k.a. retailing). After a few years, my business partner and I began keeping some rental properties because we knew that was the path to generating regular, passive income.
While my early business might sound like an exciting HGTV house-flipping show, it’s not for everyone. I experienced radical ups and downs of cash flow, and there were many unpredictable outcomes. I learned a lot being a full-time investor, but there are actually easier ways to get started.
Most investors I know started with a full-time job. They became valuable at their job, earned good money, lived frugally, and started boosting their saving rate. With their extra savings, they began buying rental properties on the side.
I’m not saying you shouldn’t begin as a real estate entrepreneur like I did — you’ll know if you’re called to make that leap — but if you currently have a non-real estate job and you’re saving money, you’re already going down the easiest path.
The next step is to learn how to invest that money profitably and safely. I personally think real estate investing is one of the best ways to do that. I’ll show you why that’s the case in the next section.
Why Real Estate Investing? Because It’s Ideal!
I’ve yet to find a better way to describe the benefits of real estate than this. All you need to remember is the acronym I.D.E.A.L:
Income. The biggest benefit of real estate is rental income. Even the worst rentals I find produce more income than a portfolio of other assets like stocks or bonds. For example, I often see unleveraged (no debt) returns of 5-10% from rental income. And with reasonable leverage, it’s possible to see these returns jump to 10-15% or higher. The dividend rate of the S&P 500, on the other hand, is only 1.99% as of 1/24/17. And the yield on a broad basket of US bonds as of the same date was only 2.41%.
Depreciation. Our government requires rental owners to spread out the cost of an asset over multiple years (27.5 years for residential real estate). This produces something called a yearly depreciation expense that can “shelter” or protect your income from taxes and reduce your tax bill. (For more about this, check my article The Incredible Tax Benefits of Real Estate Investing over at Mad Fientist.)
Equity. If you borrow money to buy a rental property, your tenant basically pays off your mortgage for you with their monthly rent. Trust me: Having somebody else pay your mortgage is a beautiful thing! Like a forced savings account, your equity in the property gets bigger and bigger over time.
Appreciation. Over the long run, real estate has gone up in value about the same rate as inflation, roughly three to four percent a year. Combined with the three benefits above, appreciation can produce a very solid long-term return. But this passive style of inflation is not the whole story. Active appreciation is even more profitable. You get active appreciation when you force the value higher by doing something to the property, like with a house remodel or changing the zoning.
Leverage. Debt leverage is readily available to buy real estate. This means your $100,000 of savings can buy five properties at $20,000 down instead of just one property for $100,000. Interest on this debt is deductible, so you also save on your taxes. (While this can be helpful, keep in mind that leverage also magnifies your losses if things go bad.)
These IDEAL benefits are core reasons to invest in real estate. But as a Get Rich Slowly reader, I think you’ll appreciate another core real estate investing benefit: control!
Controlling Your Financial Destiny
I love J.D.’s message here at Get Rich Slowly: You are the boss of you! You can apply this lesson to so many parts of life, but it especially applies to your finances. Real estate investing fits very well with the GRS philosophy. Why? Because real estate gives you much more control than other more traditional investments.
I’m also a fan of low-cost index fund investing, for example, but do you have an impact on the returns of your stock portfolio? Not really. The 3500+ managers of the companies owned by the VTI total stock market index fund do impact your returns, but not you personally. You simply control when you buy, how much you buy, and when you sell.
But with a rental duplex, for example, your decisions directly affect its profitability (for better or worse!).
You can buy in certain neighborhoods and ignore others.
You can negotiate with your bank, with the seller, and with your vendors to get better prices.
You can choose the property manager and the types of tenants who will ultimately produce the returns for your investment.
If this prospect of control excites you, then keep reading. But if your palms are clammy at the idea of hands-on investments, just focus on a different vehicle. That’s okay. There are options for everyone in this big investing universe!
To make things manageable, we’re going to break things down a little. As a baby, you learned to walk by taking tiny steps. You also fell down a lot, but with a diaper four inches from the ground, what’s the harm?!
Well, you’re no longer a baby. Financially you do have a lot to lose. Your family, your hard-earned savings, your plans for financial independence, and your pride would all suffer if you made bad investments.
I get that. And that’s why we still need to take safe, baby steps. There’ll be plenty of time to run and grow faster once you’re more confident. But in the beginning, just strive to move forward steadily.
The seven baby steps below provide a simple path to follow. I’ve taken each of these steps personally. You can use them as a blueprint to help you move forward with your own real estate investments.
Step 1: Create Financial Goals
Real estate is simply a financial vehicle. Before you begin to buy real estate, you have to have a clear picture financially where the vehicle will take you.
If you haven’t done it already, read J.D.’s Financial Independence in Plain English. You’ll learn that a solid financial independence goal is to achieve a net worth equal to your current annual expenses multiplied by 25. In other words, if you spend about $50,000 per year, your goal should be to achieve a net worth of around $1,250,000. With this level of wealth, you could likely withdraw 4% of your net worth each year without completely depleting your money.
While these assumptions are typically made for traditional portfolios of stocks and bonds, real estate works much the same. In fact, it’s much simpler.
Let’s say once again you spend about $50,000 per year. And let’s assume you can produce a cash-on-cash return of 6% with your real estate investments. (This return — or better — is achievable once you get going.) This would mean you need a net worth of $833,000 ($50,000 ÷ .06) to achieve financial independence. (For more details, check out my article How Many Rental Properties Do You Need to Retire.)
In case you didn’t notice, real estate’s income producing ability allows you to become financially independent with a much smaller net worth than alternative investments. In other words, you get to financial independence sooner!
Just another benefit of real estate investing! Now let’s pick a real estate investing strategy and niche.
Step 2: Focus on a Real Estate Investing Strategy and Niche
A niche is just a small segment of the larger real estate market. This could be a particular neighborhood, a certain kind of property (single family, duplex, commercial building), or a certain customer (like vacation rental tenants).
A strategy is a method of making money. In very basic terms, real estate strategies fall under two big umbrellas:
Flipping properties (buying and quickly selling).
Holding for rental income and growth.
Within each of these larger strategies, you’ll find a number of sub-strategies. I’ll give you my favorites below.
Many brand-new investors get overwhelmed because there are so many choices. This leads to analysis paralysis or ineffectiveness as they jump from one niche to another.
To help you avoid this, I’ll recommend a few of my favorite beginner combinations of strategies and niches within real estate investing.
