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Buying A More Expensive House: Good Investment? May 17, 2007

Posted by pf in Expenses and Savings, Retirement, Taxes.
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Previously, I had written about our goals of purchasing a new home (Buying a More Expensive House – Smart Financial Move?) and my struggle to determine whether or not it is the best move for us financially.

Real Estate Market: $100K off of a New Home

I am still grappling with this question (and honestly, the whole thing gives me a bit of anxiety) and have been searching and reading numerous articles, blogs, etc on the topic in hopes of coming to some conclusion and then being comfortable with whatever decision I make. My thoughts on this are still developing, but I think I am getting closer. Here is what I’ve gathered thus far:

1) At its most basic level, home-ownership may not be the best investment vehicle to increase my net worth

Home-ownership is expensive. You have the mortgage interest expense, taxes, maintenance, insurance, furnishings, etc. Also, obviously, if you buy more house, all of these things grow proportionally. In a pure economic sense, what I can expect from this investment is probably 3.5-5% growth on an annual basis…essentially, the rate of inflation plus a small uptick if I take a more optimistic view. Conversely, for the same amount of investment, I could direct those resources into equities and reasonably expect…7%? Of course, this will vary and 7% is lower than the historical average and certainly less than in recent years…but I think a fair assumption. Of course, I will have to live somewhere, so I’m not talking about an all or nothing proposition, but clearly whatever I invest in housing, I do so at the expense or opportunity cost of putting those dollars to work elsewhere. Heck, I think we are likely to double our property taxes with our new house…something like $4000-$6000 additional each year. This is real and significant $ that I would normally put in a Roth IRA (for example). I seriously doubt I’ll get the same rate of return for that money having invested it in the house.

2) Rent vs Buy – Not an option…for us

The gut reaction here is “renting is throwing money away”, etc. After reading more about it, I do think there is a strong case for renting under certain circumstances. One compelling aspect of this is the fact that if you are moving frequently (ex: every 3-4 years), on a 30 year mortgage, you are hardly building up any equity in the home, anyway. The National Multi-Housing Council has a number of good articles on this topic, such as “Ownership vs Renting: One Columnist’s Take”. Granted, I sense the organization is a a bit biased, but many of the arguments do make sense.

Net Worth – Jan 2008

However, in our particular situation, our plan is that the house we are planning for is going to be the one we intend to stay in for the next 20 years. The neighborhood is upscale and contains homes that will stand the test of time and the size of the home is sufficient to meet the needs of our family as we don’t plan to have any more children. In addition, it is in very close proximity to their grandparents which was another consideration.

Granted, 20 years is a long time and the assumptions we make now may not actually hold true…but given I’m not omnipotent, I think it’s the best we can do. In particular, given their age, I know our children’s grandparents will not be in their same house in 20 years. However, given the likely locations where they would move (downscale), we still think our plan stands the test of time. Simlarly, I could lose my job, etc…but that’s just life.

3) Affordability

It’s funny how as you get older, you really get to “know” yourself – both the good and not so good characteristics of your personality. For example, I know that I am a worrier and consistently have an underlying concern about being able to fund retirement and provide for my family over the long term. Of course, I don’t think that’s so different from most people…but I do sense it sometimes affects my decision making more. When faced with decision like our potential home purchase, I go to the “doomsday scenario” and consider what happens if I lose my job (I am the sole earner in our family) and am unable to recoup our level of income. Therefore, I feel as though whatever house we buy has to be able to withstand the “doomsday event” and thus will require a significant down-payment. We are well on our way to saving that amount and my ongoing delaying tactics (ex: “let’s wait until next spring to start building”) should give us the additional time needed for me to get comfortable there.

3) Why are my goals / aspirations for life?

At the end of the day, this is really what it boils down to. All the efforts I make to increase my net worth is a means to an end…not an end itself. What is important to me?

  • Creating financial security for my family and being able to meet all their current needs and some of their wants
  • Providing adequate funding for the retirement we envision for ourselves
  • Making my family and myself happy during this short journey we call “life”

At one extreme, I could force my family to live in a tent and have a much easier time fulfilling the first two…but with some sacrifice to the third. At the other end, I could put an intense focus on the last item, but potentially endanger the first two. Of course, ideally, I WANT IT ALL (doesn’t everyone?). In order to do so, I must try to find a balance.

