I’ve long been an advocate for small living, especially when it comes to housing. Nothing stunts your financial growth more than the “American Dream.” Building wealth (especially while young) is all about opportunity costs and cash flow, both of which are negatively affected by going large on your home. Also with reports coming out saying Americans are spending too much on housing (even with record low interest rates), it seems likely we’re heading for some sort of stagnation or even correction in the housing market.
Which leads me to why I put a bid on a 1 bedroom house last night. The bid, $95k (they cover closing). I’m hoping for a counter of $100k.
See, I’m the first to realize the negative effects of buying a 1 bedroom house, but this house checks too many check boxes to ignore.
The House is Extremely Affordable
Assuming 2.0% Housing appreciation, 2.0% Inflation, 1% Purchase Price Costs in Maintenance, and 7% Selling Costs, the cost to own looks like the chart below. Now it might seem a little strange for me to use 2.0% housing appreciation while bearish on the market, but for all intents and purposes 2.0% is roughly inflation (meaning no gain except via inflation/leverage). If the market performs worse than 2.0% (very possible), than owning a small house will mitigate me tremendously versus buying a larger house. Take a look and note the Year 2-5’s bottom yellow line, which represents how much it would cost to own per month including realtor fees to get out (selling costs). Also note that I have assumed I will deduct nothing from this house because it is too small, however in reality it’s possible a minimal amount might make me itemize eligible (until married). I do however receive a tax benefit of roughly $130 a month that deals with living in a city with no income tax.
So if I sold the house after Year #4, it would have been approximately $464 a month to own. Cost to rent a similar home is $850 – $1,000. So I come out roughly $400 – 500 a month ahead.. but there more to this decision that just that amount.
Low Consumption / Staying Frugal and Minimalist
Sure I come out $400-500 ahead a month via the house, but let’s also talk about the savings via not buying piles of stuff. An amount that could easily be another $400-500 a month or more. It would be hard to put a lot of money into this house unless you just went plain stupid, there’s literally no where to put it unless you add an addition.
Let’s also note that the first $400-500 a month assumed that you ate the costs of selling it ($7,729 in year #5) to still come out $400-500 ahead. Converting to a rental (and not eating the seller costs) would make it even more beneficial per month (going back to the top yellow line).
There is also less utility consumption, meaning another $75-100 a month via utility savings.
Suddenly the financial benefit becomes clearer, very possibly over $1,000 a month.
Can we talk about what $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.
Pro’s of the House
Besides forcing us to focus on quality over quantity, the house itself is in very good condition compared to what we have seen. Furnace, A/C, Roof, Windows, Bathroom, and most flooring is under 10 years old (majority are around 6 years old).
The house is landscaped very well and is relatively “cute.” The house has a driveway and a garage, something that not every house in this neighborhood has. Oh and did I mention it has a large lot? See I’m looking to do some side hustle via agriculture (more to come on this later), and I would love to have a decent amount of land to work with. It’s hard to find large cheaper lots because I want to live in one specific neighborhood. A neighborhood that tends to be extremely pricey for most houses even with small lots (300k+). So how much land does this house have? Roughly an acre. More to come on how I plan on using that acre in a later post.
The room sizes are good, which is rare for this neighborhood. This is a critical element to why the house is even on the table. The house is basically 5 rooms, a large living room, a large dining room, a medium size kitchen, an average bathroom, and a relatively large bedroom. The square footage is almost 1000 square feet dead on. It does have a little patio and deck area as well. Oh it also claims to have a 2nd bedroom in the basement, but the floor isn’t finished and the ceilings are about 6.5 feet. I don’t consider it liveable myself, maybe hobby rooms.
This house also could easily be rented, likely for a profit. Although I’m not huge on the idea of becoming a landlord, it’s likely this house would add about $6-8k of net worth a year via cash flow, appreciation, deduction, equity, and so forth. I’m relatively conservative in my numbers and something would have to go very very badly to cross under break-even. It’s possible, but remember the carrying costs are very low.
Most important to us though, it’s the neighborhood we want, or at least we think we want. See that’s the killer with any real estate, especially in an area you haven’t lived in long-term, you don’t know if it’s a long-term fit right away. This house allows us to “dip a toe in” and see if it’s a good fit while financially benefiting. Surprisingly, even houses we’ve seen in the 200-250k range still need work (some could easily “absorb” a quick 30-50k of updates/repairs). Buying a $250k house just makes no sense to me at this point. I want to own, but every time I run numbers for the larger house with larger utilities, maintenance costs, taxes, and rooms to fill with stuff and updates/upgrades, it doesn’t feel right. Not to mention the risk.
Con’s of the House
This should be relatively obvious, but let’s go over them. It’s 1 bedroom (because I don’t think the basement concrete floor bedroom is a bedroom) and 1 bathroom.
Children will force your hand in moving out or adding an addition. Whenever you have a kid, this house is no longer viable. Sure you could have a baby in your bedroom with you, but the birth of your child is likely the start of the quick death of your home. I will say that in my Area it’s roughly $100 sq/ft to add to your home, but I don’t think it’s viable unless you go all the way. You likely would want to add 2 bedrooms and 1 bathroom more off the back. Bathrooms would also likely add more complexity to the cost meaning you could easily have $50-60k in this idea, and it’s likely it would only add $30-$40k of value. Meaning it could be a $20-30k “loss,” to keep the home viable for a family. Although, in theory, it’s added $70k of net worth to you if this is year #5.
The Fear Factor
Now some people (like realtors) might make the argument that you will be priced out of a neighborhood if you wait, but as I said before, I’m not particularly bullish on housing. How is that $250k house going to be worth $290k (3% appreciation for only 5 years) if interest rates also increase? I’m not saying the market will not go up at all, but I just don’t see people paying $40k more plus an extra $2,900/yr in interest (1% rate interest) at the same time (after only 5 years). In my mind something either has to give or we have to stagnate.
So what do you think, is this a reckless decision? Pictures to come after closing (hopefully).