The Live-In House Flip
My friends and bloggers at 1500 Days to Freedom built a large part of their wealth ($1.6 million +) using a simple real estate method. It’s called the Live-in House Flip. [J.D.’s note: I too am a fan of the folks at 1500 Days. They’re funny and informative.]
Just like it sounds, this strategy involves flipping a house. But unlike most flips, you live in the house for at least two years.
Why live in the house? Because this allows you to sell the house tax-free. This is one of the most profitable sections of the U.S. tax code! (In the U.S., when you sell your primary residence, up to $250,000 of capital gains for an individual — or $500,000 for a couple — can be excluded from your income.)
One of my first residences — I’ve had a lot! — was a four-plex. I lived in one unit and rented out the other three units. My mortgage payment including taxes and insurance was $1100 per month. My rent from the other three units was $1200. I was basically living for free!
If you don’t want to live in a small multi-unit building, you could also rent out a basement or garage apartment. I have a friend who rents his basement part-time using AirBnB and pays his entire home’s mortgage.
House hacking is also a great way to transition into non-owner occupied rental properties.
While living in the property, you can obtain an owner occupied mortgage. These mortgages have the best rates and terms, and they are the easiest to get. Then after living in the building for a couple of years, you can decide to move on to a new residence. But the old property can be kept as a long-term rental that cash flows well.
If you’re looking for a low cost of housing and your first rental property, it’s hard to beat this method.
Rental Debt Snowball
You’re probably familiar with the debt snowball, which is a great way to repay your debts one-by-one. The speed of your debt payoff snowballs because the cash flow gets bigger and bigger as each debt gets paid. This cash flow is then used to pay off the next debt even faster.
You can also do a debt snowball with rental properties. It’s one of the most predictable, satisfying ways to achieve financial independence with real estate investing.
Here’s how it works in brief:
Buy the number of rental properties you need to achieve financial independence. (Remember, we covered that calculation in step one above.)
Use the excess cash flow from all rentals (and any extra savings) to pay off one mortgage at a time.
Repeat the process for each mortgage until you own all of the homes free and clear.
Enjoy the income and equity from your free-and-clear properties to do what matters in your life.
Now that you understand the big picture, let’s look at what makes a good real estate deal.
The Best Real Estate Investing Strategy - YouTube
Step 3: Understand the Basics of Good Real Estate Deals
Good real estate deals are one part quantitative analysis (i.e. the numbers) and one part qualitative analysis (i.e. intangibles that make properties desirable). To buy good real estate deals that will make a profit and help you achieve financial independence, you need to understand both.
Quantitative Analysis of Real Estate
I can summarize financial analysis for rental properties with five key metrics:
Net Operating Income. Your net operating income (NOI) is the rent left over after paying all of your property expenses, including taxes, insurance, property management, maintenance and reserves for vacancy and future capital expenses (roofs, HVAC systems, etc). Importantly, this metric does not include any mortgage expenses.
Cap Rate. You know how folks use the price-to-earnings ratio (or P/E ratio) to evaluate stock prices? Well, the cap rate is a similar tool for evaluating home prices. The cap rate — which is short for capitalization rate — describes the relationship between the net operating income (or NOI) and the price of the real estate. Imagine, for example, a rental that produces $10,000 per year in NOI and can be purchased for $100,000. This hypothetical property would have a 10% cap rate. This metric ignores any debt used to buy the property and focuses only on the income and price. So, the formula is this: Cap Rate = NOI/Price.
Net Income After Taxes. Net income after taxes is derived from a formula that builds upon the NOI. The key difference is that here you also deduct mortgage payments (if any) and tax liabilities. This is the money you’ll actually get to keep in your bank account, which I think we can all agree is a very important thing!
Cash-on-Cash Return (ConC). Like a cap rate, your cash-on-cash return describes your return on investment. But the ConC rate usually assumes you have leverage and describes the cash return on your down payment. Imagine you purchase a property with a $20,000 down payment, for instance. If this property produces a $2000 yearly net income after taxes, then you’d be earning a 10% cash-on-cash return. The formula is this: Cash-on-Cash Return = Net Income After Taxes/Cash Invested.
Price Discount. The final metric is straight-forward. How far below the full price did you pay? Unlike stocks, real estate is an illiquid market. This means there are opportunities — if you work hard — to buy a place anywhere from 10% to 30% (or more) below full value.
There are definitely many other ways to financially analyze a real estate deal. But if you understand these five core metrics, you’ll have the basics tools you need to buy a good deal.
Qualitative Analysis of Real Estate
Real estate is best viewed as a product. A lot of times, investors get caught up in the numbers, as if real estate is only a numbers game. But it’s not. In real life, people make emotional decisions to buy or rent. Qualitative analysis is all about understanding the factors that make any particular property more or less desirable.
Luckily, you’ve lived in real estate! So, when you buy residential real estate investments, you already understand some of the important factors that matter the most to renters and buyers.
But to jog your memory, here is a list of things to consider that affect the desirability of a property:
Walkability or accessibility of public transit (especially in urban areas)
Good school districts (especially in suburban areas)
Population growth in the region – increasing (good) or decreasing (bad)
Job and wage growth in the region – increasing (good) or decreasing (bad)
Outdoor living features (yard, patios, gardens, etc)
Attractive interior finishes (this varies from market to market, but it’s important)
Storage space (garages, storage lockers, etc)
Quality construction and low maintenance materials (floors, exterior surfaces, etc)
Interior layout (avoid weird wall locations, walking through bedrooms to get to bedrooms, etc)
Avoid obnoxious neighbors, dogs, smells, large power lines, noises – you can’t control these things.
Avoid steep lots or properties below the grade of the road. Water flowing towards your foundation is a difficult problem.
Real estate is very local. So, my list may not always apply to your market. But the main point is to study and learn the important factors in the area where you want to invest. You can do this best by becoming a renter or buyer yourself. Shop around. And then try to buy properties that meet both your quantitative and qualitative criteria.
Step 4: Build a Team
Real estate is a team sport. If you like to manage all of your investments from a computer and never talk to people, this may be negative. But you don’t have to be an extrovert or an amazing communicator to be the leader of your team. You just need to have a clear idea of what you want and then pay good people to help you.
Here’s a list of some of the key team members you’ll need to buy, finance, rent, and sell real estate investments:
Real estate agent (for purchases and sales)
Real estate attorney (for contracts, LLC creation, and for closings in some states)
Certified Public Accountant (C.P.A.)
