The Unusual Retirement Math of Homeownership

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Patzer
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The Unusual Retirement Math of Homeownership

Post by Patzer »

This post is only about home ownership of your primary residence. Rental properties take on additional risks.

I think homeownership outperforms a traditional investment portfolio, by reducing volatility and better matching returns to expenses, but I would love to hear other people's math based arguments for or against it.
I will use my personal home math for this argument, but would love others to chime in with their math as well.

My home is fully paid for, and I could sell my home for $168,000 and rent a comparable place for $16,000 a year.
Owning a home has some extra costs versus renting though, which come out to $5,700 per year for me.
So, the difference between owning and renting is that owning costs me $10,300 less per year.

We often talk about retiring with 25x expenses (4% SWR) or 30x expenses (3.33% SWR) for the more conservative amongst us.

If I had that extra 10.3K per year in expenses, then in order to retire with a 30x saving multiplier, I would need 309K in extra investments to cover that expense.
If I wanted to retire with a 25x savings multiplier, then I would need 258K in extra investments to cover that expense.

So in terms of getting me closer to my retirement goal my paid off house is actually benefiting me by a lot more than I could sell it for.
If we use 30x expenses, than my house is reducing the need for retirement assets by 30x10.3K = 309K. 309K/168K = 1.84, so the house has 1.84x more value.
If my target was 25x expenses, then it would be 258K/168K for a 1.54X value of assets in investments at my asset allocation.


How can it outperform so much?
1. Any expense reduction is like creating tax free income.
2. Expense reductions lower risk.
3. The house adjusts perfectly with the cost of housing where I live thereby matching my assets with my expenses, and lowering volatility.
4. The house is yielding 6.13% (10,300/168,000), and is acting like a 6.13% tax-free zero risk bond, that also adjusts with inflation. The closest product to that is a 30 year TIPS, which currently yields 0.03% and isn't tax free, which is massive outperformance.
scout1
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Re: The Unusual Retirement Math of Homeownership

Post by scout1 »

You're not factoring in the growth of the $168k over the 25 or 30 years you draw it down. A 4% growth rate on the $168k makes you indifferent between owning vs renting over 25 years. A 5% growth rate on the $168k makes you indifferent between owning and renting over 30 years. Basically if you earn more than that indifference rate, then you'd prefer to rent and invest the $168k.
Last edited by scout1 on Mon May 10, 2021 1:42 pm, edited 2 times in total.
Thesaints
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Re: The Unusual Retirement Math of Homeownership

Post by Thesaints »

An important detail is that your invested capital is not expected to be depleted at the end of retirement. Whereas by selling your home your heir will be left without that piece of real estate.
it is the same with annuities: they can provide a much larger yield than any "SWR" (not to mention that annuities would be a lot safer), but your capital is gone.
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

I think what you are basically doing is pointing out the rough industry rule of thumb of charging around 1% of property value per month in rent is 12% per year, which is a lot more than 3-4% per year!

Now of course that is not 12% income completely clear--a rental owner will also have various bills to pay before even getting to whether they finance the purchase. But still, they, like you implicitly calculated, will also likely be clearing a lot more than 3-4% per year . . . but not risk-free!

One of the risks of course is just something happening to local housing unit prices such that they depreciate in real terms. And you have that risk too, but with no mortgage, and unless you are planning to draw down equity for income in retirement, that is a problem for your heirs to worry about. But rental owners have to accept that real depreciation risk for themselves.

One caveat: if you have to (or want to) move, and there is differential appreciation/depreciation, that can become a real issue (or a big benefit!). But in this simplified model, you appear to be assuming away any such risk.

Anyway, another risk is something happening to interrupt that 12% rental income, including problems with tenants and such. As your own "virtual tenant," though, you don't have to worry about that risk either.

I think you could throw in some other considerations, but I suspect that is most of what is going on here. Rental owners are charging rents necessary to offset risks that you can essentially avoid by "renting to yourself," never moving, and thereby leaving any real depreciation risk to your heirs to worry about. And mathematically that looks like a high inflation-adjusted "withdrawal" rate.

And I don't mean to suggest that isn't a worthy consideration. Indeed, lots of older folks end up in houses they probably couldn't afford to rent if they tried to cash out their equity and then turn it into a "safe withdrawal rate" equal to that rent, and so staying in such a house might well be a solid move for them.
Last edited by NiceUnparticularMan on Mon May 10, 2021 2:02 pm, edited 1 time in total.
Thesaints
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Re: The Unusual Retirement Math of Homeownership

Post by Thesaints »

To make things very simple, the OP could just imagine he has got 168k in cash and has to decide whether to buy his home, or to rent.
His calculation is not wrong (although return from 168k of capital is neglected, as others have pointed out). However, thee is a fundamental difference he overlooked in the two choices: if he buys the home, not only he is satisfying his need for a roof, but he also owns a home, which is an additional capital asset.
dboeger1
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Re: The Unusual Retirement Math of Homeownership

Post by dboeger1 »

I realize OP is focusing on the math, but another advantage of home ownership is insulation from a variety of external factors. such as rental regulations, landlords, changing ownership, restrictions on renovations, etc. For example, a common complaint from renters in rent-controlled areas is that when market rents and renovation costs outpace the caps on rent raises, landlords have little margin or incentive to renovate, so the property conditions deteriorate over time until the renter finally moves out. Owning your own home gives you so much flexibility to manage your lifestyle and expenses according to your values and means. That's not to say nothing can go wrong with ownership, but it's generally rare for your life to get turned upside down in a matter of days as an owner, whereas renters can sometimes be evicted with relatively short notice. I'm not sure how you assign a dollar value to that, but I think home ownership helps to reduce both financial and lifestyle volatility.
Scooter57
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Re: The Unusual Retirement Math of Homeownership

Post by Scooter57 »

If you are a young retiree and healthy owning your home, especially an inexpensive one like the one you cite is a great way to cut expenses.

However, there are a couple issues to keep in mind. Time starts going a lot faster when you are past 50, and before you know it you will be in your 70s. At that point you can run into some age-related issues.

1. The house is now 20-30 years old or more and suddenly needs everything: roof, plumbing, replacement windows, siding or painting, site work/drainage, paint, furnace replacement, well replacement, etc. etc. This can cause you to have to put out a lot of money when you hadn't planned to.

2. You don't have the energy to do the maintenance you used to do on your own, so that gets expensive.

3. You can't get up the stairs comfortably, or at all, and there is no way to live downstairs (eg. no shower) so suddenly you have to move, possibly at a bad time in the real estate market.

4. Your neighborhood that you loved when you bought in changes character, neighbors let their homes deteriorate, rent to students or AirBNB, something nasty happens, like you discover dangerous pollution in your soil, a sinkhole opens up down the street, school district boundaries change putting you in a district people with kids avoid, etc.

5. Sometimes real estate markets freeze up and you can't sell a house no matter how nice it might be. And if it isn't nice it can take a couple years to sell it long after you had to move. I had this happen to me on my first house and saw it happen to friends within the last 5 years. If you have to move into assisted living and need the proceeds of the house to fund it, this could pose a real problem.

The nice thing about renting, which is why I have done it for long stints in the past is that when any of these happens you find a new place to rent, hand in the keys at the end of your lease and that's that. You don't have to deal with dead-in-the-water real estate markets, problems with neighbors, structural decay, etc.

Of course, renting only makes sense if you rent something that you can reasonably expect to be able to live in indefinitely. I was lucky to find very nice properties that fell into this category that were also in very good school districts. We got the best years out of those properties and then moved on. The last place we lived before buying this house 18 years ago, the owner put it on the market where it sat literally for 13 years. And he was a realtor! Why? Cable had come in since he built the house and become essential but the house was in a town with no cable access. Satellite service there was mediocre. So he was stuck. Meanwhile, we renters moved to a nice new place with cable.
Topic Author
Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

NiceUnparticularMan wrote: Mon May 10, 2021 1:52 pm I think what you are basically doing is pointing out the rough industry rule of thumb of charging around 1% of property value per month in rent is 12% per year, which is a lot more than 3-4% per year!

