So it looks official, I’m buying a 1002 square foot, 1 bedroom / 1 bathroom home for about $100k. I’ve already talked about the potential worst case situation in a previous article, but now it’s time to assess the financial best case scenario for this house.
Of course, I could change the housing appreciation rate assumption, which would effectively make this house look like a rock star. But I refuse to do that. The reason why is pretty simple. I’m fairly bearish on the housing market the next 5 years or so in the US. Don’t get me wrong, I’m not calling for a 30% correction, although I could easily see material correction in US housing prices. It’s a largely subjective and speculative matter. So with that, I’m going to stick to my guns here at just 2.0% a year.
So what is the best case scenario in my mind for a five year picture? Well it’s possible I will turn this place into a rental, but I think it’s more likely I would just move on from the house. What I hope for is, the house appreciates 2% a year, I sell the house myself (incurring only about 1% in transaction costs), and it looks something like this:
Total net cost per month of roughly $294/month (Year #5 sold FSBO). That’s about $600/month under what it would pay to rent this place. Do note that I assumed that I got no tax deduction via property taxes and interest (although I would get them while single, I would potentially be marriage penalty out of the tax benefits). It also assumes I received a tax benefit of $130/month for living in a city with no income tax. For a lot of people, it would be reversed (you might have a deduction, but no city tax benefit) with the same net tax benefit.
Previously I also discussed there are two other financial benefits as well. The first is your utility bills should in theory be fairly low. This house should be roughly $50 a month less than a 1600-ish square foot house. I hope to improve that to close to $75-100 a month (Large gains to be had via programmable Thermostat, Caulk, and CFL/LED Lights). The second financial benefit is not having room to buy stuff. I believe you can easily see $400-500 a month less in spending, especially when amortizing large purchases such as furniture ($12k of furniture would be $200/month alone over 5 years for instances).
So what’s the total savings? $600/month less than renting, $450 to $550 less a month in spending. Now of course not all of the $600/month less than renting is via cash flow in the first five years, but the point is that is it roughly $1,000/month cash flow difference. Recapping the first article:
“$1,000 a month ends up being after just 5 years compounded at 8%? It’s a mind blowing $73,967 ($60,000 if no return, $66,520 if you put savings into mortgage at non-deductible 4%). Meaning you could in theory have about $66.5-$74k more in net worth after only 60 months of owning and then selling the house.
If you add nothing to that $73,967 amount in Years 6-15 and only allow the 8% compounding, it would be $164,180 at the end of Year #15. Really reflect on that for a minute, that’s basically 5 years of “living small” resulting in $164k after just 15 years. That’s also not including the fact that if the property turned into a rental, it’s likely to add additional increases to net worth via appreciation, deduction, cash flow, and avoiding the roughly $8k in selling costs). In other words, that +$164k after 15 years has priced you selling after your 5th year.”
There is one final thought about the best case scenario day dream. Let’s imagine housing prices actually fall 2% a year instead of go up 2%. That $1000-$1,100-ish a month savings would be reduced by about $300/month (or about $18,000 + returns if present, over the 5 years), but that kind of would be a good thing, potentially.
That $100k house you bought is likely not to get hit as hard as a large house would percentage wise, but let’s assume for argument sake that it does. It’s time to think about that $250k house you could have bought instead in Year #1. That $250k house devalued 2% a year, and is now about 10.4% cheaper (or more). Meaning if you were to sell your small house in year #5 and buy that $250k house, you would actually likely save $25,000+ on the purchase price. Once again, it’s likely the difference is actually even greater since the small house likely got hit less and the large house got hit more. In other words, if you do decide to size up later for family, you stand to gain from market trouble.
Take a more extreme perspective to illustrate this point. Let’s say housing prices drop 30%. You eat a $30,000 loss on your small house, but can potentially buy that $250,000 house for $75,000 less. That’s a massive gain (above all of the other gains you have from the small house).
As you can probably tell, I’m pretty excited for this decision.