Personal banker (for your business bank accounts and lines of credit)
Property manager (unless you are self-managing)
Property inspector (during purchase due diligence)
Referral sources for new deals
Networking and mentorship with other local investors
That might seem like a large list, but don’t let it intimidate you. You don’t have to build this team overnight. And you can share a lot of the team members with other investors as you network at local REIA groups or online at places like the Bigger Pockets forums.
Live Real Estate Investing Q&A with Coach Carson - YouTube
Step 5: Create a Financing Plan
Real estate is closely tied to financing. Even in inexpensive markets, the price of an investment can be hundreds of thousands of dollars.
So, unless you already have a big pile of cash to invest, you’ll need to create a financing plan — and this needs to be done before you go out and start shopping for investment properties.
Here are a few things to figure out with your personal financing plan:
The source (mortgage lender, local bank, private loan, line of credit)
As a general rule, I like my financing to have a low rate of interest, long length (30 years), and no balloons. When I started, I got most of my financing from non-bank, creative sources like private money, self-directed IRA loans, and seller-financing. (I shared my five favorite non-bank financing sources in an article at Bigger Pockets.) But over time I’ve used all sorts of financing, including traditional mortgage loans and commercial financing.
You’ll need to match your financing to your strengths. If you have great credit, solid W-2 income, and a down payment, then traditional financing may be the best route in the beginning. The rates are typically low and the terms are very attractive. But if you’re self-employed, newly employed, or any form of entrepreneur (like I was), then you may also want to look at alternative financing sources like I did.
As I’ll explain in the next section, it also won’t hurt to have multiple sources of money. Traditional financing has great terms but it can be very slow to close. Alternative financing may have less attractive terms but give you quicker access to cash for good deals.
Charles Schwab has released its 2018 Modern Wealth Index, a survey of the saving and investing habits of 1000 Americans. Here’s how the company describes its methodology:
The Modern Wealth Index…is based on Schwab’s Investing Principles and composed of over 50 financial behaviors and attitudes. Each behavior or attitude is assigned a varying amount of points depending on its importance, out of a total of 100 possible points…Quotas were set so that the sample is as demographically representative as possible.
This survey divides respondents into two categories: those with a written financial plan and those without a written financial plan. About 25% of people are “Planners”; the rest are “Non-Planners”.
Unsurprisingly, the survey found that Planners are more likely to be in control of their finances. For instance, 75% of Planners pay their bill and still manage to save each month. Only 33% of Non-Planners are able to do this. Almost two-thirds of Planners have an emergency fund; less than one-quarter of Non-Planners have set money aside for a rainy day.
And the higher a person’s score in Schwab’s Modern Wealth Index, the more likely they are to have a written plan!
If having a written financial plan is so strongly correlated with desirable monetary outcomes, then why don’t more people do it? For most folks, it’s because they don’t think they have enough money to warrant one.
Personally, I’ve never had a written financial plan, although I do see their value. If I were to start again as an adult today, I’d probably create one.
I thought that the most interesting part of the Schwab survey was how participants viewed wealth. One question asked participants about their personal definition of wealth. What is wealth? Two of the top three answers weren’t about money at all:
Related to yesterday’s article about the relationship between time, money, and happiness, Americans say the things that make them feel wealthiest in their day-to-day lives are having personal free time and spending time with family. (When asked to focus on the numbers, respondents said they needed $1.4 million on average to be “comfortable”, or $2.4 million to really be wealthy.)
Want to see where you fit on Schwab’s Modern Wealth Index? You can take a 16-question quiz at their website. But note that some questions aren’t really applicable to folks who have already retired or achieved Financial Independence. Also note that you’ll have to enter your contact info in order to actually see your results. (I took the quiz, but didn’t see my results because I hate giving out personal info.)
Update! I just received an email from the Schwab PR team. As Rita noted in the comments below, it is possible to see your score without supplying contact info. When the contact info form appears on the screen, just leave everything blank and click the button below to move on to the numbers. I scored an 83. I think that’s largely because I didn’t know how to answer the income questions since I don’t really have an income anymore.
The older I get, the more I’m convinced that time is money (and money is time). We’re commonly taught that money is a “store of value”. But what does “store of value” actually mean? It’s a repository of past effort that can be applied to future purchases. Really, money is a store of time. (Well, a store of productive time, anyhow.)
Now, having made this argument, I’ll admit that time and money aren’t exactly the same thing. Money is a store of time, sure, but the two concepts have some differences too.
For instance, time is linear. After one minute or one day has passed, it’s irretrievable. You cannot reclaim it. If you waste an hour, it’s gone forever. If you waste (or lose) a dollar, however, it’s always possible to earn another dollar. Time marches forward but money has no “direction”.
More importantly, time is finite. Money is not. Theoretically, your income and wealth have no upper bound. On the other hand, each of us has about seventy (maybe eighty) years on this earth. If you’re lucky, you’ll live for 1000 months. Only a very few of us will live 5000 weeks. Most of us will live between 25,000 and 30,000 days.
After twelve years of reading and writing about money, I’ve come to love financial rules of thumb.
Financial rules of thumb provide helpful shortcuts for making quick calculations and decisions. You don’t always have time (or want to take the time) to create elaborate spreadsheets when choosing a course of action. In these cases, it’s nice to have some rough guidelines you can rely on.
You’ve probably heard of the “rule of 72”, for example. This shortcut says that if you divide 72 by a particular rate of return, you’ll get the number of years it’ll take to double your money. If your savings account yields 4%, say, it will take about 18 years for your nest egg to increase by 100%. But if you were able to earn 12% on your investment, that money would double in six years.
Like all rules of thumb, the rule of 72 isn’t precise. It doesn’t give an exact answer but a ballpark figure. Financial rules of thumb don’t always hold true. But they’re true enough for us to make loose plans based on them.
I have some engineer friends who’d get tense at this sort of sloppy guesswork, but most of the rest of us are happy to trade a bit of precision for speed. That’s what rules of thumb are all about!
The trick, of course, is knowing which rules of thumb to use. Most are handy, but some common guidelines do more harm than good.
Rules Gone Wild
In the past, you’ve probably seen my rant about some of my most-hated financial rules of thumb. Let’s look at three things I think conventional wisdom gets wrong (and what I believe are better alternatives).
How much should you save for retirement?
For instance, I get frustrated when I hear financial advisers push the idea that you should base your retirement savings on 70% of your income. Instead of estimating your retirement needs from your income, it makes far more sense to base them on spending. Your spending reflects your lifestyle; your income doesn’t.