Now of course that is not 12% income completely clear--a rental owner will also have various bills to pay before even getting to whether they finance the purchase. But still, they, like you implicitly calculated, will also likely be clearing a lot more than 3-4% per year . . . but not risk-free!

One of the risks of course is just something happening to local housing unit prices such that they depreciate in real terms. And you have that risk too, but with no mortgage, and unless you are planning to draw down equity for income in retirement, that is a problem for your heirs to worry about. But rental owners have to accept that real depreciation risk for themselves.

One caveat: if you have to (or want to) move, and there is differential appreciation/depreciation, that can become a real issue (or a big benefit!). But in this simplified model, you appear to be assuming away any such risk.

Anyway, another risk is something happening to interrupt that 12% rental income, including problems with tenants and such. As your own "virtual tenant," though, you don't have to worry about that risk either.

I think you could throw in some other considerations, but I suspect that is most of what is going on here. Rental owners are charging rents necessary to offset risks that you can essentially avoid by "renting to yourself," never moving, and thereby leaving any real depreciation risk to your heirs to worry about. And mathematically that looks like a high inflation-adjusted "withdrawal" rate.

And I don't mean to suggest that isn't a worthy consideration. Indeed, lots of older folks end up in houses they probably couldn't afford to rent if they tried to cash out their equity and then turn it into a "safe withdrawal rate" equal to that rent, and that might well be a solid move for them.
What a response!! Thank you!
Yes, as the tenant of my own property, assuming I intend to live in the property indefinitely, then most of the risks a landlord would normally be compensated for are removed and the landlord (me) is effectively given additional return without additional risk.
Jayhawker
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Re: The Unusual Retirement Math of Homeownership

Post by Jayhawker »

Interesting post. I like this different way of thinking about it. The math really seems brutal for long-term renters in a LCOL area.

One caveat I have is that you are looking at a 10.5x price-to-rent ratio ($168,000 vs. $16,000) which is quite good. A 20x price-to-rent ratio is not uncommon in HCOL areas at this time and changes the calculation quite a bit. If we increase the price in your example to 20x rent ($320,000) and keep all the other numbers the same, the yield will be 3.2% ($10,300/$320,00) instead of 6.13%.

So I would propose the math isn't quite as clear-cut in higher cost of living areas. Though as you correctly point out, the imputed rent yield is tax free and adjusts perfectly with your cost of housing.
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Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

Scooter57 wrote: Mon May 10, 2021 2:04 pm If you are a young retiree and healthy owning your home, especially an inexpensive one like the one you cite is a great way to cut expenses.

However, there are a couple issues to keep in mind. Time starts going a lot faster when you are past 50, and before you know it you will be in your 70s. At that point you can run into some age-related issues.

1. The house is now 20-30 years old or more and suddenly needs everything: roof, plumbing, replacement windows, siding or painting, site work/drainage, paint, furnace replacement, well replacement, etc. etc. This can cause you to have to put out a lot of money when you hadn't planned to.

2. You don't have the energy to do the maintenance you used to do on your own, so that gets expensive.

3. You can't get up the stairs comfortably, or at all, and there is no way to live downstairs (eg. no shower) so suddenly you have to move, possibly at a bad time in the real estate market.

4. Your neighborhood that you loved when you bought in changes character, neighbors let their homes deteriorate, rent to students or AirBNB, something nasty happens, like you discover dangerous pollution in your soil, a sinkhole opens up down the street, school district boundaries change putting you in a district people with kids avoid, etc.

5. Sometimes real estate markets freeze up and you can't sell a house no matter how nice it might be. And if it isn't nice it can take a couple years to sell it long after you had to move. I had this happen to me on my first house and saw it happen to friends within the last 5 years. If you have to move into assisted living and need the proceeds of the house to fund it, this could pose a real problem.

The nice thing about renting, which is why I have done it for long stints in the past is that when any of these happens you find a new place to rent, hand in the keys at the end of your lease and that's that. You don't have to deal with dead-in-the-water real estate markets, problems with neighbors, structural decay, etc.

Of course, renting only makes sense if you rent something that you can reasonably expect to be able to live in indefinitely. I was lucky to find very nice properties that fell into this category that were also in very good school districts. We got the best years out of those properties and then moved on. The last place we lived before buying this house 18 years ago, the owner put it on the market where it sat literally for 13 years. And he was a realtor! Why? Cable had come in since he built the house and become essential but the house was in a town with no cable access. Satellite service there was mediocre. So he was stuck. Meanwhile, we renters moved to a nice new place with cable.
Good call outs. I don't want to make this too much about myself, because I am trying to talk theory here, but this is a townhouse, so a lot of maintenance is handled by the community, so the risk is shared, and doesn't require a homeowner to deal with many of the potential maintenance issues.

This home is in a very hot area, has Google Fiber, and a CAGR of 7% over the last 10 years. While the CAGR is high, rent prices have also gone up just as much, so it's just matching the local housing market inflation.

Personally, the biggest risk you called out is if I am no longer able to do stairs at some point, since it is 2 levels. As an avid hiker/climber, I hope that is never the case.
jsprag
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Re: The Unusual Retirement Math of Homeownership

Post by jsprag »

Let's look at it another way: When would you be better off immediately selling the house for $168K and renting it back from new owner?

Your choices are:
A. Keep the house and pay $5.7k in annual expenses from your other income.
B. Sell the house, invest proceeds, and spend $10.3k of it each year (in addition to $5.7k from other income) on rent.

When does option B make more sense? Over a 40 year horizon, if your investments return more than 5.4% annually then you would have been better off selling the house and paying rent..
Topic Author
Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

Jayhawker wrote: Mon May 10, 2021 2:15 pm Interesting post. I like this different way of thinking about it. The math really seems brutal for long-term renters in a LCOL area.

One caveat I have is that you are looking at a 10.5x price-to-rent ratio ($168,000 vs. $16,000) which is quite good. A 20x price-to-rent ratio is not uncommon in HCOL areas at this time and changes the calculation quite a bit. If we increase the price in your example to 20x rent ($320,000) and keep all the other numbers the same, the yield will be 3.2% ($10,300/$320,00) instead of 6.13%.

So I would propose the math isn't quite as clear-cut in higher cost of living areas. Though as you correctly point out, the imputed rent yield is tax free and adjusts perfectly with your cost of housing.
Great call out. While most places in the US do seem to favor owning, some quick napkin math says, the following markets favor renters: San Francisco, Oakland, LA, San Jose, NYC, Seattle, DC, San Diego, Boston, Portland, and Denver.
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

dboeger1 wrote: Mon May 10, 2021 2:03 pm I realize OP is focusing on the math, but another advantage of home ownership is insulation from a variety of external factors. such as rental regulations, landlords, changing ownership, restrictions on renovations, etc. For example, a common complaint from renters in rent-controlled areas is that when market rents and renovation costs outpace the caps on rent raises, landlords have little margin or incentive to renovate, so the property conditions deteriorate over time until the renter finally moves out. Owning your own home gives you so much flexibility to manage your lifestyle and expenses according to your values and means. That's not to say nothing can go wrong with ownership, but it's generally rare for your life to get turned upside down in a matter of days as an owner, whereas renters can sometimes be evicted with relatively short notice. I'm not sure how you assign a dollar value to that, but I think home ownership helps to reduce both financial and lifestyle volatility.
I'd say the forced move thing is the biggest major risk to watch out for. Maybe it is sick relative. Maybe YOU are the sick relative! Maybe your house burns down . . . .

