RPF_0009_-_Why_Your_House_is_a_Terrible_Investment_-_Interview_with_James_Collins_from

00:00:00.000 | Joshua Sheets, TMZ Foundation Welcome to the Radical Personal Finance

00:00:04.120 | Podcast. I'm your host, Joshua Sheets. Today's show is certain to be challenging,

00:00:11.120 | controversial and I hope appropriately radical. Our topic today is real estate and we'll be

00:00:18.320 | discussing why your house is a terrible investment, how to do a proper rent versus own calculation

00:00:25.240 | and other wealth building topics with our special guest, James Collins. James got his

00:00:30.320 | start selling flyswatters door to door and picking up empty pop bottles from the side

00:00:34.440 | of the road at eight years old. Since then, he's earned his living as a soda jerk, bus

00:00:38.920 | boy, a dishwasher, an order puller, a grocery bagger, a stock clerk, a produce clerk and

00:00:43.320 | a gas station pump jockey, a mail clerk, ground man for a tree crew, landscaper, ad agency

00:00:48.760 | founder, account executive, ad space salesman, investment officer, entrepreneur, consultant,

00:00:53.800 | sales trainer, speaker, writer, radio talk show host and a publisher.

00:00:58.680 | Today he is officially retired, sort of, but from time to time he shares his wisdom with

00:01:05.680 | the world over at JLCollinsNH.com in addition to sitting on a couple of corporate boards

00:01:11.720 | for small entrepreneurial companies that he finds interesting. James, welcome to the Radical

00:01:17.400 | Personal Finance Podcast. James Collins, Jr.

00:01:19.320 | Thank you, Joshua, but I got to say that sounds like a guy who can't hold a job.

00:01:24.320 | When I went and read your about page I couldn't resent because you did such a good job on

00:01:28.120 | there. That is a great list. It was kind of my life flashing before my

00:01:32.280 | eyes. I figured it out one time. I had, someday I

00:01:37.360 | got to make that list for myself because I think I had like 20 jobs or something like

00:01:42.960 | that by the time I was in my 20s and anyway I got to go and like count them all up sometime

00:01:48.080 | but it's so fun to do that and see all the different experiences.

00:01:50.400 | Well, it is kind of fun and of course when you do that you think back on them and I can

00:01:56.640 | honestly say with maybe one or two exceptions I like doing them all.

00:02:03.640 | Well, that's good. So today I'm excited to have this interview with you. I think it's

00:02:10.640 | going to be fun. We're going to attack the American religion of home ownership which

00:02:16.000 | I'm excited to do. Oh goody, I'm going to get in trouble with

00:02:21.120 | some more people now. Exactly. So we'll get into that in just a second

00:02:25.800 | though. Before we do, give the audience just a quick background on you, kind of your history

00:02:32.160 | in addition to what I just shared and specifically how did you get interested in the topics of

00:02:37.480 | money and personal finance? Well, that's a great question. I think actually

00:02:43.920 | I've probably been interested in that since the very beginning. I mean, anybody who picks

00:02:49.120 | up pop bottles on the side of the road when they're eight is obviously interested in money.

00:02:53.400 | I got a two cent, in those days pop bottles had a two cent deposit on them. So I was making

00:03:01.080 | nickels and dimes but I guess I've always liked earning money and at some point I discovered

00:03:08.360 | that my money could earn money. That was a real eye opening experience and of course

00:03:16.000 | that's a route to financially independent and being financially independent and being

00:03:22.120 | much more able to pick and choose what kind of work if any you want to do at various points

00:03:27.120 | in your life. So once I discovered that then the whole world

00:03:31.640 | of investing opened up to me and I started exploring that and making mistake after mistake

00:03:37.920 | after mistake. And so when I write my blog and I talk about the various concepts that

00:03:45.080 | I have behind the way, I look at investing, index funds being the core example. I probably

00:03:51.960 | come to that by making mistakes in investing and all the other things. I mean, when I hear

00:03:57.120 | people arguing about index funds, I will argue against them. I hear myself 25 years ago.

00:04:03.960 | I know those arguments I used to make. So yeah, that's kind of how it started and developed.

00:04:12.720 | >> I know you write a blog on varied topics and you've got a lot of interesting things

00:04:19.720 | that we could talk about but I want to talk about your favorite essay or excuse me, my

00:04:24.240 | favorite essay on your blog. And I don't know what your favorite is but this one is my favorite.

00:04:30.840 | >> And the one you picked by the way is also the one that has proven to be most controversial

00:04:36.800 | and got me the most hate. >> Good.

00:04:39.800 | >> Easy for you to say. Fortunately, most of that hate has occurred on forums other

00:04:48.000 | than my blog. My readers are a much more civil group by and large but not that they necessarily

00:04:57.680 | agree with me all the time but they are civil in the conversation. But I've had other forums

00:05:05.240 | pointed out to me where that's not so much the case.

00:05:09.360 | >> Yeah. Well, the tone that I hope that my show has as time goes by is that it's just

00:05:15.320 | to look at facts and not come with a bias that this is the right way or that's the right

00:05:20.480 | way but look at facts and look at individual situations. And what I love was that this

00:05:25.160 | essay that I'm about to read really did a good job of kind of laying out some facts.

00:05:32.540 | And so in the right situation, different people are going to make different choices. And I

00:05:36.400 | think that after we read the essay, we'll talk about that because you've made different

00:05:39.640 | choices as time gets on over the years. But I think this is going to be a really valuable

00:05:45.040 | tool for people who are considering buying houses, renting houses and to give them some

00:05:50.520 | confidence that they can make their own decision based upon what their goals are. So what I'm

00:05:56.280 | going to do is since I've got the author here with your permission, I'm actually going to

00:05:59.760 | read your essay. I've read this essay at least half a dozen times to friends and family members

00:06:05.760 | so that's how compelling that I think it is. And then we'll talk about it. So anything

00:06:10.920 | you want to add before I read it though?

00:06:12.840 | >> No. I mean, the only thing I would say is that as you're going to read it and I think

00:06:17.960 | one of the reasons that it drew some negative response from some corners is that in and

00:06:23.680 | of itself it makes it sound like I think that nobody should ever own a home under any circumstances.

00:06:30.440 | And there are other, and I know we're going to talk about this, there are other posts

00:06:33.560 | on the blog that talk about one being roots and wings where home ownership is, home ownership

00:06:41.200 | is a very personal decision and it's not just a financial one. So the essay you're about

00:06:45.960 | to read is based on looking at it just as a financial tool, as an investment alone,

00:06:53.760 | taking out any of the other considerations. And maybe when you're done I'll explain why

00:07:00.160 | I think that's a useful exercise.

00:07:01.960 | >> Absolutely. So let me read it here. This is James' essay, "Why Your House Is a Terrible

00:07:08.560 | Investment." "My pal James Altucher calls home ownership a part of the American religion.