Zillow

Therefore, ultimately, while I am now convinced that buying a more expensive house is not the optimal investment for increasing my wealth, I do believe that it will go a long way toward satisfying my last goal while not putting undue risk on the other two.

That is not to say that I don’t still worry about the “doomsday scenario” (I can’t run away from myself), but will just have to take things as they come and adapt accordingly…you know, “live life”.

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Comments»

1. JMS - May 17, 2007

I think piece-of-mind is an important consideration. Though I had the salary to afford it, a big mortgage hanging over my head was a big worry for me when my company was going through lay-offs.

Also, a larger house is going to cost more to heat/cool (in our case, it was alot more). Watch out for HOA fees, as well. (Hidden costs you didn’t mention above).

I’d say buy a house that is just a little bigger than you think you need, and not much more.

2. JMS - May 17, 2007

err, make that “peace-of-mind”…

3. dong - May 21, 2007

The other issue with more upscale houses (assuming you’re not just paying for location) is they’re more expensive to maintain. Repairs cost more. That said, I’m firmly of the camp that you buy a house not as investment but for a place to live. If you want a nicer house then should buy a nicer house assuming you have comfortable margin for error. Also, i don’t necessarily think you need to put down a bigger downpayment just because you’re worried about losing your job as long as you’re willing to move if that happens. I know if I ever found myself in that situation that’s what I do, but of course I don’t have kids…

4. pf - May 21, 2007

You’re absolutely right Dong, it IS more expensive and it’s something I think about…a lot. I think one thing that really drives me is that I just hate the thought of being forced to move (thus the bigger down payment). “Comfortable” is in the eye of the beholder…but rest assured I’ll be at least “comfortably uncomfortable”? Heh. Obviously, of course, I would do whatever must be done in the best interests of my family.

I have also had quite a few discussions with my in-laws about this decision (I love them like my own parents and value their opinion very much). In particular, my father-in-law and I think very much alike and really understand where each other are coming from (he’s a worrier too). I’ve been very fortunate to have their input throughout the decision making process.

5. Carnival Of Personal Finance 102 - May 29, 2007

[…] My Personal Finance Odyssey – Is buying a more expensive house a good investment? […]

6. Christopher Smith - May 29, 2007

Good post.

Over the long run, owning a home is an important key to financial security. Building equity – interest deduction – price appreciation – it’s a slam dunk. Now isn’t always the best time to buy, but eventually you’ll have to take the plunge.

You ask an interesting variation on the question though: is buying a more expensive house a good investment.

There is definitely a correct answer to this question: no, it’s not a good investment.

Buying “more house” actually isn’t an investment at all. It’s .

Think of it this way: You need a “certain amount of house” – defined however you wish: amenities, number of bedrooms, school district – whatever. You can meet this need either by buying or renting. And as a million “buy vs. rent” blog postings have already pointed out, buying takes the day.

When it comes to upgrading, however, it’s a different story. You don’t “need” those extra three bedrooms, or the indoor swimming pool, or whatever else you’re getting to add a bit more bling and curb appeal. These are things you want, not need – and they’re expensive.

So…you could either put that extra cash into your mortgage payment/taxes/expenses/etc and buy your Mc Mansion and hope that property values go up and keep you whole…or you could sock that cash into an investment property (that generates revenue) or stocks (that generate dividends) or bonds (with a fixed yield)…you get the picture.

Buy your big house if you want it and you’ll enjoy it. Just don’t think that it’s an investment. It’s not; it’s an expense.

7. Christopher Smith - May 29, 2007

Good post.

Over the long run, owning a home is an important key to financial security. Building equity – interest deduction – price appreciation – it’s a slam dunk. Now isn’t always the best time to buy, but eventually you’ll have to take the plunge.

You ask an interesting variation on the question though: is buying a more expensive house a good investment.

There is definitely a correct answer to this question: no, it’s not a good investment.

Buying “more house” actually isn’t an investment at all. It’s speculating.

Think of it this way: You need a “certain amount of house” – defined however you wish: amenities, number of bedrooms, school district – whatever. You can meet this need either by buying or renting. And as a million “buy vs. rent” blog postings have already pointed out, buying takes the day.