But in situations like that, this math can reverse on you, in that suddenly you are trying to figure out how to pay for housing expenses, and the equity you get out of selling your home might prove inadequate to finance that wherever you are moving.

Of course, you can try to mitigate that risk in various ways. But if you actually have a portfolio that can cover your inflation-adjusted rent at a safe withdrawal rate, you might be forced to move, but you also CAN move.

Which gets into the issue of rent potentially being subject to different inflation than other goods and services, but it is still a component of CPI. So, on average it should be covered by any SWR which can adjust with CPI, even if over time you find more of your income going to rent and less to computers and whatnot.
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Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

jsprag wrote: Mon May 10, 2021 2:23 pm Let's look at it another way: When would you be better off immediately selling the house for $168K and renting it back from new owner?

Your choices are:
A. Keep the house and pay $5.7k in annual expenses from your other income.
B. Sell the house, invest proceeds, and spend $10.3k of it each year (in addition to $5.7k from other income) on rent.

When does option B make more sense? Over a 40 year horizon, if your investments return more than 5.4% annually then you would have been better off selling the house and paying rent..
Not sure how you got 5.4%
10.3K/168, is 6.13%.
This, also ignores taxes, so my investments would have to return 6.13% after tax.
Furthermore, this ignores capital appreciation. Nationally it has been about 3.5% over the last decade for real estate, but locally it has been 7%.
So the return from investments would have to be even higher to cover that.
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

jsprag wrote: Mon May 10, 2021 2:23 pmWhen does option B make more sense? Over a 40 year horizon, if your investments return more than 5.4% annually then you would have been better off selling the house and paying rent..
But why are most people here only figuring on 3-4% SWRs (or indeed less)? Because they are not counting on a volatility-free, inflation-adjusted return of 5.4% annual!

And I think it is an important observation that equity from a home, in many markets at least, would not be sufficient to guarantee you could finance the rent of living in a similar home indefinitely.
Last edited by NiceUnparticularMan on Mon May 10, 2021 2:44 pm, edited 1 time in total.
Thesaints
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Re: The Unusual Retirement Math of Homeownership

Post by Thesaints »

Well, 10.3k on a 168k capital is 6.13%. Furthermore, the 168k invested not only have to provide 6.13% yearly, but also match whatever appreciation (or depreciation) that particular home goes through. On top of all that, there is inflation to be matched; not the CPI-U, but the increase/decrease in rent.
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Ben Mathew
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Re: The Unusual Retirement Math of Homeownership

Post by Ben Mathew »

Patzer wrote: Mon May 10, 2021 1:29 pm 1. Any expense reduction is like creating tax free income.
2. Expense reductions lower risk.
3. The house adjusts perfectly with the cost of housing where I live thereby matching my assets with my expenses, and lowering volatility.
4. The house is yielding 6.13% (10,300/168,000), and is acting like a 6.13% tax-free zero risk bond, that also adjusts with inflation. The closest product to that is a 30 year TIPS, which currently yields 0.03% and isn't tax free, which is massive outperformance.
Generally agree with these points. I made some of these points in this thread: Renting vs Owning your Home.

#4 assumes 0% growth in the real price/rental rate of the house. Homes in LCOL areas seem to be priced for low or negative growth and homes in HCOL seem to be priced for high growth. You can disagree with the market's estimate of price growth in different areas. But the growth assumption will have a significant impact on the estimated rate of return.
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jsprag
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Re: The Unusual Retirement Math of Homeownership

Post by jsprag »

Patzer wrote: Mon May 10, 2021 2:36 pm
jsprag wrote: Mon May 10, 2021 2:23 pm Let's look at it another way: When would you be better off immediately selling the house for $168K and renting it back from new owner?

Your choices are:
A. Keep the house and pay $5.7k in annual expenses from your other income.
B. Sell the house, invest proceeds, and spend $10.3k of it each year (in addition to $5.7k from other income) on rent.

When does option B make more sense? Over a 40 year horizon, if your investments return more than 5.4% annually then you would have been better off selling the house and paying rent..
Not sure how you got 5.4%
10.3K/168, is 6.13%.
This, also ignores taxes, so my investments would have to return 6.13% after tax.
Furthermore, this ignores capital appreciation. Nationally it has been about 3.5% over the last decade for real estate, but locally it has been 7%.
So the return from investments would have to be even higher to cover that.
10.3k / 168k has nothing to do with it.

Q: If you were to sell your house and invest the $168K, how much would your investments have to return in order to draw $10.3k per year for 40 years?
N = 480 (months)
PMT/year = 12
PV = -168,000
PMT = 10,300/12 = 858.33
FV = 0
Solve for RATE = 5.43 % annually

We're all ignoring a lot of things, including capital appreciation, differing terminal conditions, and choices (and their opportunity costs) before today that led to a fully paid house vs. the alternatives.

Since you appear open to letting past performance guide our expectations about the future, let's run it again for a 10 year period:

Option A: Keep the $168K house, which for the next decade appreciates at 7% annually (as it has the last decade) for a final value of $330k.

Option B: Sell the house, invest the $168K in a S&P 500 fund which grows at 13.5% annually for the next decade (as it has the last decade) while paying out rent $858.33 per month for a final value of $427k
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Ben Mathew
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Re: The Unusual Retirement Math of Homeownership

Post by Ben Mathew »

jsprag wrote: Mon May 10, 2021 3:38 pm
Patzer wrote: Mon May 10, 2021 2:36 pm
jsprag wrote: Mon May 10, 2021 2:23 pm Let's look at it another way: When would you be better off immediately selling the house for $168K and renting it back from new owner?

Your choices are:
A. Keep the house and pay $5.7k in annual expenses from your other income.
B. Sell the house, invest proceeds, and spend $10.3k of it each year (in addition to $5.7k from other income) on rent.

When does option B make more sense? Over a 40 year horizon, if your investments return more than 5.4% annually then you would have been better off selling the house and paying rent..
Not sure how you got 5.4%
10.3K/168, is 6.13%.
This, also ignores taxes, so my investments would have to return 6.13% after tax.
Furthermore, this ignores capital appreciation. Nationally it has been about 3.5% over the last decade for real estate, but locally it has been 7%.
So the return from investments would have to be even higher to cover that.
10.3k / 168k has nothing to do with it.

Q: If you were to sell your house and invest the $168K, how much would your investments have to return in order to draw $10.3k per year for 40 years?
N = 480 (months)
PMT/year = 12
PV = -168,000
PMT = 10,300/12 = 858.33
FV = 0
Solve for RATE = 5.43 % annually
You're assuming that price of the house after 40 years is zero. If you assume the price remained constant at $168K, you should get

$10.3K/$168K = 6.13% annual return (if you compute annually)

or

$858/$168K = .511% monthly return = 6.31% annual return (if you compute monthly)
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NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

jsprag wrote: Mon May 10, 2021 3:38 pm Option B: Sell the house, invest the $168K in a S&P 500 fund which grows at 13.5% annually for the next decade (as it has the last decade) while paying out rent $858.33 per month for a final value of $427k
I'll just note again Option B depends on very different assumptions from what motivates SWRs of 3-4%.
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Re: The Unusual Retirement Math of Homeownership

Post by Thesaints »

Ben Mathew wrote: Mon May 10, 2021 3:53 pm You're assuming that price of the house after 40 years is zero. If you assume the price remained constant at $168K, you should get
That's precisely the difference (and the issue). SWR does not assume capital is completely exhausted at the end of the period. Otherwise, it would be a very unsafe withdrawal ratio.
There are two very different outcomes between the one in which the retiree has satisfied his housing needs and the one where he has satisfied his housing needs AND is left with a property.
rich126
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Re: The Unusual Retirement Math of Homeownership

Post by rich126 »

This will apply to very, very, few people here (and maybe no one) but home ownership and passing it on to the next generation is a huge thing in low income families.