00:07:14.440 | So I know I'm treading dangerous ground here. But before you get out the tar and feathers

00:07:18.800 | let's do a little thought experiment together. Imagine over a cup of coffee or a glass of

00:07:23.920 | wine we get to talking about investments and maybe one of us says, "Hey, I've got an idea.

00:07:29.440 | We're always talking about good investments. What if we came up with the worst possible

00:07:33.320 | investment we can construct? What might that look like?" Well, let's see now. Let's make

00:07:38.920 | a list. To be really terrible it should be not just an initial but if we do it right

00:07:44.880 | a relentlessly ongoing drain on the cash reserves of the owner. It should be illiquid. We'll

00:07:51.240 | make it something that takes weeks. No, wait, even better, months of time and effort to

00:07:56.000 | buy or sell. It should be expensive to buy and sell. We'll add very high transaction

00:08:02.680 | costs, maybe 5% commissions on a deal coming and going. It should be complex to buy or

00:08:08.720 | sell. That way we can ladle on lots of extra fees and reports and documents we can charge

00:08:13.480 | for. It should generate low returns, certainly no more than the inflation rate, maybe a bit

00:08:19.800 | less. It should be leveraged. This one's great. This is how we'll get people to swallow those

00:08:25.520 | low returns. If the price goes up a little bit leverage will magnify this and people

00:08:30.560 | will convince themselves it's actually a good investment. Don't worry about it. Most will

00:08:35.680 | never even consider that leverage is also very high risk and could just as easily wipe

00:08:40.840 | them out. It should be mortgaged. Another beauty of leverage. We can charge interest

00:08:46.200 | on the loans. Yep, and with just a little more effort we should easily be able to persuade

00:08:50.400 | people who buy this thing to borrow money against it more than once. It should be unproductive.

00:08:57.000 | While we're talking about interest, let's be sure this investment we're creating never

00:09:01.280 | pays any. No dividends either of course. It should be immobile. If we can fix it to one

00:09:08.040 | geographical spot we can be sure at any given time only a tiny group of potential buyers

00:09:13.480 | for it will exist. Sometimes, some places, none at all. It should be subject to the fortunes

00:09:19.800 | of one country, one state, one city, one town, no, one neighborhood. Imagine if our investment

00:09:27.600 | could somehow tie its owner to the fate of one narrow location. The risk could be enormous.

00:09:33.160 | A plant closes, a street gang moves in, a government goes crazy with taxes, an environmental

00:09:38.520 | disaster happens nearby. We could have an investment that not only crushes its owner's

00:09:44.120 | net worth but does so even as they are losing their job and income. It should be something

00:09:50.080 | that locks its owner in one geographical area. That'll limit their options and keep them

00:09:55.520 | docile for their employers. It should be expensive. Ideally, we'll make it so expensive that it

00:10:02.200 | will represent a disproportionate percentage of a person's net worth. Nothing like squeezing

00:10:07.120 | out diversification to increase risk. It should be expensive to own too. Let's make sure this

00:10:13.640 | investment requires an endless parade of repairs and maintenance without which it will crumble

00:10:18.800 | into dust. It should be fragile and easily damaged by weather, fire, vandalism and the

00:10:24.760 | like. Now we can add on expensive insurance to cover these risks, making sure, of course,

00:10:29.520 | that the bad things that are most likely to happen aren't actually covered. Don't worry.

00:10:33.560 | We'll bury that in the fine print or maybe just charge extra for it. It should be heavily

00:10:38.340 | taxed too. Let's get the feds in on this. If it should go up in value, we'll go ahead

00:10:43.260 | and tax that gain. If it goes down in value, should we offer a balancing tax deduction

00:10:48.880 | on the loss like with other investments? Nah. It should be taxed even more. Let's not forget

00:10:54.560 | our state and local governments. Why wait till this investment is sold? Unlike other

00:10:59.860 | investments, let's tax it each and every year. Oh, and let's raise those taxes any time it

00:11:05.480 | goes up in value. Lower than when it goes down? Don't be silly. It should be something

00:11:11.580 | that you can never really own. Since we're going to give the government the power to

00:11:16.440 | tax this investment every year, owning it will be just like sharecropping. We'll let

00:11:21.800 | them work it, maintain it, pay all the costs associated with it, and as long as they pay

00:11:26.340 | their annual rent -- oops, I mean taxes -- we'll let them stay in it, unless we decide we want

00:11:31.680 | it. For that, we'll make it subject to eminent domain. You know, in case we decide that instead

00:11:37.820 | of getting our rent -- darn, I mean taxes -- we'd rather just take it away from them.

00:11:43.080 | I'm adding two bonus ones here for you, James, from your commenters. It should increase stress,

00:11:47.240 | lead to more divorces, but then be impossible to divide. And finally, you only need one

00:11:53.760 | motivated -- read -- desperate seller to set the price for the whole neighborhood. Imagine

00:11:59.160 | your so-called investment suddenly gets scuttled when your neighbor decides to sell his particle

00:12:04.600 | board mansion at 20% below assessment. Wow, howdy, that's quite a list. Any investment

00:12:10.960 | that ugly would make my skin crawl. In fact, I'm not sure you could rightly call anything

00:12:16.480 | with those characteristics an investment at all. Then, too, the challenge would be to

00:12:21.400 | get anybody to buy this turkey, but we can. In fact, I bet we can get them not only to

00:12:26.800 | buy, but to believe that doing so is the fulfillment of a national dream, nay, a national birthright.

00:12:38.360 | So that, Jim, is one of my favorite essays that is in the personal finance blog. And

00:12:45.840 | I thank you for writing it. It's a gem.

00:12:48.320 | >> You're welcome.

00:12:50.320 | >> So, yes, obviously, right before the essay -- and by the way, you mentioned earlier James

00:13:00.320 | Altucher, who's also one of my favorite bloggers. I will link to his posts on home ownership.

00:13:05.200 | He also writes two excellent essays on home ownership. But you rightly point out --

00:13:10.000 | >> His assessment, by the way, is even harsher than mine.

00:13:12.960 | >> Oh, yeah. But then again, there's nothing tame about any of his essays. So he's good

00:13:19.320 | at stirring the pot.

00:13:20.320 | >> That's true.

00:13:21.320 | >> So just to start with, I think that you made a valid point before, is that the key

00:13:30.000 | point here is that -- and the essay is ironic. It's a little bit tongue-in-cheek. But the

00:13:36.440 | key point here is not that people shouldn't buy a house. Knowing all of these things very

00:13:42.280 | well, I personally bought a house seven months ago. And I'm very happy with that decision.

00:13:48.640 | I don't have any problem with it. I'm pleased to be there. And we'll talk about why. It's

00:13:52.240 | not that people shouldn't buy houses. But it's the fact that it's a different set of

00:13:56.160 | decision criteria. And it's not just that buying is always better than renting. Is that

00:14:01.920 | a good place to start?