I think a better rule of thumb for determining retirement needs is this: When estimating how much you’ll need to save for retirement, assume you’ll spend as much in the future as you do now. Use 100% of your current expenses to calculate your retirement spending. (And if you want to build in a safety margin, base your future needs on 110% of your current spending.)
How much should you spend on a house?
As I mentioned last week, another rule of thumb that makes me cranky is this common guideline espoused by all sectors of the homebuying industry: “Buy as much home as you can afford.” No no no no no! Of all financial rules of thumb, this is probably the worst. It’s certainly one of the most prevalent. This is how folks end up house poor, chained to a mortgage they resent.
Lenders quantify this guideline by saying your housing payments should be nor more than 28% or 33% or 41% of your income. But, as David Bach wrote in The Automatic Millionaire Homeowner, “You should generally assume that the amount the bank or mortgage company is willing to loan you is more than you should borrow.” A better rule of thumb? Spend as little on housing as possible. Spending less than 25% of your net income is best — less than 20% is even better.
How much life insurance should you carry?
A third rule that bugs me is the one for determining how much life insurance you should buy. Different experts give different answers. Some say your policy should cover five times your annual income. Others say ten times. And Suze Orman recommends 20 times annual income needs.
The truth is that not everyone needs life insurance. Like all insurance, it’s designed to prevent financial catastrophes. You only need it if other people — like a spouse or children — would face financial hardship when you die. If you don’t have kids, if your spouse has a good income, or you have substantial savings, then life insurance isn’t a necessity.
Even if you do need life insurance, you probably don’t need to carry as much as your insurance agent is willing to sell you. To find out the amount that’s right for you, check out the Life Insurance Needs Calculator from the non-profit Life Happens organization. (How much life insurance should I carry? According to this calculator, I shouldn’t have any at all. And I don’t.)
Useful Financial Rules of Thumb
Financial rules of thumb usually aren’t this bad. In fact, most are useful. Here are eighteen of my favorites.
When estimating income, $1 an hour in wage is equivalent to $2000 per year in pre-tax earnings. The reverse is also true: $2000 per year in salary is equal to $1 an hour in hourly wage. (This rule works because the average worker spends roughly 2000 hours per year on the job.)
How wealthy should you be? According to the authors of The Millionaire Next Door, the following “wealth formula” can tell you if you’re on target: Divide your age by ten, then multiply by your annual gross income. Your net worth should be equal to this number (less any inheritances). So, if you’re 40 and make $50,000 per year, your net worth should be $200,000. If you have less than half the expected amount, you’re an “under-accumulator of wealth”. If you have twice the target, you’re a “prodigious accumulator of wealth”. (Note that the authors are well aware that this formula doesn’t work well for young people; it’s meant to be used by folks nearing retirement age.)
On average, each dollar an American spends represents about $2.50 of after-tax value in ten years or $10 in thirty years. (If you live outside the U.S., the consequences of spending that dollar are probably even greater.) This is due to two reasons: taxes and compounding. When you buy something, you spend after-tax dollars. On average, Americans have to earn $1.33 to have $1.00 left over.
Historically, U.S. stocks have earned long-term real returns (meaning inflation-adjusted returns) of about 7%. Bonds have long-term real returns of around 2.5%. Gold and real estate have long-term real returns of close to 1%.
If you withdraw about four percent of your savings each year, your wealth snowball will maintain its value against inflation. During market downturns, you might have to withdraw as little as three percent. If times are flush, you might allow yourself five percent. But four percent is generally safe. (For more on safe withdrawal rates, check out this article from the Mad Fientist.)
Based on the previous rule of thumb, there’s a quick way to check whether early retirement is within your reach. Multiply your current annual expenses by 25. If the result is less than your savings, you’ve achieved financial independence — you can retire early. If the product is greater than your savings, you still have work to do. (If you’re conservative or have low risk tolerance, multiply your annual expenses by 30. If you’re aggressive and/or willing to take on greater risk, multiple by 20.)
Building on the above, Mr. Money Mustache’s shockingly simple math behind early retirement gives us a useful rule of thumb for determining how long you’ll need to save before you’re financially independent. Figure out your current saving rate (or profit margin, if you prefer). Subtract this number from 60. Roughly speaking — and assuming you’ve started from a zero net worth — that’s how long you’ll need to work before your nest egg is big enough to support you in retirement. (Note that this rule breaks down at saving rates over 40%. If you save a lot, subtract from 70.)
Joe from Stacking Benjamins likes what he calls the “penny approximation”: Assuming a safe withdraw rate of roughly four percent, every $100 you save gives you one penny per day in perpetuity. Once you stack enough Benjamins you have enough pennies to sustain you forever. If you change your own brake pads and save $200, thats two cents a day for the rest of your life because you avoided paying a mechanic.
I hate detailed budgets because they bog people down. Instead, I’m a fan of budget frameworks that focus more on the Big Picture. My favorite budget framework is the Balanced Money Formula: Spend no more than 50% of your after-tax income on Needs, put at least 20% into savings (including debt reduction), and spend the rest (around 30%) on Wants. This is a great beginner budget, but it’s also useful for transitioning to the mindset of Financial Independence. If you decide early retirement is a goal, then part of your Wants spending becomes additional savings.
If you own your home, it’s wise to set aside money for maintenance and repairs. Each year, contribute 1% of your home’s current value to a separate account. If you don’t spend the money, keep it there for future remodeling and improvements.
Is it better to buy or to rent? The price-to-rent ratio is a useful rule of thumb for making this decision. Find two similar places, one for sale and one for rent. Divide the sale price of the one by the annual rent for the other. The result is the P/R ratio. Say you find a $200,000 house for sale in a nice neighborhood, and a similar home for rent on the next block for $1000 per month, which is $12,000 per year. Dividing $200,000 by $12,000, you get a P/R ratio of 16.7. If the P/R ratio is low, it’s better to buy. If the price-to-rent ratio is over 15, it’s probably better to rent.
How much does it cost to raise a child? As a rule of thumb, budget $10,000 per child per year. That’s not quite a quarter of a million dollars per kid, but it’s close.
If you get a windfall, use 1% to treat yourself. (Or maybe 2%, tops.) Put the rest in a safe place and ignore it for six months. After you’ve had time to think about it, then take action. So, if you inherit $100,000 from Aunt Marge, only allow yourself a $1000 splurge. Stash the remaining $99,000 someplace you won’t be tempted to spend it.
To approximate a new vehicle’s five-year cost of ownership (in monthly terms), double the price tage and divide by 60. Looking at a brand-new Mini Cooper ? Double that $30,000 sticker price to get $60,000, then divide by 60. Is it really worth $1000 per month to get rid of your crummy Ford Focus?