I'm currently in a very low income, largely hispanic neighborhood in Arizona and many of them certainly could not afford homes now but their parents or grandparents bought a place many years ago and subsequent generations grew up and continue to live in the home. Sometimes the homes are kept very nice and unfortunately some aren't (literally look like a junkyard). In some cases they will do a tear down and rebuild on the same land since that can be cheaper than buying a place elsewhere.

Personally I think owning a home is a good idea since while you have to do maintenance, you don't have to worry about increasing rents. You have a stable place where you usually have friends. I don't currently own a place but certainly hope to do so again once the current craziness calms down.
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Re: The Unusual Retirement Math of Homeownership

Post by Nohbdy »

Do the calculations above consider the tax flexibility awarded by having a reduced cost use asset?

For example say OP has a paid for home, a tax deferred account, and a taxable account. Say the market tanks and OP want to let equities ride in tax deferred. OP would be in a better position to sell assets in taxable while incurring reduced capitol gains (because reduced necessary taxable income, by having no rent). If staying at home lockdown style, maybe it’s even possible (depending on other specifics) to reduce your tax rate to zero for capitol gains, qualify for subsidized healthcare, tax credits, etc.
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Re: The Unusual Retirement Math of Homeownership

Post by secondopinion »

rich126 wrote: Mon May 10, 2021 4:52 pm This will apply to very, very, few people here (and maybe no one) but home ownership and passing it on to the next generation is a huge thing in low income families.

I'm currently in a very low income, largely hispanic neighborhood in Arizona and many of them certainly could not afford homes now but their parents or grandparents bought a place many years ago and subsequent generations grew up and continue to live in the home. Sometimes the homes are kept very nice and unfortunately some aren't (literally look like a junkyard). In some cases they will do a tear down and rebuild on the same land since that can be cheaper than buying a place elsewhere.

Personally I think owning a home is a good idea since while you have to do maintenance, you don't have to worry about increasing rents. You have a stable place where you usually have friends. I don't currently own a place but certainly hope to do so again once the current craziness calms down.
Passing down real estate is a strong argument, and it applies despite income. I think too few even think about it.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

secondopinion wrote: Mon May 10, 2021 6:08 pm
rich126 wrote: Mon May 10, 2021 4:52 pm This will apply to very, very, few people here (and maybe no one) but home ownership and passing it on to the next generation is a huge thing in low income families.

I'm currently in a very low income, largely hispanic neighborhood in Arizona and many of them certainly could not afford homes now but their parents or grandparents bought a place many years ago and subsequent generations grew up and continue to live in the home. Sometimes the homes are kept very nice and unfortunately some aren't (literally look like a junkyard). In some cases they will do a tear down and rebuild on the same land since that can be cheaper than buying a place elsewhere.

Personally I think owning a home is a good idea since while you have to do maintenance, you don't have to worry about increasing rents. You have a stable place where you usually have friends. I don't currently own a place but certainly hope to do so again once the current craziness calms down.
Passing down real estate is a strong argument, and it applies despite income. I think too few even think about it.
So if you can comfortably manage a SWR of 3 to 4%, including covering rent in a desirable area, odds are you are going to leave a substantial estate.

Having some chunk of that portfolio in a home instead might work out better for your heirs, but it easily might not.

In other words, investing your future heirs' money in a single, undiversified, unleveraged residential property is probably not a best practice in general. But it of course might be the main part of an estate anyway, due to making the most sense during the life of the original owner.
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

secondopinion wrote: Mon May 10, 2021 6:08 pm
rich126 wrote: Mon May 10, 2021 4:52 pm This will apply to very, very, few people here (and maybe no one) but home ownership and passing it on to the next generation is a huge thing in low income families.

I'm currently in a very low income, largely hispanic neighborhood in Arizona and many of them certainly could not afford homes now but their parents or grandparents bought a place many years ago and subsequent generations grew up and continue to live in the home. Sometimes the homes are kept very nice and unfortunately some aren't (literally look like a junkyard). In some cases they will do a tear down and rebuild on the same land since that can be cheaper than buying a place elsewhere.

Personally I think owning a home is a good idea since while you have to do maintenance, you don't have to worry about increasing rents. You have a stable place where you usually have friends. I don't currently own a place but certainly hope to do so again once the current craziness calms down.
Passing down real estate is a strong argument, and it applies despite income. I think too few even think about it.
So if you can comfortably manage a SWR of 3 to 4%, including covering rent in a desirable area, odds are you are going to leave a substantial estate.

Having some chunk of that portfolio in a home instead might work out better for your heirs, but it easily might not.

In other words, investing your future heirs' money in a single, undiversified, unleveraged residential property is probably not a best practice in general. But it of course might be the main part of an estate anyway, due to making the most sense during the life of the original owner.
westie
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Re: The Unusual Retirement Math of Homeownership

Post by westie »

Life is so much simpler with a paid off house and a generous government pension. Threads like this make that abundantly clear to me. :sharebeer :sharebeer
secondopinion
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Re: The Unusual Retirement Math of Homeownership

Post by secondopinion »

NiceUnparticularMan wrote: Mon May 10, 2021 6:17 pm
secondopinion wrote: Mon May 10, 2021 6:08 pm
rich126 wrote: Mon May 10, 2021 4:52 pm This will apply to very, very, few people here (and maybe no one) but home ownership and passing it on to the next generation is a huge thing in low income families.

I'm currently in a very low income, largely hispanic neighborhood in Arizona and many of them certainly could not afford homes now but their parents or grandparents bought a place many years ago and subsequent generations grew up and continue to live in the home. Sometimes the homes are kept very nice and unfortunately some aren't (literally look like a junkyard). In some cases they will do a tear down and rebuild on the same land since that can be cheaper than buying a place elsewhere.

Personally I think owning a home is a good idea since while you have to do maintenance, you don't have to worry about increasing rents. You have a stable place where you usually have friends. I don't currently own a place but certainly hope to do so again once the current craziness calms down.
Passing down real estate is a strong argument, and it applies despite income. I think too few even think about it.
So if you can comfortably manage a SWR of 3 to 4%, including covering rent in a desirable area, odds are you are going to leave a substantial estate.

Having some chunk of that portfolio in a home instead might work out better for your heirs, but it easily might not.

In other words, investing your future heirs' money in a single, undiversified, unleveraged residential property is probably not a best practice in general. But it of course might be the main part of an estate anyway, due to making the most sense during the life of the original owner.
I am more talking about the multigenerational homes... It saves a lot of money.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
JBTX
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Re: The Unusual Retirement Math of Homeownership

Post by JBTX »

Patzer wrote: Mon May 10, 2021 1:29 pm This post is only about home ownership of your primary residence. Rental properties take on additional risks.

I think homeownership outperforms a traditional investment portfolio, by reducing volatility and better matching returns to expenses, but I would love to hear other people's math based arguments for or against it.
I will use my personal home math for this argument, but would love others to chime in with their math as well.

My home is fully paid for, and I could sell my home for $168,000 and rent a comparable place for $16,000 a year.
Owning a home has some extra costs versus renting though, which come out to $5,700 per year for me.
So, the difference between owning and renting is that owning costs me $10,300 less per year.

We often talk about retiring with 25x expenses (4% SWR) or 30x expenses (3.33% SWR) for the more conservative amongst us.

If I had that extra 10.3K per year in expenses, then in order to retire with a 30x saving multiplier, I would need 309K in extra investments to cover that expense.
If I wanted to retire with a 25x savings multiplier, then I would need 258K in extra investments to cover that expense.