00:14:02.920 | >> I think that's a good place to start. And I would also add, the thing that I was probably

00:14:09.760 | reacting to as I wrote this was the common wisdom that buying a house is always a good

00:14:16.880 | investment. There are lots of reasons to buy a house. But buying one as an investment should

00:14:21.840 | be at the bottom of that list, if on that list at all. Owning a house -- and I actually

00:14:29.240 | just sold my house in the spring. I'm now renting, which I'm thrilled to be doing, by

00:14:34.280 | the way. But prior to that, I owned that house for 13 years. And I owned the house before

00:14:39.240 | that for 15 years. So I have been a homeowner for 28 years. I, too, have seen in my lifetimes

00:14:46.840 | when it makes sense to own a house. But I've never lost sight of the fact that it is a

00:14:51.120 | decision that is always an expensive indulgence. As long as you understand the expense you're

00:14:57.000 | undertaking in buying that house, and that you're indulging in a consumer good, so to

00:15:02.800 | speak, in the way that buying a Mercedes is a consumer good, then I have no problem with

00:15:08.280 | how you spend your money. That's entirely up to you.

00:15:11.800 | >> Yeah, absolutely. And the interesting thing is that most people -- I think you make a

00:15:16.200 | good example with the car. There's absolutely nothing wrong with driving a fancy car. If

00:15:22.440 | that floats your boat and you want to and it's your money, go for it. But many times

00:15:26.560 | you'll find that people who drive fancy cars feel a little bit -- they do it with a little

00:15:33.200 | bit of a red face sometimes. They make comments saying, "Well, you know, it's an indulgence

00:15:37.320 | for myself." But yet so many times people will go and they'll buy a fancy house and

00:15:42.800 | they'll justify it with the idea that, "Well, at least it's a house. At least I own something.

00:15:48.400 | At least it's going to go up in value and it's a good investment." So as long as we

00:15:53.080 | kind of make that differentiation, then you can look at it accurately and start with what

00:15:58.920 | I would say is a rational way to do it, which is, "What are my needs? What are my wants?

00:16:04.280 | What level of luxury do I want?" And then let's make a shopping decision and say, "In

00:16:09.720 | my market, in my area, with my needs and wants, what can I buy? What can I rent? How can I

00:16:15.760 | arrange my living space in such a way that I can get everything that I want in life in

00:16:21.240 | an efficient manner?"

00:16:22.240 | >> Exactly, in a manner that you can afford. There's nothing magic about houses and I think

00:16:32.320 | that people are convinced that they are. They're convinced that they're buying a great investment

00:16:37.480 | and therefore they can and should buy more house than they need or maybe more house than

00:16:42.640 | they can really afford. And there are a lot of things in our society, a lot of institutions

00:16:49.320 | that drive that way of thinking and it's profitable for them to drive it. Real estate industry

00:16:55.240 | is of course at the top of that list. I mean, real estate industry loves it when we buy

00:17:00.000 | and sell houses. The whole idea that you start with a starter house and then you buy a little

00:17:04.480 | better house and a little better house and then finally you get into your ultimate house

00:17:08.320 | and then when your kids are grown you sell that and you go into your retirement house.

00:17:11.760 | I mean, that's not an accident that that's the path that is laid out in the shining waters

00:17:20.560 | down the line. I mean, it's a very profitable path for us to follow for the people selling

00:17:27.480 | us the houses or for the people selling us the services to maintain those houses or to

00:17:32.280 | insure them or to mortgage them. So, there are a lot of people who make money owning

00:17:37.720 | houses, not so much the people who buy them. And when they do, it's more often as I mentioned

00:17:43.480 | in that essay you just read, it's more often a function of leverage working for them than

00:17:48.080 | a good investment working for them. And I think people didn't really understand that

00:17:53.120 | and when the housing market collapsed a few years ago, that of course is what caused it

00:17:58.600 | to collapse is that leverage can work very powerfully for you and for many years in housing

00:18:05.440 | it did but it can also work very powerfully against you. And so, suddenly people were

00:18:11.040 | taking out mortgages for 95, sometimes even 100% of the price of the house. I won't even

00:18:17.080 | say value because the houses have gone way beyond what they were really worth but the

00:18:21.880 | price of the house. Well, if that house then goes up 10% and you've borrowed 100% of the

00:18:28.880 | money, you've made $10,000 for a $100,000 house, you've made $10,000 let's say out of

00:18:34.840 | thin air and that's got to feel wonderful. But if it goes down 10%, you've just lost

00:18:41.560 | $10,000 that you might not have and that many, many people didn't have and the next thing

00:18:46.600 | you know you're foreclosed. And there in a nutshell is what happened when housing collapsed.

00:18:53.560 | And I think I want to continue on that theme of leverage for a moment and point out where,

00:18:58.120 | why houses are a useful point for leverage and then where the disadvantages are. I think

00:19:05.120 | my thoughts is that for the most part people are comfortable leveraging houses because

00:19:11.520 | everybody leverages houses. It's common and it's understood. People understand if I buy

00:19:17.160 | a 30-year fixed rate mortgage then this is how it works and this is what happens. So

00:19:24.160 | they're comfortable doing it. They forget that many things can be leveraged. You can

00:19:29.280 | borrow money to buy just about anything including other investments. So it's just that most

00:19:34.560 | people don't have a margin account open with their stock broker. They're not accustomed

00:19:38.840 | to how that works and they're not accustomed to how that works so they're comfortable

00:19:45.840 | buying and getting a mortgage though. Now when it comes to that little comparison, to

00:19:51.000 | be fair, the advantage does go to the house. So if you're looking for ways to leverage

00:19:56.720 | and you want to use real estate as a place to leverage, it's been a dramatically good

00:20:00.800 | time to do that with low interest rates, interest rates near the long-term rate of inflation.

00:20:06.660 | Also with the fact that generally mortgages are not callable. So if your house does decline

00:20:11.700 | in value by 10% like in your example, if you can figure out how to make the monthly payment

00:20:18.620 | you might be able to afford to sit and wait it out. Whereas on a margin account with a

00:20:23.200 | stock broker, generally if your account value declines below the term set in the margin

00:20:34.720 | agreement, they're going to sell your investment. They're going to sell your stocks and the

00:20:38.220 | stock broker is just going to take the money. So there are some advantages there to leveraging

00:20:42.060 | real estate that don't exist in other areas.

00:20:44.780 | >> Well you're absolutely right and that's not a mistake by the way. It didn't happen

00:20:49.900 | by mistake. During the Great Depression, before the Great Depression, very, very few people

00:20:56.340 | borrowed money for houses. I mean if you wanted to buy a house, and this is true in many places

00:21:02.060 | in the world today by the way.

00:21:03.660 | >> Sorry, hang on one second. My phone is ringing on my, I can't figure out how to turn

00:21:10.660 | it off. Here we go. All right, keep going. Sorry about that.

00:21:12.800 | >> No, I'll just back up a second.