The standard rule of thumb is to save at least 10% of your income. I think a better goal is to aim for 20% — and more is better. Financial guru Liz Weston says that if you’re young, you should follow this guideline: “Save 10% for basics, 15% for comfort, 20% to escape.”
Nobody agrees how much you should set aside for an emergency fund. Even the experts offer advice ranging from $1000 up to 12 months of expenses. (The most common suggestions range from three to six months of expenses.) One clever rule of thumb to determine how much you should have set aside: Your emergency fund should cover X months of expenses, where X is the current unemployment rate. In other words, because the U.S. unemployment is about 4% right now, you should aim to have enough money in the bank to cover four months of expenses.
According to Consumer Reports, wen you’re faced with the repair of an appliance (such as a refrigerator or washing machine), you should buy a new one if the appliance is more than eight years old (or if the repair would cost more than half what it would take to buy a replacement).
It’s important to remember that rules of thumb aren’t set in stone. They’re guidelines. They’re meant to help you make quick evaluations, not actual life-changing decisions. Financial rules of thumb are a starting point. Start with them, then adjust for your individual goals and situation.
Other Useful Financial Guidelines
Strictly speaking, rules of thumb deal with numbers. Still, there are a lot of non-numeric guidelines that I think are useful to know. If you’ve done any reading about personal finance, for example, you’ve probably heard the admonition, “Pay yourself first.” While not strictly a rule of thumb, this guideline is very similar.
Bank a raise. When you get a salary bump, don’t increase your spending. Stay the course and put the added income into savings.
Always take the employer match on the 401(k).
Never touch your retirement savings — except for retirement.
Never co-sign on a loan. (Ever.)
Avoid paying interest on anything that loses value. It’s okay to finance a home or a college education but avoid taking out a loan on a car.
Speaking of cars: When you buy a vehicle, buy used or buy new and plan to drive it for at least ten years. (Do both and you’ll save even more!)
Don’t mess with the IRS. When it comes to taxes, don’t try to cheat. Pay what you owe. Claim all the deductions you deserve, but don’t try to stretch things.
In general, save an emergency fund first; pay off high-interest debt second; and begin investing (at the same time you pay down remaining debt) last.
It almost always makes more sense (and cents) to repair your old car than to buy a new one.
If you’re not willing to pay cash for it, then it doesn’t make sense to buy it on credit. (I have a friend whose guiding principle is: “If I wouldn’t buy five, why would I buy one?” Similar idea taken to an extreme.)
Save for your own retirement before saving for your children’s college education. They can get loans for school. You can’t get loans for retirement.
Now it’s your turn. What rules of thumb did I miss? Do you disagree with any of those I suggested? What are some of your favorite rules of thumb?
When Kim and I moved last summer from our riverfront condo to this country cottage on the outskirts of Portland, one of my primary aims was to slash our spending on both housing and food.
Although we owned our condo free and clear, living there still cost us roughly $1200 per month. Plus, there were the added costs that came from living so close to bars and restaurants. Sure, we didn’t have to eat out as often as we did — we understand that was a choice — but we enjoyed exploring what the neighborhood had to offer.
Well, I’ve now had time to gather enough data to determine whether we were able to achieve this goal, to cut our monthly costs. I’m pleased to say the answer is “yes”! But for a few years, this gain is going to be completely negated by our massive home remodeling project.
Let’s look at some numbers.
Saving on Housing
To start, here’s how my monthly housing costs have changed:
During the first four months of 2017, we paid an average of $1169.91 to live in our condo. Of that, $644.65 went to our HOA and utilities. The remaining $525.27 was spent on taxes and condo insurance.
During the first four months of 2018, we paid an average of $472.55 to live on our house. Of that, $187.91 went to utilities and $284.64 went to taxes and insurance.
Before we made the move, I estimated that it’d cost us about $500 per month for housing expenses. That was a good guess. My expenses are actually a little lower than that. And because Kim is paying me $500 per month to “vest” into ownership of the house, my net monthly housing costs are actually minus $21.45. I’m making money by living here! (Haha. I wish.)
Food for Less
Meanwhile, our eating habits have also changed. We don’t go out to eat nearly as much as we used to. When we do dine out, we choose cheaper places. (Our current neighborhood isn’t quite as hip as our old neighborhood.) Last night, for instance, we hit up our favorite pub. It cost us $54, and that’s expensive for this neck of the woods. In our previous neighborhood, we’d often hit a hundred dollars when dining out.
Here’s how my food spending has changed:
During the first four months of 2017, I spent an average of $568.42 per month on groceries and $554.14 on restaurants. That’s a total of $1169.91 per month on food. Holy cats! (And that doesn’t include money that Kim paid for groceries…)
During the first four months of 2018, I spent an average of $477.33 per month on groceries and $332.01 per month on restaurants. That’s a total of $809.34 per month on food.
Let me be the first to point out that I spend a lot of money on food. I acknowledge that. This wasn’t a weak spot in my budget back when I started Get Rich Slowly in 2006, but it certainly is today!
That said, moving to the suburbs did indeed help me spend less on food. My grocery bills aren’t down as much as I’d expected — only about 16% — but that’s still saving me nearly $100 per month. Meanwhile, my restaurant spending has been cut nearly in half! Overall, my monthly food budget has declined by 28% (which is more than $300 per month).
Creating Cash Flow
When we were planning for our move last spring, I wrote that I hoped my cash flow would improve by $1200 to $1300 per month. With the reduction in housing and food spending, I’ve saved an average of $1010.58 per month so far in 2018. When you add in Kim’s monthly $500 “mortgage” payment to me, my cash flow has improved by $1510.58.
“But wait, J.D.” you may be saying. “Have other aspects of your budget ballooned because of the move? Are you driving more, for instance? And what about your outlandish home improvement projects? You’ve already admitted that you’ve spent roughly $100,000 on renovations since moving in!”
I am spending about twice as much on fuel as I was before. During the first four months of 2017, I spent an average of $25.79 per month on fuel. So far in 2018, I’ve averaged $56.69 per month on fuel. Other than that, however, the move has had no adverse effect on my finances…except for the very expensive remodeling projects we’ve been doing.
The Big, Fat Elephant in the Room
I haven’t included the remodeling costs in the above numbers because they’re not a regular expense. Trust me: I’m perfectly aware of how much I’m spending on home improvement, and it’s caused me plenty of anxiety. But those costs aren’t recurring, so I don’t include them when calculating average monthly expenses.