So in terms of getting me closer to my retirement goal my paid off house is actually benefiting me by a lot more than I could sell it for.
If we use 30x expenses, than my house is reducing the need for retirement assets by 30x10.3K = 309K. 309K/168K = 1.84, so the house has 1.84x more value.
If my target was 25x expenses, then it would be 258K/168K for a 1.54X value of assets in investments at my asset allocation.



How can it outperform so much?
1. Any expense reduction is like creating tax free income.
2. Expense reductions lower risk.
3. The house adjusts perfectly with the cost of housing where I live thereby matching my assets with my expenses, and lowering volatility.
4. The house is yielding 6.13% (10,300/168,000), and is acting like a 6.13% tax-free zero risk bond, that also adjusts with inflation. The closest product to that is a 30 year TIPS, which currently yields 0.03% and isn't tax free, which is massive outperformance.
Only having to pay $168k for a house that rents for $16k a year seems in favor of owning. In the homes around here, which run significantly over that, rental rates seem to run close to mortgage+prop tax+insurance.

Are you factoring in all maintenance and renovation costs? Around here, where an average home is around $300k, a $168k home is really old, small and practically falling down.
59Gibson
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Re: The Unusual Retirement Math of Homeownership

Post by 59Gibson »

Having imputed rent at 5%+ in todays real estate mkt is nice diversification in retirement , rather then having to rely totally on mkt returns and rent prices not running away from you.
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Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

JBTX wrote: Mon May 10, 2021 6:48 pm Only having to pay $168k for a house that rents for $16k a year seems in favor of owning. In the homes around here, which run significantly over that, rental rates seem to run close to mortgage+prop tax+insurance.

Are you factoring in all maintenance and renovation costs? Around here, where an average home is around $300k, a $168k home is really old, small and practically falling down.
Yes, all costs are included.
It's 2BR townhome in a LCOL (but safe) area that is growing fast, with a lot of 6 figure jobs being added.
10.75 years ago, I paid 80K for it when the market was depressed from the financial crisis, and at the time comparable properties were renting for 9.6K/yr. (8.3 price-to-rent).
Since then, the home has risen to 168K and the rental value has risen to 16K/yr (10.5 price-to-rent).
That's a 7.1%/year increase in home prices and a 4.9%/year increase in rental rates.

During the last 10.75 years I have spent 61K on renovations, insurance, taxes, HOA dues, etc., which has averaged out to 5.7K/yr. That included a new HVAC system, new flooring, repainting, and a kitchen makeover.
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Re: The Unusual Retirement Math of Homeownership

Post by JBTX »

Patzer wrote: Mon May 10, 2021 7:54 pm
JBTX wrote: Mon May 10, 2021 6:48 pm Only having to pay $168k for a house that rents for $16k a year seems in favor of owning. In the homes around here, which run significantly over that, rental rates seem to run close to mortgage+prop tax+insurance.

Are you factoring in all maintenance and renovation costs? Around here, where an average home is around $300k, a $168k home is really old, small and practically falling down.
Yes, all costs are included.
It's 2BR townhome in a LCOL (but safe) area that is growing fast, with a lot of 6 figure jobs being added.
10.75 years ago, I paid 80K for it when the market was depressed from the financial crisis, and at the time comparable properties were renting for 9.6K/yr. (8.3 price-to-rent).
Since then, the home has risen to 168K and the rental value has risen to 16K/yr (10.5 price-to-rent).
That's a 7.1%/year increase in home prices and a 4.9%/year increase in rental rates.

During the last 10.75 years I have spent 61K on renovations, insurance, taxes, HOA dues, etc., which has averaged out to 5.7K/yr. That included a new HVAC system, new flooring, repainting, and a kitchen makeover.
If you had a mortgage it would be about $600. That would be about $13k total cash out, still less than $16k cost to rent, and that ignores future appreciation. Those numbers definitely favor ownership. Like I said, in many instances the rent is typically lower than total annual cash out costs of ownership.
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Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

Ben Mathew wrote: Mon May 10, 2021 3:20 pm
Patzer wrote: Mon May 10, 2021 1:29 pm 1. Any expense reduction is like creating tax free income.
2. Expense reductions lower risk.
3. The house adjusts perfectly with the cost of housing where I live thereby matching my assets with my expenses, and lowering volatility.
4. The house is yielding 6.13% (10,300/168,000), and is acting like a 6.13% tax-free zero risk bond, that also adjusts with inflation. The closest product to that is a 30 year TIPS, which currently yields 0.03% and isn't tax free, which is massive outperformance.
Generally agree with these points. I made some of these points in this thread: Renting vs Owning your Home.

#4 assumes 0% growth in the real price/rental rate of the house. Homes in LCOL areas seem to be priced for low or negative growth and homes in HCOL seem to be priced for high growth. You can disagree with the market's estimate of price growth in different areas. But the growth assumption will have a significant impact on the estimated rate of return.
That's a great post you put together Ben on Renting vs Owning, thanks for sharing.

#4 is assuming inflation indexed growth in house prices, since I am comparing to a TIPS, which is also inflation indexed.
I did this to make my post less about my home and more about the broader market, and so when comparing to a TIP, a home you live has absolutely insane outperformance.

I am in a LCOL area, with high growth due to a steady stream of 6 figure jobs being added in a few of the fastest growing industries in the US.
I have owned the home for 10.75 years and it has a 7.1% CAGR so far. That will probably slow down, but I doubt it will get slower than the CPI.
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Re: The Unusual Retirement Math of Homeownership

Post by international001 »

Thesaints wrote: Mon May 10, 2021 2:42 pm Well, 10.3k on a 168k capital is 6.13%. Furthermore, the 168k invested not only have to provide 6.13% yearly, but also match whatever appreciation (or depreciation) that particular home goes through. On top of all that, there is inflation to be matched; not the CPI-U, but the increase/decrease in rent.
People seem to miss the main point. 6.13% of *net* return for a house is an excellent investment.
Even if you assume you get 7% on stocks, SWR are lower than that. Even if you had a mix of bonds and portfolios, SWR are lower than 6.13%
Reason is that SWR protect you against bad markets (sequence of returns)

Your house is in essence a 6.13% SWR for the portion of the housing expense. So keep the house.

If I could buy a farm that would give me a constant 6.13% of its today value in groceries every year (at todays prices) I would buy it as well.
jsprag
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Re: The Unusual Retirement Math of Homeownership

Post by jsprag »

Thesaints wrote: Mon May 10, 2021 4:36 pm That's precisely the difference (and the issue). SWR does not assume capital is completely exhausted at the end of the period. Otherwise, it would be a very unsafe withdrawal ratio.
Safe withdrawal rate also doesn't require that you have any capital remaining and the end. It only requires that every period, including the last, not be less than zero.
Thesaints wrote: Mon May 10, 2021 4:36 pm There are two very different outcomes between the one in which the retiree has satisfied his housing needs and the one where he has satisfied his housing needs AND is left with a property.
They are, and I also articulated a third - one where the retiree has satisfied their housing needs AND is left with assets that significantly exceed the appreciated value of the property. There is safety in that also.

Here's the larger point: there's a lot of reasons why home ownership can be important, but "because it's the very best use of my accumulated capital" is one of the least compelling.

Follow-on question...
Suppose OP just inherited $168K in a TSM fund (he has no capital gains), and there's another house in the neighborhood selling for exactly that amount. Expected annual upkeep is $5.7k and the market suggests that $16k is a fair annual rent (net $10.3k). Housing in the area has appreciated an average of 7% annually over the last decade.

Should he unequivocally sell the TSM shares and buy the second home as a rental property?