00:21:14.600 | >> Internet phone, keep going.

00:21:15.840 | >> And I'll say that it's not a mistake that houses are easily leveraged, easily mortgaged

00:21:22.840 | and there are certain protections to that. Before the Great Depression, people didn't

00:21:32.600 | borrow money to buy houses. By the way, in many parts of the world today, people don't

00:21:36.720 | borrow money to buy houses. It's a certain financial structure that the government put

00:21:42.480 | in place in the 1930s and they wanted to, there was a lot of social unrest in those

00:21:49.480 | times because of the Depression and of course there were a lot of European countries that

00:21:54.040 | were going the way of Nazi Germany and Communist Russia and there was a fair amount of, there

00:22:02.040 | was a fair amount of social unrest leaning in those directions in this country and the

00:22:06.000 | government wanted to stabilize that. And one of the things they very strategically did

00:22:11.000 | or one of the concepts they very strategically came up with was that if we want people to

00:22:18.000 | have a stake in the society and one of the ways to do that is for them to own a house.

00:22:23.800 | And one of the ways to do that is allow them to borrow money to own a house and we want

00:22:30.000 | to make that available and desirable and we want to encourage banks to extend that money

00:22:37.000 | and that was kind of the beginning of it. That's one of the reasons for some of the

00:22:42.440 | points that you made. So there's a real strong motivation to push people into houses and

00:22:49.440 | it may be good, it's certainly, you can make the argument good for the country and it might

00:22:55.200 | also be good for the individuals, for many people it is, but not always. And that's a

00:22:59.800 | decision that people ought to, if you decide to buy a house, and I would never suggest

00:23:05.000 | that don't buy a house, what I would suggest is go in with your eyes open and understand

00:23:10.120 | what you're doing and make sure that you're doing it because you've run the numbers, you've

00:23:15.440 | calculated the risks and the benefits and it best fits your needs, not because you've

00:23:22.020 | always heard it's a good thing to do.

00:23:26.560 | >> It's interesting how that whole government stabilization kind of track when taken to

00:23:32.320 | its ultimate conclusion back in the early 2000s. I would argue that that made a significant

00:23:38.600 | contribution to the real estate bubble and it's interesting how when you take anything

00:23:44.200 | to an extreme, it always seems to turn on itself.

00:23:48.400 | >> Well, I think that's true and all of these things are done with the best of intentions,

00:23:55.400 | right? The expression of the road to hell is paved with good intentions. But yeah, you

00:24:01.660 | have Fannie Mae and Freddie Mac who are guaranteeing loans, federally guaranteeing mortgage loans,

00:24:08.660 | of course that's done to make banks more willing to issue those loans and then the banks figured

00:24:15.180 | out that unlike that famous movie from the 40s, It's a Wonderful Life where you place

00:24:22.180 | the banker in the community and people deposit their money in the local bank and then the

00:24:28.020 | bank lends it out and other people build and buy houses and over time they pay the bank

00:24:33.540 | back.

00:24:33.740 | Well, of course that's not how it works anymore. I mean the bank or the mortgage lender might

00:24:39.740 | not even be a bank, issues the loan and then they probably turn around and sell it. And

00:24:45.340 | they sold it to Wall Street firms who would bundle it and resell it as a package and sometimes

00:24:51.780 | they'd strip out the payments and it became a whole different kind of product and for

00:24:58.780 | a while there was an insatiable market for this stuff. And so lenders became more and

00:25:07.780 | more aggressive in seeking out borrowers and by aggressive I mean they lowered their standards

00:25:12.900 | more and more and more. So when I first bought a house, you put 20% down. I mean at the end

00:25:19.900 | of just before it blew up, people were buying houses with nothing. Now people were buying

00:25:25.060 | houses where not only did they put nothing down but the lender would kick in 5, 10, 15

00:25:32.100 | dollars to fix the place up. So you could buy a house not only with no money down but

00:25:38.020 | they'd actually cut you a check. Well, that all came out of the incredible demand for

00:25:45.020 | these packaged products that Wall Street was creating and selling.

00:25:50.940 | >> Eric Lander: It's amazing the distortion that that brings to the market.

00:25:55.460 | >> Tom Hanks: And all of it was federally guaranteed which is why we wound up on the

00:26:01.220 | front porch.

00:26:02.220 | >> Eric Lander: Yeah. So to be fair, you've been a homeowner up until this year for the

00:26:07.460 | last 28 years. What were some of the reasons that you owned two houses in a row?

00:26:14.460 | >> Tom Hanks: Well, let me start with the most recent one. We live in New Hampshire

00:26:19.300 | now and when we moved to New Hampshire, my daughter was in second grade. And as anybody

00:26:24.740 | who has kids will appreciate, when you have kids, most all of your decisions revolve around

00:26:31.740 | what's best for your kids and what's best for raising them. And there are advantages

00:26:39.060 | to raising a kid in a house in the kind of neighborhood that we were fortunate to be

00:26:44.420 | able to afford and the kind of school district that I wanted her to have access to.

00:26:51.460 | Before when we lived in Ohio, we lived in an inner ring suburb. It was a very urban

00:26:56.620 | suburb and we like city life. This is before our daughter was born. And we bought that

00:27:03.260 | house. We've been renting and we liked renting but I got restless quite honestly and I like

00:27:09.820 | change. We kind of started going out looking at houses just for kicks and we found one

00:27:15.500 | that was a beautiful old century house that just really appealed to us emotionally and

00:27:19.780 | we could pretty easily afford it. We bought it but then when our daughter came along,

00:27:24.020 | it wasn't in a particularly good school district. And of course, we hadn't been thinking about

00:27:28.740 | that and the purchase of that house. So we sent her to private school for kindergarten

00:27:34.420 | first and half of second grade. And then as I say, we happened to move to New Hampshire

00:27:38.820 | but when we moved to New Hampshire and I was looking at neighborhood and school district

00:27:44.700 | were the big things that were driving that factor. But I never for a moment thought that

00:27:51.220 | these were great investments. They were lifestyle choices I was making and that I could easily

00:27:56.500 | afford. And by the way, neither one of them came close to costing what the real estate

00:28:03.340 | agents and the mortgage companies were telling me I could afford and worse were telling me

00:28:08.020 | I should afford. There's a lot of pressure on people when they go out and buy houses

00:28:12.140 | to, "Oh, you can afford half a million dollars for a house. So obviously, you want to look

00:28:18.740 | at half a million dollar houses." Well, maybe but that's probably the outlier of what you

00:28:25.740 | can afford. And in my world, you don't buy the absolute most you can afford. You buy

00:28:30.780 | something considerably less than that so you have considerably less risk involved in owning.

00:28:37.780 | >> Yeah. There's something about house fever that seems to be one of the most incredible

00:28:43.860 | like powerful fevers that people get. And maybe it's because it's so visible, maybe

00:28:49.420 | it's because it involves something that all of our friends know where we live but it's

00:28:55.580 | so common. You see people and they get house fever and it's easy to succumb.