What I have been doing is some mathematics gymnastics:
My cash flow has improved by $1510.58 per month.
Our pre-deck (and hot tub) home improvement costs totalled $92,934.61. Of that, $59,000 came from selling the condo, which means we’ve had $33,934.61 in un-budgeted home improvements since moving in.
We don’t have a final tally on the deck and hot tub project (and won’t for several weeks), but I expect it to be close to that $33,934.61.
Based on these numbers, we can calculate how long it will take to recover the remodeling costs (compared with having remained in the condo). Dividing our $33,934.61 excess costs by my $1510.58 per month improved cash flow, we find that it’ll take 22.5 months — just under two years — to compensate. And, of course, it’ll take roughly the same amount of time to compensate for the deck and hot tub.
Translation for non-nerds: Moving from the condo to this house saved me just over $1500 per month. This savings has been temporarily negated by all of the home projects. But after about four years — assuming we find no further problems — we’ll pass the break-even point. At that time, the move will become a financial win!
I’ve been a homeowner for 24 of the last 25 years. Based on this, you might think I’m an advocate of homeownership over renting. That’s not the case. The older I get, the more I appreciate there’s no correct answer in the perennial “is it better to rent or buy?” debate. Sometimes buying a home makes the most sense. Sometimes renting is the smarter choice.
In an editorial in the June 2007 issue of Kiplinger’s Personal Finance, Knight Kiplinger wrote, “It often costs less to rent. The annual cost of owning a property, be it a house or a condo, is usually greater than the cost of renting, after taxes.” I agree.
Today, let’s look at a handful of ways to evaluate the rent versus buy decision from a financial perspective.
The Price-to-Rent Ratio
One way to tell whether it’s better to rent or buy is by calculating the price-to-rent ratio (or P/R ratio). This number gives you a rough idea whether homes in your area are fairly priced. Figuring a P/R ratio is simple. All you need to do is:
Find two similar houses (or condos or apartments), one for sale and one for rent.
Divide the sale price of the one place by the annual rent for the other. The resulting number is the P/R ratio.
For example, say you find a $200,000 house for sale in a nice neighborhood. You find a similar house on the next block for rent for $1,000 per month (which works out to $12,000 per year). Dividing $200,000 by $12,000, you get a P/R ratio of 16.7. But what does this number mean?
Writing in The New York Times, David Leonhardt says, “A rent ratio above 20 means that the monthly costs of ownership well exceed the cost of renting.” That’s a little opaque, I know. Leonhardt is saying that the higher the P/R ratio, the more it makes sense to rent — and the less it makes sense to buy.
The normal P/R ratio range nationwide is between 10 and 14 (meaning it would cost between $1200 and $1600 to rent a $200,000 house). During the 1990s, just before the housing bubble, the national P/R ratio was usually between 14 and 15 (about $1100 to $1200 to rent a $200,000 house). During last decade’s housing bubble, national price-to-rent ratios rose to 22.73 (in 2005) then to 24.50 (in 2007) before the market collapsed. As most folks were rushing to buy homes, the numbers said they ought to be renting.
Based on this info, I’d argue that:
When price-to-rent ratios are under 12, it’s generally better to buy than to rent.
When price-to-rent ratios are between 12 and 15, the financial decision is murky.
When price-to-rent ratios climb above 15, you’re probably better off renting.
Nationwide numbers don’t tell the full story, of course. While the national price-to-rent ratio might be around 20, the actual numbers in your city could be very different.
For kicks, I wasted ninety minutes playing with price-to-rent ratios using Zillow data. (What can I say? I’m a nerd!) I downloaded their list of median home prices and median monthly rents, then calculated the P/R ratio for 48 major metro areas. (For a variety of reasons, this is a somewhat arbitrary selection of cities.) Here’s my list of price-to-rent ratios in the United States as of January 2018.
If you’re moving to Scranton for your new job at Dunder Mifflin Paper Company, it’s likely you’ll want to purchase a home. But if you’re headed to the Bay Area, your best bet is going to be to rent.
I’m somewhat skeptical that these numbers are accurate — they do come from a site eager to create homebuyers, after all — but it’s tough to find better info. As far as I’m aware, there’s no reliable source that generates these stats on a regular basis. (I personally believe numbers from articles like this are more accurate. However, that article is also eighteen months out of date and doesn’t explain its methodology.)
Please note that city-wide price-to-rent ratios only really matter if you’re moving from another town. Otherwise, what actually matters are price-to-rent ratios for the specific properties you’re thinking of buying or renting.
Home Price vs. Household Income
Another way to gauge the cost of housing is to compare it to your family’s income. From 1984 to 2000, median home prices were about 2.8 times the median yearly family income. (In other words, the typical house cost about three times what a family earned in a year.) During the early 1970s, home prices were about 2.3 times median family income. During the housing bubble, this ratio jumped to 4.2.
These numbers may not mean a whole lot on their own, but they can give you some sort of idea whether housing is overpriced in your area. Plus, it seems safe to assume based on past figures that most families can comfortably afford a home that costs about 2.5x their annual income. (So, if your family makes $80,000 a year, you can afford a $200,000 house.)
According to the most recent numbers from the U.S. Census Bureau, the median household income in the United States was $57,617 at the end of 2016. (Average household income is greater — $73,207 — but that number is skewed by high earners, which is why I prefer to use the median.)
Using the current U.S. median home price of $232,700, we can see that home prices are currently running at about 4.04 times the typical household income. This ratio isn’t quite as high as it was during the housing bubble, but it’s still pretty steep.
My Favorite “Rent or Buy?” Calculator
Finally, I want to share what might be my favorite way to compare the costs of renting against the costs of buying.
The New York Times has a great rent vs. buy calculator that can help you decide which is best for you. Just plug in the numbers for your situation, and the calculator tells you how long it would take you to break even if you bought a house. This calculator is an amazing tool. Although it lives behind a soft paywall (which can be circumvented using incognito mode in your browser), it’s well worth using if you’re trying to make a decision about whether to rent or buy.
For fun, I ran the numbers for my own situation. Last summer, Kim and I purchased our current home for $442,000. When you figure all of the remodeling we’ve done, our actual cost will be closer to $600,000. (Holy cats!) Based on our situation, the NY Times calculator says that we’d be better off renting if we could find a similar property for less than $2767 per month.