I'd argue that no, it's not unequivocal. In fact it's far from certain that he (or anybody) is better off with their money in a house vs. other investments, and this is true whether it's the primary or secondary residence. The math is the same. It goes back to the basics - need, ability, and willingness to take risk.
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Re: The Unusual Retirement Math of Homeownership

Post by reader79 »

Many people become wealthy investing in stocks. Almost no one becomes wealthy by treating their home as an investment. If you want an extra $10k/yr, find a way to make more money rather than tying yourself down to an illiquid asset that will cost you thousands of dollars to sell. Here is a fun article that rains on the parade of home ownership: https://jlcollinsnh268650683.wpcomstagi ... nvestment/
VTI: 50%, QQQM: 30%, VO: 10%, VB: 10%
Scooter57
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Re: The Unusual Retirement Math of Homeownership

Post by Scooter57 »

Patzer wrote: Mon May 10, 2021 2:23 pm

Good call outs. I don't want to make this too much about myself, because I am trying to talk theory here, but this is a townhouse, so a lot of maintenance is handled by the community, so the risk is shared, and doesn't require a homeowner to deal with many of the potential maintenance issues.

This home is in a very hot area, has Google Fiber, and a CAGR of 7% over the last 10 years. While the CAGR is high, rent prices have also gone up just as much, so it's just matching the local housing market inflation.

Personally, the biggest risk you called out is if I am no longer able to do stairs at some point, since it is 2 levels. As an avid hiker/climber, I hope that is never the case.
Condos are the first kind of property to freeze up when real estate markets crashed. We rented for 5 years in a brand new, highly architected, luxury complex, with beautiful river views and upscale neighbors for a ridiculously cheap rent after the real estate crash of 1989 in Connecticut. The price of the condos had been cut in half within a few weeks, as that crash happened fast. When we moved out in 1994 the condos were still trading at that same low price. The few people who had bought in before the crash were trapped. Everyone else was renting.

You also can have problems where in a condo-type situation where the homeowner's group maintains the complex too may people get foreclosed on and the maintenance costs go way up for the remaining owners.

As far as the stairs thing goes, we all hope it isn't the case. But stuff happens. I am aware of this issue because my parents had to sell a wonderful home under pressure because my mom who had always been completely healthy became unable to climb the stairs in her early 80s.

Re: home price appreciation. We sold a house in Connecticut in 1989 in a red hot market for $184K. In 2015 houses like it in the same development were trading for only $207K. Realtor.com tells me that 1989 is the last time that house was sold and that right now in this red hot market the home would be priced around $250K. After the realtor's commission of $15K, the owner would make $235K on the sale. This works out to a profit of $51K, which works out to an annual price appreciation over 32 years of about 1.5%. However, that house is over 50 years old now and will have needed a lot of work over that 32 years. It was costing us at least $500 a year in maintenance when we lived there. That house had been in comfortable commuting distance to a huge number of high paying professional jobs that were outsourced overseas in the 1990s.

So no, you can't count on robust price appreciation.
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

jsprag wrote: Tue May 11, 2021 12:03 am Follow-on question...
Suppose OP just inherited $168K in a TSM fund (he has no capital gains), and there's another house in the neighborhood selling for exactly that amount. Expected annual upkeep is $5.7k and the market suggests that $16k is a fair annual rent (net $10.3k). Housing in the area has appreciated an average of 7% annually over the last decade.

Should he unequivocally sell the TSM shares and buy the second home as a rental property?

I'd argue that no, it's not unequivocal. In fact it's far from certain that he (or anybody) is better off with their money in a house vs. other investments, and this is true whether it's the primary or secondary residence. The math is the same. It goes back to the basics - need, ability, and willingness to take risk.
Unequivocal, no.

But, IF he would have a 3-4% SWR on those funds, and he wants to live in a house like that for a long time, THEN probably yes, he should live in the FIRST home. But not necessarily buy the second, because it isn't going to have the same feature of him being his own tenant.

That isn't the math you are using, because you are not assuming he is the tenant, and you are further making assumptions inconsistent with the assumptions that lead to a SWR of only 3-4%. But if you assume he is the tenant, and you accept the assumptions behind a SWR of only 3-4%, then even 4% of $168K is only $6,720, which is not enough to make up the $10,300 difference between the expenses he can cover ($5,700) and the rent ($16,000).

Again, you are arguing if he assumes a long-term return on TSM that is far higher than 4% or indeed 7%, then at the end of that long term an investment in TSM will have returned more than investing in this home. Which is true, given those assumptions. But in that model, you are not making the same assumptions that lead to SWRs of only 3-4%, which combine withdrawals with possible ranges and sequences of returns on stocks, none of which you are accounting for.

So the math very much does depend on whether it is a primary residence or a rental property, in the context of a SWR analysis.
Last edited by NiceUnparticularMan on Tue May 11, 2021 6:33 am, edited 2 times in total.
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

secondopinion wrote: Mon May 10, 2021 6:24 pm
NiceUnparticularMan wrote: Mon May 10, 2021 6:17 pm
secondopinion wrote: Mon May 10, 2021 6:08 pm
rich126 wrote: Mon May 10, 2021 4:52 pm This will apply to very, very, few people here (and maybe no one) but home ownership and passing it on to the next generation is a huge thing in low income families.

I'm currently in a very low income, largely hispanic neighborhood in Arizona and many of them certainly could not afford homes now but their parents or grandparents bought a place many years ago and subsequent generations grew up and continue to live in the home. Sometimes the homes are kept very nice and unfortunately some aren't (literally look like a junkyard). In some cases they will do a tear down and rebuild on the same land since that can be cheaper than buying a place elsewhere.

Personally I think owning a home is a good idea since while you have to do maintenance, you don't have to worry about increasing rents. You have a stable place where you usually have friends. I don't currently own a place but certainly hope to do so again once the current craziness calms down.
Passing down real estate is a strong argument, and it applies despite income. I think too few even think about it.
So if you can comfortably manage a SWR of 3 to 4%, including covering rent in a desirable area, odds are you are going to leave a substantial estate.

Having some chunk of that portfolio in a home instead might work out better for your heirs, but it easily might not.

In other words, investing your future heirs' money in a single, undiversified, unleveraged residential property is probably not a best practice in general. But it of course might be the main part of an estate anyway, due to making the most sense during the life of the original owner.
I am more talking about the multigenerational homes... It saves a lot of money.
If you mean multiple generations living in one home, that can certainly be true!

I was more just disputing the math behind the idea that if, say, the grandparents had invested in diversified stocks rather than paying off a home a long time ago, and the parents had done the same, the grandchildren would be worse off inheriting that stock portfolio than the home.

That's very likely wrong in most markets, and in some markets it wouldn't have been remotely close.

But, of course, there are practical reasons why that hasn't happened in many families, that they have ended up invested in homes rather than stocks. And in those cases, it is obviously true the home ends up the main way wealth is passed on to the next generation.
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Re: The Unusual Retirement Math of Homeownership

Post by Zeno »

deleted
Last edited by Zeno on Sun May 16, 2021 4:14 pm, edited 1 time in total.
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Patzer
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Re: The Unusual Retirement Math of Homeownership

Post by Patzer »

jsprag wrote: Tue May 11, 2021 12:03 am Follow-on question...
Suppose OP just inherited $168K in a TSM fund (he has no capital gains), and there's another house in the neighborhood selling for exactly that amount. Expected annual upkeep is $5.7k and the market suggests that $16k is a fair annual rent (net $10.3k). Housing in the area has appreciated an average of 7% annually over the last decade.

Should he unequivocally sell the TSM shares and buy the second home as a rental property?

I'd argue that no, it's not unequivocal. In fact it's far from certain that he (or anybody) is better off with their money in a house vs. other investments, and this is true whether it's the primary or secondary residence. The math is the same. It goes back to the basics - need, ability, and willingness to take risk.
I would argue no as well, because as a landlord to a tenant, you have to pay taxes on that income and you have risks like the property going unrented or the tenants causing untold damages.