00:29:01.020 | >> Well, I mean that's true and I actually wrote a post on the emotional aspects of owning

00:29:08.020 | houses and I entitled it Roots versus Wings. And one of the things that was striking to

00:29:13.540 | me when we sold our house this past spring and we by the way had been trying to sell

00:29:20.340 | this house for three years. I mean, as soon as our daughter went off to college, we were

00:29:24.620 | ready because the house, we no longer needed the advantages that the house provided. We

00:29:29.620 | didn't need the school district or the neighborhood and I've never been one to be emotionally

00:29:34.260 | attached to anything I own and that includes houses. So we immediately were looking to

00:29:41.260 | sell. Unfortunately, as most people will remember, it was very bad market to be trying to sell

00:29:46.500 | a house in. So we didn't have much luck until the spring. But what was striking, so by the

00:29:50.860 | spring I was really, really ready to be rid of this house in a real profound way and go

00:29:57.900 | back to the much more carefree lifestyle of renting. But what was striking to me is the

00:30:04.900 | young couple who bought it and it was a young couple who bought it and they had two little

00:30:10.220 | girls who were just about the age that my daughter was when we bought it, could not

00:30:14.140 | have been more thrilled to acquire this thing. I could not have been more thrilled to get

00:30:18.420 | rid of it. And it's a difference in needs at the time. I mean, they were looking to

00:30:24.820 | put down roots and raise a family. My wife and I were looking to spread our wings and

00:30:31.820 | have a lot less obligations and a lot less ties and a lot more flexibility in where we

00:30:38.380 | live and how we live and how we travel. And it's a different needs. So I did this post

00:30:44.580 | based on what I call Roots vs. Wings that talks about those different kinds of things.

00:30:50.740 | There was that when I was doing a garage sale to get rid of some of the stuff in preparation

00:30:54.140 | for the move, there was another young couple who came and they picked up a lot of the garden

00:30:58.260 | tools and things that we were selling and we get to talking and they just bought a house.

00:31:04.580 | They got it in a foreclosure sale and they evidently, I don't know the numbers, they

00:31:10.900 | didn't share them, but they seemed to think they got a great deal on it and they were

00:31:14.060 | real excited but needed a lot of work and they were excited to do that. And this is

00:31:18.780 | a young couple who are looking to put down roots. So some people are roots people, some

00:31:23.420 | people are wings people. I think I'm personally more of a wings person but that's also varied

00:31:29.180 | depending on what was going on in my life at the time.

00:31:34.180 | That would be similar to where my wife and I are with our housing decisions. We bought

00:31:39.100 | a house in January of this year.

00:31:41.980 | My condolences.

00:31:45.580 | And we thought pretty carefully about it because we really considered what did we want to do

00:31:51.460 | and what were we looking for. I ran the Rent vs. Own calculations and analysis and I want

00:31:59.900 | to come back to that and spend a good bit of time walking people through that. But one

00:32:04.340 | challenge with Rent vs. Own is that a national or I guess international podcast or a national

00:32:09.860 | magazine article can never tell the story of what's going on in any one neighborhood.

00:32:15.980 | Everything is intensely local and if you don't factor that into your decision making and

00:32:21.220 | look at your specific scenario and run the numbers on your specific situation it's tough

00:32:30.380 | to, you've got to run the numbers which is why I probably spend the back half of the

00:32:34.940 | show walking through how to do that.

00:32:37.500 | But for us we wanted some place where we could grow a garden without any problem. I'm into

00:32:47.660 | a lot of urban homesteading stuff. I want to grow a garden. I want my house to be super

00:32:52.700 | efficient and low ongoing costs. I want a backyard for the dogs. So we found a house

00:32:59.220 | that was exactly what we were looking for right next to the grocery store and the library

00:33:04.740 | at the third of the mile from my office. So with all of these advantages of being so geographically

00:33:11.580 | centrally located and all that plus the timing and the market was a fair price. It was cheaper

00:33:17.700 | than what we could rent something for. So all those things put together it came out

00:33:22.540 | and we decided it's a good decision. But it wasn't based upon any idea that I was going

00:33:28.900 | to get rich by owning a house and my experience over the first seven, eight months of home

00:33:33.540 | ownership has been that it has definitely taken money out of my pocket as it's want

00:33:39.140 | to do.

00:33:40.140 | >> Probably in ways that you never anticipated. I mean that's one of the insidious things

00:33:47.020 | about it. You know as I hope has come across so far in our conversation here as harsh as

00:33:53.740 | the essay you read is and I meant it to be a little harsh. I also as you pointed out

00:33:58.220 | meant it to be tongue in cheek and I hope that comes across. But the point, the fundamental

00:34:03.660 | point is not don't buy a house. The fundamental point is to run the numbers and understand

00:34:10.180 | what you're getting yourself into. And I actually have a tendency to do this with everything

00:34:16.500 | that I buy or everything that I own or do that involves money. I want to know what it's

00:34:22.540 | going to cost me, what it's really going to cost me. Most people have no idea what the

00:34:25.900 | car cost them to operate. I know to the penny what my car cost me to operate. Maybe I'm

00:34:31.420 | sick by doing that but I think it's useful to know what things actually cost you. And

00:34:36.620 | most people in my experience don't have a clue. So in buying a house I think the first

00:34:42.940 | thing to do is to start out and run the numbers and see how it compare. You're looking at

00:34:47.940 | to buy a house and as you were six, eight months ago. So you say okay I'm going to run

00:34:52.740 | the numbers based on this house that I think I want to buy and then I can compare it with

00:34:57.460 | what it's going to cost me to where I am living now. And it will either be higher or lower.

00:35:04.220 | If it's lower and I want to move, I like this house and it's kind of a bit of a no brainer.

00:35:09.780 | If it's higher that doesn't mean you shouldn't necessarily do it but it does mean that you

00:35:14.620 | now know that it's going to cost you money to own this thing that you think you want

00:35:19.900 | to own. And you'll have a pretty good idea of how much money it's going to cost you.

00:35:23.780 | And it's not just the purchase price by the way, it's the ongoing cost that you have to

00:35:28.540 | consider. And once you know that then you can make a rational decision as to whether

00:35:32.420 | or not that is money well spent. And of course you have to look at it in terms of not only

00:35:38.100 | is it money well spent but what else could that money be doing for you. And then it's

00:35:43.500 | your call. I mean if you look at it and you say okay I'm living in the place I am currently

00:35:50.500 | in but I want to buy this house but it's going to cost me an extra $10,000 a year to live

00:35:54.900 | in this house. Now you know and now you can make a decision as to whether you have that

00:36:00.140 | $10,000 and whether that's how you want to spend that $10,000 knowing you have it. Or

00:36:06.940 | whether that $10,000 would be better invested or better in a different car or whatever floats

00:36:13.940 | your boat.