Scanning current listings, there are three nearby rental homes similar to ours (more than 1200 square feet, more than an acre of land). They’re fetching $2900 to $3000 per month. So, it sounds like buying or renting a property like ours in Portland is a toss-up at the moment. (If I run the numbers using our home’s actual purchase price — $442,000 — I’d have to be able to rent for less than $2100 for that to be the smarter option.)
The Bottom Line
Deciding whether to rent or to buy is a complicated financial and emotional decision. I believe it’s a shame when folks who are unprepared get driven into the housing market due to misplaced notions of imagined benefits. Homeownership is not a panacea. Renting is not universal folly.
Part of the problem is the vast Real-Estate Industrial Complex, each piece of which has a vested interest in convincing consumers that bigger is better. (As I mentioned in my recent article on the history of homeownership in the U.S., the real estate industry is a relatively recent invention, barely 100 years old. But in that hundred years, it’s grown into a powerful force in our economy.)
The housing industry does its best to propagate certain myths about homeownership, myths like:
If you rent, you’re throwing your money away. (This is false. As with all financial choices, there are opportunity costs whether you choose to rent or choose to buy.)
Owning a home is a forced savings plan. (Also false. Yes, it’s possible to build equity in a home if you buy it in the right place at the right time and/or you stay put for a while. Most folks don’t stay put, however, so they end up paying a whole lot toward interest and very little toward building equity before buying a bigger, “better” place.)
You should buy as much home as you can afford. (Complete and utter bullshit. You should spend as little as you possibly can. Instead of pushing the upper bounds of your housing budget, as happens in most cases, you should instead be aiming as low as you can go.)
Now, let me be clear. There’s no question that buying a house makes sense for some folks, but mainly for non-financial reasons. Owning a home gives you stability (you’re not at the mercy of a landlord) and freedom (you can do what you want with the place). Heck, last year I chose to buy an eighty-year-old “country cottage” on the outskirts of Portland, so I completely understand the non-monetary reasons for wanting to own.
But there are also advantages to renting.
For one, you have flexibility; you can move at a moment’s notice. For another, you’re not responsible when things go wrong. If the shower starts leaking before you leave for your vacation in Duluth, you don’t have to worry about it — you call in the landlord.
If you decide to buy a home, do it for the right reasons: because it fits your goals and will make you happy. Don’t do it because you think it’s a good investment. A mortgage is not a retirement plan — it won’t make you rich. Instead, think of it as purchasing a way of life.
If homeownership is a lifestyle you want and can afford, then buy. If not, rent.
My mother turned seventy a couple of weeks ago. This means a couple of things:
First, she’s reached the age at which she can receive maximum retirement benefits from Social Security.
Second, it’s time for her to start taking Required Minimum Distributions from her retirement accounts.
If you’ve been reading Get Rich Slowly for a while, you know that these two routine tasks are less than routine for my family. My mother has fought a long-time battle with mental illness. After a crisis in 2011, my brothers and I realized that she could not live alone. We found a highly-regarded local assisted living facility that specializes in patients with memory issues. (Mom has some sort of cognitive disability that includes memory loss, but which the doctors have been unable to diagnose.)
For the past seven years, Mom has lived at Happy Acres in a comfortable apartment with her cat (Bonnie) and her television. When I see her, I often ask if there’s anything more she needs or wants. She assures me that this is all she needs to be happy.
At this point, Mom struggles with routine personal hygiene, so there’s no way she can take care of tasks like signing up for Social Security or taking withdrawals from her retirement accounts. As her sons, that’s now our job. (And we’re happy to do it.)
You might think that this process would be easy — but you’d be wrong. I suspect that in most cases, getting retirement benefits started is easy, but it’s much less so in our situation.
A Little Bit of Kafka
At first, my brother Jeff and I thought that setting up Social Security would be simple. He and I both have Power of Attorney. We’re accustomed to this allowing us to breeze through most financial tasks as if we were Mom herself.
In March, about a month before Mom’s birthday, I spent an afternoon at the local Social Security office. I took all of the documentation that I could gather.
I arrived to find the waiting room was packed with other folks applying for benefits. It was standing-room only. Rather than get frustrated, I sighed and resigned myself to waiting. And wait, I did. I waited for two hours before my number was called. (It was all fine, though. I spent the time absorbed in a good book.)
When my turn came, I sat at the desk and talked to the clerk. “I’m here to apply for Social Security benefits for my mother,” I said.
“Is your mother with you?” the clerk asked.
“No,” I said. “But I have Power of Attorney.” I pulled out the paperwork to offer proof.
The clerk waved her hand and shook her head. “The Social Security Administration does not recognize Powers of Attorney,” she told me. “To conduct business on your mother’s behalf, you must be a designated representative, a legal guardian.”
“What does that mean?” I asked.
“For all practical purposes, it means you probably should make an appointment to bring your mother in with you. That’s going to be the easiest thing to do.”
“Okay,” I said. “But she’s not really going to be able to carry on a conversation or to make an informed decision about anything. Still, let’s make an appointment.”
“Even if she’s not mentally fit, she has to be the one who applies in person,” the clerk said. She clicked at her keyboard, searching for appointment times. “I’m sorry, but we don’t have any appointments available.”
I was puzzled. “Let me get this straight. Mom has to apply in person. To apply in person, we have to make an appointment. But there are no appointments available?”
“Well, there three other options,” the clerk said. “She can do what you did today and wait in the lobby. She can call each morning to see if there are any cancellations. Or she can apply online. However, she has to apply herself. You can’t fill out the application for her.”
I’ll admit that I was both baffled and a little steamed. “She’s not able to fill out the application herself. She’s not capable,” I said. “I don’t think it’s a good idea to have her wait here with me for two hours as a drop-in. And calling the day-of to get an appointment is problematic. It would take roughly three hours from the time I called in order to get her here.”
The clerk shrugged. “I don’t know what to tell you,” she said. “Those are your three options.”
Skirting the Law
When I returned home, I called my brother to explain the situation. “I feel like there’s no way we can get this done,” I said, “unless we fudge things a little.”
“What do you mean?” he said.
“Well, there’s no way for Mom to complete the application hereself, right? Legally, she’s required to. But what if we completed it for her while she’s in the room?”
“I’m okay with that,” Jeff said.
And that’s what we did: Jeff and I sat with Mom and worked through the online Social Security benefits application.
Much of the application asked for standard stuff, such as age, mailing address, and so on. It was easy for us to answer those questions. But some of the questions required sleuthing. To set up Mom’s online Social Security account, for instance, we had to puzzle out a battery of questions drawn from her credit history. (Solution? Just pull a free credit report, which you’re allowed to do three times per year.) To actually complete the benefits application, we needed to figure out important dates regarding her marriage and her work history.