The math is not the same.
Reduced costs, don't result in taxes. Collected rent does.
A homeowner living in their primary residence has a 0% risk of having unrented months.
A homeowner living in their primary residence controls whether or not the damage the property.

My argument is not for real estate ownership in general as a better investment than stocks/bonds, but that real estate ownership for your personal residence if often a better choice, especially in the context of comparing it to a SWR of an investment, which is effectively what a renter is doing.
A renter to meet their SWR usually needs a lot more in investment assets to cover the cost of renting than they would need if they just bought a property.
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Re: The Unusual Retirement Math of Homeownership

Post by bonglehead »

Not sure if someone has already mentioned this but in some places, the property tax is reduced significantly for retirees so that also tilts the balance in the favor of home ownership in retirement
NiceUnparticularMan
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

Patzer wrote: Tue May 11, 2021 8:11 am
jsprag wrote: Tue May 11, 2021 12:03 am Follow-on question...
Suppose OP just inherited $168K in a TSM fund (he has no capital gains), and there's another house in the neighborhood selling for exactly that amount. Expected annual upkeep is $5.7k and the market suggests that $16k is a fair annual rent (net $10.3k). Housing in the area has appreciated an average of 7% annually over the last decade.

Should he unequivocally sell the TSM shares and buy the second home as a rental property?

I'd argue that no, it's not unequivocal. In fact it's far from certain that he (or anybody) is better off with their money in a house vs. other investments, and this is true whether it's the primary or secondary residence. The math is the same. It goes back to the basics - need, ability, and willingness to take risk.
I would argue no as well, because as a landlord to a tenant, you have to pay taxes on that income and you have risks like the property going unrented or the tenants causing untold damages.

The math is not the same.
Reduced costs, don't result in taxes. Collected rent does.
A homeowner living in their primary residence has a 0% risk of having unrented months.
A homeowner living in their primary residence controls whether or not the damage the property.

My argument is not for real estate ownership in general as a better investment than stocks/bonds, but that real estate ownership for your personal residence if often a better choice, especially in the context of comparing it to a SWR of an investment, which is effectively what a renter is doing.
A renter to meet their SWR usually needs a lot more in investment assets to cover the cost of renting than they would need if they just bought a property.
Just to get somewhat philosophical for a moment, I think part of the disconnect here is really we are not talking about something on the investment side, we are talking about something on the expense side.

In a SWR context, substantially reducing the cost of consuming an equivalent good or service over a long period of time is very powerful financially, precisely because of how it leverages up through the standard SWR ratios in question. And we should rationally be willing to take some money out of our investment portfolios in order to pay up front for things which will predictably reduce our long-term expenses by substantial amounts. And thinking of that as an alternative "investment" of our portfolio rather than as redirection of capital from "investment" to "expense reduction" is only likely to lead to errors in evaluating how much capital we should spend on such expense reductions.

By way of analogy, I would suggest this is sort of like things we can buy that predictably increase our long-term income during our working years. For example, we might be looking at the cost of the education necessary to get a lucrative professional career. That definitely has financial implications, and people can (and have) tried to understand that through the lens of an "investment in human capital" or some such term. But really, "investing in your human capital" in that way requires a pretty different sort of analysis than conventional retirement portfolio investment analysis, and it is probably doing more harm than good to try to analyze it through such a lens.

Long story short, I don't mean to suggest owning a home is always the right move for a retiree in financial terms. Rather, I am just suggesting it MIGHT be, and a good start on answering that question is to think of it in terms of how it will affect your expenses. And if the expected marginal reduction in your long-term expenses is larger than the marginal reduction in your income at your SWR, then it might well have substantial financial benefits.
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Re: The Unusual Retirement Math of Homeownership

Post by jsprag »

Patzer wrote: Tue May 11, 2021 8:11 am
jsprag wrote: Tue May 11, 2021 12:03 am Follow-on question...
Suppose OP just inherited $168K in a TSM fund (he has no capital gains), and there's another house in the neighborhood selling for exactly that amount. Expected annual upkeep is $5.7k and the market suggests that $16k is a fair annual rent (net $10.3k). Housing in the area has appreciated an average of 7% annually over the last decade.

Should he unequivocally sell the TSM shares and buy the second home as a rental property?

I'd argue that no, it's not unequivocal. In fact it's far from certain that he (or anybody) is better off with their money in a house vs. other investments, and this is true whether it's the primary or secondary residence. The math is the same. It goes back to the basics - need, ability, and willingness to take risk.
I would argue no as well, because as a landlord to a tenant, you have to pay taxes on that income and you have risks like the property going unrented or the tenants causing untold damages.

The math is not the same.
Reduced costs, don't result in taxes. Collected rent does.
A homeowner living in their primary residence has a 0% risk of having unrented months.
A homeowner living in their primary residence controls whether or not the damage the property.
Fair points, and well-stated. Don't forget, however, that you're renting that second home for $16k annually but only pocketing $10.3k of that. There's already $5.7k in the budget for taxes, repairs, and vacancies. And let's not pretend that home ownership doesn't have significant risk as well.

Further, remember that your threshold is only beating the equivalent SWR. With this metric, you could pocket just $6.72k annually (25x $6.72k = $168k) from the rental home and still fulfill your criteria for smart use of capital. That leaves $9.28K per year for taxes, upkeep, and vacancies. That can underwrite a lot of risk, plus you've got that 7% housing market appreciation working for you on two homes.
Patzer wrote: Tue May 11, 2021 8:11 am My argument is not for real estate ownership in general as a better investment than stocks/bonds, but that real estate ownership for your personal residence if often a better choice, especially in the context of comparing it to a SWR of an investment, which is effectively what a renter is doing.
Here's the central point I see from your OP:
1. I have an asset
2. I can employ this asset to reliably reduce my expenses
3. If I do so, my expenses are reduced by at least 1/25th of the value of the asset
4. Therefore, this is the best way to employ my asset

If true, then the conclusion should hold no matter if the asset is one we already own or could buy. Or if it's a home or mutual fund shares. Or if we're reducing expenses or providing after-tax (or tax-free) income. Or if it's a primary home or a second home. What is it mathematically that makes this often true for a primary residence but sometimes/rarely/never true for other assets?

Despite appearances, I generally agree that owning your primary residence is a worthwhile goal. Even if not optimal, it's desirable nonetheless for the legal protections afforded to primary residences, as a hedge against financial and non-financial risks, and the peace of mind and quality of life associated with somewhat greater control.
surfstar
Posts: 2853
Joined: Fri Sep 13, 2013 12:17 pm
Location: Santa Barbara, CA

Re: The Unusual Retirement Math of Homeownership

Post by surfstar »

C. Whatever mental / gymnastic math that lets you sleep well at night with your decision.

This is always the correct answer for multiple choice questions. "When in doubt, C-it out."
NiceUnparticularMan
Posts: 6103
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Re: The Unusual Retirement Math of Homeownership

Post by NiceUnparticularMan »

jsprag wrote: Tue May 11, 2021 2:50 pm
Patzer wrote: Tue May 11, 2021 8:11 am
jsprag wrote: Tue May 11, 2021 12:03 am Follow-on question...
Suppose OP just inherited $168K in a TSM fund (he has no capital gains), and there's another house in the neighborhood selling for exactly that amount. Expected annual upkeep is $5.7k and the market suggests that $16k is a fair annual rent (net $10.3k). Housing in the area has appreciated an average of 7% annually over the last decade.

Should he unequivocally sell the TSM shares and buy the second home as a rental property?

I'd argue that no, it's not unequivocal. In fact it's far from certain that he (or anybody) is better off with their money in a house vs. other investments, and this is true whether it's the primary or secondary residence. The math is the same. It goes back to the basics - need, ability, and willingness to take risk.
I would argue no as well, because as a landlord to a tenant, you have to pay taxes on that income and you have risks like the property going unrented or the tenants causing untold damages.