00:36:15.300 | >> And now we get into one of my, I think is, I wish high school classes hammered opportunity

00:36:22.300 | costs home into every student's head every day for four years of high school so that

00:36:29.740 | everyone could say oh the opportunity cost of my decision here is such and such. Because

00:36:34.780 | people forget the concept that you just talked about which is the opportunity cost is that

00:36:39.460 | if I'm going to make this purchase what am I giving up and what is the alternative use

00:36:43.340 | of the dollar. And that's what you have to do I think with every buying decision in order

00:36:47.900 | to make good decisions. If you don't run that scenario you just jump at thing after thing

00:36:52.820 | after thing. But if you run that scenario you don't get buyers remorse. But you've got

00:36:57.900 | to run that.

00:36:58.460 | >> Well you don't have buyers remorse because you really understand what you just bought.

00:37:05.460 | And by virtue of going through the process of understanding what you're about to buy

00:37:11.260 | you have a chance to back away from it if in fact it is something that would turn out

00:37:14.900 | to give you buyers remorse. But I agree with you the opportunity cost is the single biggest

00:37:21.140 | thing that people don't understand and they don't think about it when it comes to their

00:37:25.260 | home ownership. And the most glaring way I see that is people who, you know my house

00:37:32.260 | I've chosen to pay off the mortgage for a variety of reasons. So I owned it free and

00:37:37.940 | clear and people say well gee you know then you don't have any cost in your house. You

00:37:44.100 | don't have a mortgage. Well no I mean I have a huge amount of capital tied up that is stagnant.

00:37:50.860 | It's not doing anything. There is an opportunity cost to that. Owning your house free and clear

00:37:56.100 | is not necessarily better than having a mortgage. It's different. But you still have, there's

00:38:01.420 | still a very real cost in having that capital tied up in that house. And that's by the way

00:38:08.420 | in the formula that I talk about in the post I think you want to get to is one of the key

00:38:15.340 | things that I talk about is calculating what that opportunity cost is. So you have a realistic

00:38:20.820 | when you're comparing owning a house, not owning a house or even owning this house versus

00:38:26.180 | some other house. You have an accurate assessment of what you're looking at. If you don't consider

00:38:33.180 | the effect of having a bunch of capital tied up and that does, and by the way you don't

00:38:37.660 | have to have your house paid off for this to be an effect that you have to consider.

00:38:44.020 | I mean just putting money down on your house ties up a certain amount of capital to the

00:38:48.620 | degree of how much you're putting down.

00:38:50.980 | Absolutely. And if you don't put much down you got to ask yourself what's your back door

00:38:56.300 | out. I think in any transaction you should have an exit plan in case you need to get

00:39:02.020 | out. And you should consider the ultimate potential downside and see if you're willing

00:39:07.820 | to live with that. And that is one of the most dangerous things in the no money down

00:39:13.340 | world over the last decade whenever that was possible. Things would change and if people

00:39:19.820 | hadn't factored in a margin of safety into their decision their job would change and

00:39:24.460 | they have to move. Well now they're stuck, they can't sell the house because they're

00:39:27.260 | upside down in it and then they can't rent it out for more than they're paying and now

00:39:31.340 | they got a house in Colorado when they're living in Florida or vice versa and they're

00:39:34.780 | trying to be a landlord from across the country.

00:39:37.100 | So just by going a little bit slower, having a margin of safety and having an exit plan

00:39:44.100 | it'll help eliminate some of the stress in life.

00:39:47.340 | I think that's a great point. Having an exit plan is a great point and a great strategy

00:39:52.180 | and a lot fewer people would buy a lot fewer houses if they thought in those terms and

00:39:58.220 | they'd buy a lot fewer bad investments of all kinds. The moment you buy a house you

00:40:03.780 | start thinking about buying a house you ought to be thinking about how you're going to sell

00:40:08.100 | it.

00:40:08.900 | I got a lot of pushback from that essay you read and in fact I'm going to do a follow

00:40:15.900 | up post kind of addressing some of the points that people make because a lot of them repeat.

00:40:24.220 | But one of the points that comes up on a routine basis is well if I own a house I can do anything

00:40:30.980 | I want to. If I want to knock down a wall I can knock down a wall. If I want to paint

00:40:35.300 | a room black I can paint a room black. Well yeah technically that's true if you don't

00:40:42.300 | care anything about resale value. If you want to start knocking down walls or punching holes

00:40:50.620 | in walls and painting rooms black and parking junk cars in your yard which of course will

00:40:59.900 | irritate your neighbors you can do that when you own a house but you're going to destroy

00:41:06.300 | any value you have in that house. Most people are smart enough not to want to do that so

00:41:11.540 | the truth is that no owning a house doesn't mean you can do anything you want. The irony

00:41:17.540 | is when you own a house you spend most of your time fixing it up preparing it and caring

00:41:22.540 | for it for the next people who are going to own your house for the people you're going

00:41:25.900 | to sell it to. At least if you're looking at it with any kind of financial savvy.

00:41:32.900 | So how did you do your rent versus buy analysis with the recent move that you've made?

00:41:41.900 | Well let's take a look at that. First of all there are a lot of rent versus buy calculators

00:41:49.740 | on the internet. One of the core principles in the blog when I write about investments

00:41:56.740 | of any kind including this is that most of the investing world is made far more complicated

00:42:04.860 | than it needs to be made. The reason for that is that the more complicated things are the

00:42:10.940 | more people will throw up their hands and turn to the "experts" and the more the experts

00:42:16.700 | will be able to charge for their expertise to walk people through the maze. So I'm a

00:42:22.420 | big believer in keeping things absolutely as simple as they need to be on investments.

00:42:28.020 | I think when I look at these calculators they're great but some of them are just way more complicated

00:42:35.020 | than they functionally need to be. The other objection that I have to a lot of the ways

00:42:39.900 | that people figure this is it's an academic exercise rather than an exercise that looks

00:42:45.860 | at a person's real situation. What do I mean by that? Well if you're an academic and you're

00:42:52.780 | doing a study and you say, "You know what? I want to do a little research here and I

00:42:56.340 | want to figure out definitively is renting better than buying or vice versa?" Well you're

00:43:03.340 | going to construct an academic study and one of the things you're going to want to do is

00:43:09.020 | compare absolute apples to apples but that's not how people live. When I sold my company

00:43:15.700 | and sold my house and moved into the apartment where we live, it's not the same square footage

00:43:21.780 | and it's not the same location. It's apples to oranges but that's real life. So I don't

00:43:28.780 | care and I also, you can run the numbers, it happens somebody offered to rent my house

00:43:34.180 | at one point so I had a pretty good idea of what the rental was worth. So I can run the

00:43:38.020 | numbers looking about, "Okay, what if I sold this house and rented an equivalent house?"

00:43:43.700 | But in my real life, I don't care about that. I care about what if I sell this house in

00:43:48.060 | my case and I move to where I want to move. So anyway, with that little bit of background,

00:43:53.740 | we can walk through the numbers a bit if you'd like.