Whenever we reached a question that stumped us, we asked Mom for the answer. She never had the answers, though, so we had to dig through various documents to find the info.
After a couple of hours, we’d finished the application. We asked Mom to type in her name for the digital signature. (Even that was tough for her.) The process was over…or so we thought.
About a week later, we got a letter in the mail from the Social Security Administration. “Thank you for contacting us for an appointment to visit our office,” the letter read. “This is confirmation of the date and time of your appointment.”
“What in the world is this?” Jeff asked me. “We never made an appointment for Mom.”
“I have no idea,” I said. “I thought we’d done everything we need to do at this point. But I’ll tell you what. It sounds like we have a firm date and time for an appointment, so let’s just take it. We may be duplicating our efforts, but that’s okay. I’m willing to sacrifice a few hours of my time just to make sure everything is correct.”
Return to Purgatory
Jeff handled everything with the assisted living facility, arranging for Mom to have an early breakfast, and getting her approved to take a field trip. His wife showed up yesterday morning just to make sure everything went according to plan.
Meanwhile, I left the house at 7:30, stopped by the family box factory to pick up supporting documentation, then headed to Happy Acres to pick up Mom.
When we reached the Social Security office at 8:55, there was already a long line at the door. “There’s no way we’re going to get inside in time for our nine o’clock appointment,” I thought to myself, but it turns out I needn’t have worried. When the office opened, a security guard summoned folks with appointments to the front of the line. Mom and I went inside to meet the clerk who would be conducting the interview.
Our clerk was both friendly and helpful. He was also meticulous and business-like. At first, he directed his questions to Mom (as he should have), but when it became clear that Mom couldn’t answer for herself, he addressed me instead.
“We’ve received your mother’s application for retirement benefits,” the clerk told me. “But she’s also eligible for survivors benefits. That’s what today’s interview is about. We want to get her set up in the system so that she receives everything she’s due.”
The clerk interviewed us for about twenty minutes. Unfortunately, we weren’t able to answer all of his questions because we weren’t prepared for them. When did Dad die? I remember that date very clearly. When were Mom and Dad married? I don’t know off the top of my head and Mom can no longer remember.
“Do you have a copy of their marriage certificate?” the clerk asked. No, we do not. “Ah, you’ll need to get a certified copy and mail it to me in order to complete this process.”
“How do I do that?” I asked.
“You’ll need to contact the Department of Vital Records in whichever state she was married,” he said. “Once you get a certified copy, mail it to me in this envelope. After we have all of the documentation we need, benefits will begin a few weeks later.”
To Be Continued…
Last month during my road trip through the southeastern United States, I stopped to visit my pal Cameron Huddleston in Bowling Green, Kentucky. Huddleston, a personal-finance columnist, has experienced something similar herself. Her mother has Alzheimer’s, so Huddleston has had to learn to manage her money. And, in fact, she just signed a deal to write a book about managing your parents’ money.
“It’s kind of a boring topic, but it’s important,” Huddleston told me. “It’s something that more and more people are wrestling with, especially as lifespans increase and personal finances become more complicated.” She hopes to produce a useful guide to help people like me figure this stuff out. From what we can tell, nothing like this exists right now. It’s like each person in my situation has to re-invent the wheel, to puzzle through the process on our own each time. I’m eager to be the first person to buy Huddleston’s book!
Obviously, my family still has work to do.
From what we can tell, Mom’s application for Social Security retirement benefits has been accepted and now it’s simply a matter of waiting for payments to begin. (This can take up to three months, apparently.)
Meanwhile, in order for her to receive survivors benefits, we need to track down a copy of her marriage certificate, which I suspect is going to eat another couple hours of my time. That’s a task for this afternoon, I guess.
Plus, I haven’t even started talking to Vanguard about how to take Required Minimum Distributions from Mom’s IRA. We have another 5-1/2 months to solve this piece of the puzzle. (RMDs must begin by the time the account holder is 70-1/2 years old.) I’m going to wait until the Social Security benefits are finally flowing before I move on to the IRA.
One final task? The next time I see that Mom is having a lucid day, I want to ask her what we can buy her to improve her life. She says she’s content sitting in front of the television with a cat in her lap, but I feel like there must be something more we can do for her. Maybe get her a second and third cat? Maybe get her a super-deluxe television? Or how about buying a fancy chair with built-in massage?
Mom has some money now. It’d be awesome to use that money to give her a better life.
Important footnote: Dad died in July 1995. Mom has missed out on 23 years of Social Security survivors benefits because we weren’t aware that she should apply for them. That’s crazy! “Do you have any literature on survivors benefits?” I asked the clerk at the Social Security office yesterday. He have me a few pamphlets. Soon, I’ll read all of this material and write a short blog post summarizing the most important pieces.
Today, I’m pleased to present the first-ever video from the Get Rich Slowly channel on YouTube. If all goes according to plan, there will be many more such videos in the future, not all of which will be shared here on the blog. So, if you’re interested in catching all of the video material I produce, you should subscribe to the YouTube channel!
This first clip is a 27-minute recording of a talk I gave on April 15th at Camp FI in Spring Grove, Virginia.
For those unfamiliar, Camp FI is a series of weekend retreats that let a few dozen folks come together to chat about Financial Independence and early retirement. The events are largely unstructured, a chance for attendees to meet and mingle with like-minded folks. But they’re not entirely unstructured. Throughout the weekend, there are a handful of presentations on subjects like real-estate investing, safe withdrawal rates, and credit card hacking.
But when I speak, I like to talk about Big Picture topics, such as the importance of purpose and why you should create a personal mission statement.
In fact, that’s the subject of this presentation, which took place on the twelfth anniversary of Get Rich Slowly. “What’s your why?” I asked attendees. Why do you want financial independence? Why do you want to retire early? Why do you want to sacrifice today in favor of tomorrow?
What's Your Why? The Power of Purpose - YouTube
Typically when I share videos from other people, I provide in-depth summaries. As an old man, I’d much rather read a presentation than be forced to watch it. I don’t want to force you folks to watch videos either. In this case, however, I’m not going to do that. If you’ve been following me for any length of time, much of this will be familiar to you. (See how to write a personal mission statement if you’re new around here and don’t want to watch the video.)
Whether or not you watch this particular video, I’d be grateful if you subscribed to the GRS YouTube channel. Apparently certain features on YouTube can’t be “unlocked” unless you have enough folks who want to view your stuff.