The math is not the same.
Reduced costs, don't result in taxes. Collected rent does.
A homeowner living in their primary residence has a 0% risk of having unrented months.
A homeowner living in their primary residence controls whether or not the damage the property.
Fair points, and well-stated. Don't forget, however, that you're renting that second home for $16k annually but only pocketing $10.3k of that. There's already $5.7k in the budget for taxes, repairs, and vacancies. And let's not pretend that home ownership doesn't have significant risk as well.

Further, remember that your threshold is only beating the equivalent SWR. With this metric, you could pocket just $6.72k annually (25x $6.72k = $168k) from the rental home and still fulfill your criteria for smart use of capital. That leaves $9.28K per year for taxes, upkeep, and vacancies. That can underwrite a lot of risk, plus you've got that 7% housing market appreciation working for you on two homes.
Patzer wrote: Tue May 11, 2021 8:11 am My argument is not for real estate ownership in general as a better investment than stocks/bonds, but that real estate ownership for your personal residence if often a better choice, especially in the context of comparing it to a SWR of an investment, which is effectively what a renter is doing.
Here's the central point I see from your OP:
1. I have an asset
2. I can employ this asset to reliably reduce my expenses
3. If I do so, my expenses are reduced by at least 1/25th of the value of the asset
4. Therefore, this is the best way to employ my asset

If true, then the conclusion should hold no matter if the asset is one we already own or could buy. Or if it's a home or mutual fund shares. Or if we're reducing expenses or providing after-tax (or tax-free) income. Or if it's a primary home or a second home. What is it mathematically that makes this often true for a primary residence but sometimes/rarely/never true for other assets?

Despite appearances, I generally agree that owning your primary residence is a worthwhile goal. Even if not optimal, it's desirable nonetheless for the legal protections afforded to primary residences, as a hedge against financial and non-financial risks, and the peace of mind and quality of life associated with somewhat greater control.
So the little I know about renting houses I learned when being executor of my father's estate, because he had put together a small collection of rental homes in retirement, in the aftermath of the housing bubble bursting. After he passed, I wound up that business and eventually sold off all the properties, but we operated it for a while, and I also went over his records.

And I think the practical context of such a business is you typically cannot assume 30 years of steady real appreciation returns, nor steady positive cash flows, year after year. Part of why the cash flows are not necessarily always positive is often in a real such business, you have some sort of financing. But, also, things happen--you DO have extended periods of non-paying tenants that take a long time to resolve. Increasing rents can cause issues with tenants. There is some sort of serious damage caused by a tenant that you have to fix. Eventually to keep getting market rents, you have to pause for significant upgrades. You can get sued by tenants! And on and on.

So I really think you are not properly accounting for what is so different about being your own tenant, and not having to count on any real appreciation return. You never don't pay your virtual rent on time. You also don't complain about deferred maintenance, lack of upgrades, virtual rent increases, or so on. You don't ever sue yourself! And since the entire return you need for your expense-reducing purposes is the virtual rent avoidance, what happens any given year, or even overall, with real appreciation is not something you need to worry about.
calwatch
Posts: 1447
Joined: Wed Oct 02, 2013 1:48 am

Re: The Unusual Retirement Math of Homeownership

Post by calwatch »

There is a risk you could be in a less desirable market. Places like Detroit, St. Louis, Cleveland, Buffalo, etc. have had housing prices going downhill for decades. Larger Sun Belt cities like Houston, Las Vegas, Phoenix, etc. tend to sprawl and so their homes lose value as people gravitate toward the new shiny thing. There is a back to the city movement happening in some areas but 30-50 year old homes in those cities are uniformly unloved. Not so in California where my now 70 year old home continues to increase in value.

The other "unusual" math is the ability to go negative on the home and not get evicted, through reverse mortgages and low income property tax postponement (available in most states). Certainly, one hopes to never be in a situation where their income is low enough to use property tax postponement, but it is available, and that thing doesn't exist for renters.
ajcp
Posts: 719
Joined: Fri Dec 13, 2013 5:44 pm

Re: The Unusual Retirement Math of Homeownership

Post by ajcp »

It's a very simple answer. A 4% withdrawal rate is conservative, the point is to be okay even if your retirement market is among the worst possible times in history. According to firecalc, a retiree with a strict 4% withdrawal rate would have died with more money than they started with.

Landlords follow a similar idea, they need to account for some amount of vacancy and problem tenants to make sure it's still worth their while. If the numbers only work when you assume an ideal long term tenant, rents would be cheaper, but landlords who didn't get that would lose out big time. You're paying a bit more for that risk, but as a homeowner you get that guarantee that your tenant is a good one. You're guaranteed an above average outcome on tenant luck, but with 4% you're staying safe for a very below average outcome on market luck.
brian91480
Posts: 683
Joined: Fri Jan 29, 2021 6:44 pm
Location: Minnesota

Re: The Unusual Retirement Math of Homeownership

Post by brian91480 »

bonglehead wrote: Tue May 11, 2021 8:57 am Not sure if someone has already mentioned this but in some places, the property tax is reduced significantly for retirees so that also tilts the balance in the favor of home ownership in retirement
I did not know this. Thank you for sharing! I will have to investigate if this is true where I live. 😀👍
hiduplex
Posts: 99
Joined: Sat Jan 19, 2019 10:04 am
Location: IA

Re: The Unusual Retirement Math of Homeownership

Post by hiduplex »

Nohbdy wrote: Mon May 10, 2021 6:03 pm Do the calculations above consider the tax flexibility awarded by having a reduced cost use asset?

For example say OP has a paid for home, a tax deferred account, and a taxable account. Say the market tanks and OP want to let equities ride in tax deferred. OP would be in a better position to sell assets in taxable while incurring reduced capitol gains (because reduced necessary taxable income, by having no rent). If staying at home lockdown style, maybe it’s even possible (depending on other specifics) to reduce your tax rate to zero for capitol gains, qualify for subsidized healthcare, tax credits, etc.
I feel that the value of a paid off homestead is something that people really undervalue. I only own one piece of real estate and it's a duplex that I live in one side and rent the other out. I got a good deal on the property and the rental income is enough to cover a majority of my meager expenses.

One of the other ways you can measure value is the properties bankruptcy exemption. In the state of Iowa where I live they have no dollar limit on how much real estate your homestead can be worth it's just based on an acre limit and it has different amounts for urban or rural homesteads In the urban/city limits it's an acre that you can keep. I checked with a bankruptcy lawyer and my duplex would count as one homestead.

You can't live in your 401k or your stock portfolio even if it pays dividends it's not a roof over your head. Stock prices and dividends ebb and flow. The value of keeping a roof over your head it's pretty hard to put a price on that especially if you buy in a low cost of living area and are able to pay it off rapidly.

I have a chronic health issue and my health's been declining since I was 25 years old that was also around the same time I bought the duplex. I was able to have the duplex paid off in my early 30s. I'm glad it's owned out right.
I ended up in the ICU on a ventilator earlier this year it was non-covid-related. It did tie into my chronic illness.
I ended up losing my job, selling my car, and losing my health insurance in the whole process. I did not apply/get unemployment or social security disability. The thing that really benefited me was getting Medicaid. I have a medicine that costs $1,000 a month and there's no generic for it at this time. I don't have to pay anything for that medicine now and that's helped me a lot. Also being on Medicaid opens a lot of other subsidies and discounts.

I believe in diversification...
I have over 100k in IRA accounts both Roth and traditional. I have been investing in the market since I was a teenager and got my 1st job. I also have a small taxable stock portfolio.
I have a paid off duplex worth around 100k.

I'm going to do a post on the economics of Medicaid and very low cost living at some point here if anyone is interested.
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