00:43:57.460 | Yeah, absolutely and that's where I think ultimately I believe the fundamental foundation

00:44:04.460 | question that you have to start with in good financial planning is, "What do I want?"

00:44:13.420 | Depending on what you want, that's going to determine the decision that you make and

00:44:17.940 | there's no right or wrong unless you want something and your decision isn't helping

00:44:22.020 | you get that. So that's why the lifestyle stuff is so important but so is the opportunity

00:44:28.300 | cost. So yeah, go through the numbers here.

00:44:30.980 | Okay. So basically, again, I think this should be very simple and hopefully you'll provide

00:44:37.620 | a link to this post so anybody who wants to look at it, the advisor can look at it and

00:44:42.060 | they can do that. Maybe it's easier to look at it black and white than just listening

00:44:45.780 | to us talk about it.

00:44:47.380 | But basically, there's only four things you really have to think about in terms of what

00:44:51.300 | a house costs you. You have to think about opportunity cost and that's frequently one

00:44:56.340 | of the biggest. You have to consider utility cost, particularly in the northeast where

00:45:02.580 | we live. The heating oil is a big one so I include that. You have to think about the

00:45:07.540 | maintenance repair and insurance which I'll embalm together. You have to think about those

00:45:13.220 | kinds of costs and then you have to think about taxes.

00:45:17.140 | So if you look at our house, our house and as I sit here, I can't remember exactly what

00:45:23.620 | we sold it for and what we netted but as you know, when you sell a house, of course, that's

00:45:28.700 | not what you get after commissions and all the fees and everything. You get something

00:45:32.500 | significantly less than that. But at the time when I did this post and the house hadn't

00:45:37.260 | sold, I calculated that after going through all that, we would net $330,000 in the sale

00:45:43.540 | of our house and that's pretty close to where we came. I think we came in a little bit higher

00:45:46.940 | than that but I'm going to use the 330 number because that's where I ran these numbers in

00:45:55.180 | the post and it's just a little bit easier because the math works without my calculating

00:45:59.180 | it as I'm talking here.

00:46:00.980 | So I sell the house as I did. I wind up and as I mentioned, my mortgage was paid so I

00:46:06.060 | owned it free and clear. After I paid all the fees, I got a check for $330,000. The

00:46:13.100 | first thing, so first question is, all right, if I have that $330,000 and it's no longer

00:46:19.460 | tied up in the house which was the opportunity cost we were talking about in the moment,

00:46:24.900 | what could it be earning for me?

00:46:27.300 | Well now you have to choose a proxy. You have to say, well if it's not tied up in the house,

00:46:32.900 | where would I have it invested? I happen to think real estate is a pretty good investment

00:46:37.620 | and the real estate vehicle I prefer is the REIT which is a real estate investment trust

00:46:44.220 | because that's what R-E-I-T, REIT stands for. Vanguard has a great index of various REITs

00:46:53.220 | and it's VGSLX if anybody is interested. So that was my proxy.

00:47:00.260 | Now this REIT fund, this REIT index fund pays a dividend of about 3.5% a year. So I say,

00:47:08.180 | okay, if I take my $330,000 and I invest it in VGSLX which by the way is exactly what

00:47:15.940 | I did after I sold the house, that will generate a 3.5% dividend and 3.5% of $330,000 is $11,555.

00:47:29.300 | So now I am earning $11,555 that I didn't have coming to me when it was tied up in the

00:47:36.340 | house. That's the opportunity cost of owning that house. So that's cost number one.

00:47:43.860 | Then I looked at the other three costs and they came up to about $18,000 altogether.

00:47:51.980 | We're in a very expensive heating oil state as I alluded to so I got about $2,500 in annual

00:47:57.500 | heating costs based on the actual records of owning the house. It cost me about $7,000

00:48:04.580 | a year in maintenance, repair, insurance. So those things lumped together. And then

00:48:09.580 | my real estate taxes on the place we owned was $8,500. So we add those three together

00:48:15.420 | and you've got $18,000. So now I know with my opportunity costs and my actual cash costs,

00:48:23.300 | my house cost me $29,555. Now at the time, and I'll keep using this number, at the time

00:48:31.620 | I was guessing that the kind of apartment around here that we wanted would cost me about

00:48:36.940 | $2,000 a month. Actually, we found one that cost us much, much less than that. But we'll

00:48:43.020 | use the $2,000 as a number because that's what I was using when I did the post. So $2,000

00:48:49.580 | a month obviously is $24,000 a year in rent. You subtract 24 from 29,555 and I know now

00:48:59.020 | that my annual premium on average, and of course the cost of owning a house go up and

00:49:03.460 | down year to year, but on average it was costing me about $5,555 a year to live in the house.

00:49:12.540 | So now I'm sitting here owning a house and I can say, "Well, is it worth the extra $5,500

00:49:19.460 | to live in this house or not?" Well, in my case, not only wasn't worth it, I mean when

00:49:25.860 | my daughter was young and I cared about the school district and the neighborhood and all

00:49:29.420 | that kind of stuff, yes, absolutely it was worth it. I was happy to pay it. Now she's

00:49:34.140 | off in college, now I don't care about that stuff, now I would prefer not to have all

00:49:38.660 | the hassles involved in owning a house. I prefer to have the flexibility and freedom

00:49:43.180 | of renting. I prefer to live back in the city where I can walk to places. It's not worth

00:49:48.580 | the extra $5,000 a year at all. In fact, I'd probably be willing to pay a premium to be

00:49:55.700 | rid of it. So there you have a real simple formula that allows you to make the decision

00:50:01.260 | that you're looking to analyze and think about. Does that make sense?

00:50:06.660 | It does. I think that putting numbers to it, I would challenge any person who's considering

00:50:15.060 | decisions like this to put actual numbers to it. I want you to keep going with your

00:50:19.060 | post and then I'm going to come back and I'm going to pick all your numbers apart, not

00:50:22.220 | because they're wrong for you, because they're absolutely right for you, but I want to demonstrate

00:50:27.820 | how they would change for somebody else depending on different choices that people would make.

00:50:32.820 | But this is where each person has to do their own individual numbers. It's pretty staggering

00:50:39.020 | when you look at it like that and you realize that, yeah, you had a paid off house, which

00:50:43.660 | is what most people's dream is, had a paid off house and yet it's costing you $5,500

00:50:49.060 | a year more than going and living in an apartment that was more conducive to the lifestyle you

00:50:53.340 | wanted to live in, lower hassle, more flexible, just a better option for you.