When it comes to upgrading, however, it’s a different story. You don’t “need” those extra three bedrooms, or the indoor swimming pool, or whatever else you’re getting to add a bit more bling and curb appeal. These are things you want, not need – and they’re expensive.

So…you could either put that extra cash into your mortgage payment/taxes/expenses/etc and buy your Mc Mansion and hope that property values go up and keep you whole…or you could sock that cash into an investment property (that generates revenue) or stocks (that generate dividends) or bonds (with a fixed yield)…you get the picture.

Buy your big house if you want it and you’ll enjoy it. Just don’t think that it’s an investment. It’s not; it’s an expense.

8. John Hunter - June 16, 2007

I believe it makes sense to own your home (there are also circumstances where renting is best). However I do not believe it makes financial sense to buy a more expensive home – the more it costs initially and in upkeep is a negative. As an investment it might make sense to buy a more expensive house that you thought would increase in value more than an alternative (say close in to a large city rather than far out in the suburbs) but that is an investment decision based on the return expected (not on just paying more up front). It might be you would enjoy having a larger house and the extra cost was worth the added expense.

But if you are looking at the investment choice I think you would be much better off getting a cheaper house and then if you wanted a larger percentage of your portfolio in real estate buy a rental property (though that has management hassles – you can hire someone to do that for you though it reduces your investment return substantially) or a REIT.

9. Buying a More Expensive House: Update « My Personal Finance Odyssey - January 24, 2008

[…] trackback Some months ago, I had written some thoughts about our potential purchase of a new home (Buying A More Expensive House: Good Investment?). Since then, the real-estate market has tanked. This was an easy reason to postpone any purchase […]

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11. julie - March 3, 2011

i love my new home haha i just bought it for 500,000 and that was the most best day of my whole entire life yay…..! 🙂

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13. marcus anthony bynum - February 4, 2012

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14. Dirk Kettlwell - July 19, 2012

Great article. thanks for sharing.

15. Townhouses For Sale In Toronto - September 17, 2012

It’s cheaper to buy than rent in many major markets, especially since rents have risen due to increased demand.

16. Dean Friedman - April 29, 2013

Expensive vs cheap home – Assumptions: average home appreciation 3%, average equity mutual fund appreciation 7% after tax – The difference in down payment plus the difference in 30 yr mortgage payment (plus the minor difference in additional home expenses from bigger home with pool for example) invested at a 10% rate yields about 4-5 times net worth in 15 years. Eg: buying an $90k (small home in ok area at 2.5% growth) is worth $130k in 15 years (($50k profit) vs $190k (bigger home w pool home in nicer area at 3.5% growth) is worth $318k in 15 years ($128k profit). That difference in profit ($128k less $50k is $78k). The mutual fund investment ($10k difference down payment plus $10k difference per year) compounded over 15 years at 7% after tax) equals $278k. Therefore you are forfeiting $200k ($278k mutual fund less $78k home profit diff) to live a nicer lifestyle. So, the question is: would you rather have an extra $200k in the bank or a bigger home? That’s over $13k per year to pay for lifestyle. Think about it. Over 30 years there’s a difference of $245k profit on home vs $1020k in mutual fund. Hmmmmmm better home or better money?

17. Dean Friedman - April 29, 2013

Expensive vs cheap home – Assumptions: average home appreciation 3%, average equity mutual fund appreciation 7% after tax – The difference in down payment plus the difference in 30 yr mortgage payment (plus the minor difference in additional home expenses from bigger home with pool for example) invested at 7% rate yields about 4-5 times net worth in 15 years. Eg: buying an $90k (small home in ok area at 2.5% growth) is worth $130k in 15 years (($40k profit) vs $190k (bigger home w pool home in nicer area at 3.5% growth) is worth $318k in 15 years ($128k profit). That difference in profit ($128k less $40k is $88k). The mutual fund investment ($10k difference down payment plus $10k difference per year) compounded over 15 years at 7% after tax) equals $278k. Therefore you are forfeiting $190k ($278k mutual fund less $88k home profit diff) to live a nicer lifestyle. So, the question is: would you rather have an extra $190k in the bank or a bigger home? That’s $13k per year to pay for lifestyle. Think about it. Over 30 years there’s a difference of $245k profit on home vs $1020k in mutual fund. Hmmmmmm better home or better money?

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