00:51:00.780 | It is and you do have to look at those things. But now, seeing as you've kind of suggested

00:51:11.740 | it, I'll kind of walk through the post here. But the next step that people should pay attention

00:51:18.420 | to and I think that probably some of our listeners will have already picked up on is the fact

00:51:25.460 | that, well, wait a second, that opportunity cost is not that when owning the house is

00:51:31.300 | not cash out of pocket and all of that rent that I've now taken on is absolutely cash

00:51:38.380 | out of pocket as was the $18,000. So if you turn around and you say, well, wait a second,

00:51:46.260 | if you look at it in terms of cash outlay, it actually does cost me more to live in the

00:51:52.340 | apartment now, right? Because my actual out of pocket cost for the house, weren't the

00:51:57.100 | 29, I'm going to call it, I'm going to round it to $30,000 to make the conversation easier,

00:52:03.140 | wasn't the $30,000. In total, it was $18,000 and then plus $12,000 in opportunity cost,

00:52:12.020 | plus or minus. Of course, my rent, at least in the exercise we're doing is $24,000. So

00:52:17.460 | out of pocket cash flow is actually a $6,000 advantage to owning the house. I hope that's

00:52:24.340 | making sense so far. This is kind of for anybody who has a business background, this is EBITDA.

00:52:31.100 | This is earnings before interest taxes, depreciation and amortization, which is what businesses

00:52:36.340 | do all the time. And cash flow is critical to running a business and it's critical to

00:52:41.140 | somebody owning a house. Now, you can turn that around and say, "Okay, my investment,

00:52:47.940 | my refund is now thrown off this $12,000 and that certainly helps." But setting that aside

00:52:53.820 | for a second, one of the things that you want to ask yourself is, "Do I have the cash flow

00:52:58.780 | resources to make this change?" Because a paid for house is going to require less cash

00:53:05.260 | coming out of your pocket, perhaps. I mean, you're more likely to be more cash positive

00:53:11.500 | than renting. Now, in my case, it didn't matter in the actual dollar value was a very real

00:53:18.540 | one that I was happy to have. As I say in the post, overall costs trump cash flow costs

00:53:24.860 | because they're more complete. But that's assuming that you can afford the cash flow.

00:53:29.540 | And that's true in owning your house versus renting. It's also true as any business person

00:53:34.660 | will tell you in running a business. I mean, if you run out of cash, you run out of business.

00:53:39.420 | >> It's also true paying off a mortgage early. So if you say, "I've got excess funds. Should

00:53:46.300 | I pay off a mortgage or should I invest the money instead and which is going to be a better

00:53:52.340 | use of the dollar?" A lot of that comes down to emotion and cash flow. So if somebody is

00:54:00.140 | going to actually invest the money, many times that may be better, but they're still going

00:54:05.780 | to have that money, that cash coming out of their pocket. And this is where if somebody

00:54:11.260 | is potentially maybe a low income earner, kind of on the edge, and you said you have

00:54:15.260 | an opportunity and their jobs are unstable, maybe, there could be a tremendous peace of

00:54:19.660 | mind that could come by not having that cash flow deficit. But if somebody feels good about

00:54:24.660 | their income, they have other reserves to draw on, then they can handle the cash flow

00:54:29.500 | difference in favor of the total net cost difference.

00:54:32.060 | >> Of course, the other side of that is that if the person is owning the house free and

00:54:37.420 | clear and is worried about their income, they're also tied to that location. And that's a very

00:54:43.460 | dangerous position to be in. And you look at, as I'm sure most people are aware of,

00:54:49.020 | the fact that Detroit just defaulted and services are up and taxes are going up. And if you

00:54:59.060 | own a house in Detroit, you're in a world of hurt. And so, yeah, location is a very

00:55:07.460 | risky, it's one of the things that makes owning a house a very risky thing. And it's one of

00:55:11.900 | the, looking at it from a purely financial point of view, and I understand that buying

00:55:16.180 | a house, I mean, I did it myself, as I've already said, is more than just looking at

00:55:20.780 | numbers. But just for a moment, looking at it from a purely financial point of view,

00:55:26.540 | not only should you not buy a house unless it's less money than renting, but it should

00:55:33.340 | be significantly, in my opinion, significantly less money than renting to compensate you

00:55:38.340 | for the risks that you're taking on with that investment.

00:55:42.540 | >> Absolutely. That's a good point. Also, there's something that you point out, I think

00:55:49.300 | that a lot of people don't point out, don't realize, and it goes back to your roots versus

00:55:54.380 | Wings Post, an example. Many people don't think about the power of what the equity in

00:56:02.980 | a home could buy for them in terms of lifestyle. So, a $330,000 house, assume for a moment

00:56:10.300 | that someone has no other assets and investments, and using the numbers that you gave, and I'm

00:56:15.940 | going to use $12,000 for convenient numbers, even though the actual answer is $11,555.

00:56:23.460 | But let's say that that portfolio could throw off $12,000. It can throw off that $12,000

00:56:30.180 | under the scenario you gave without invading principle and purely based on dividends, which

00:56:35.260 | means it's perpetual as long as the dividend rate on that fund stays high, which means

00:56:41.060 | that they can take and they can rent for $1,000 a month anywhere in the world. So, instead

00:56:46.620 | of it being forever, exactly. When you get to retirement planning, which is where you're

00:56:51.980 | in the early stages of retirement, unless you change your mind, of course, think about

00:56:57.980 | a lot of people. You have to consider the fact that many people's dreams is to have

00:57:02.380 | a paid-off home when they enter into retirement, but yet many people have dreams of doing things

00:57:07.980 | like traveling in retirement. The paid-off home may be a great asset, but every single

00:57:15.060 | month, no matter where you are, it's tied to the same piece of real estate, whereas

00:57:20.540 | if it were an investment asset, that cash flow will follow you wherever you want to

00:57:25.740 | be. This ties into your buddy, Matt Fientist. One of the things that he's into is slow

00:57:36.220 | travel. This concept of instead of just simply taking a whirlwind two-week trip or three-week

00:57:41.460 | trip, I can simply move more slowly and live like a local. People say, "Where do I get

00:57:49.220 | the money to travel?" You're living in it. Maybe you should consider turning it into

00:57:54.420 | cash flow instead of a roof over your head.

00:57:56.500 | >> I personally wouldn't do this because I think there are headaches and worries that

00:58:02.100 | are involved in it that I wouldn't want to have, but there are some people who would

00:58:05.660 | say, "That's right. What I'm going to do is I'm going to keep my house, my paid-for

00:58:09.220 | house, but I will rent it out, and that will be the cash flow." If you're of the correct

00:58:14.260 | temperament and your house is a reasonable kind of rental property, that too can work.

00:58:21.620 | As we've already discussed, there are a lot of different solutions. Personally, I would

00:58:26.540 | be uncomfortable in retirement having that big a chunk of money tied up in one location

00:58:32.900 | and one asset.

00:58:35.700 | The other point, by the way, that I want to make before we move on from that is that sometimes

00:58:42.500 | people will say to me when I do this analysis, "Well, yeah, but the house might go up in

00:58:47.260 | value." Well, it might, but the real estate fund also has the potential to go up in value.

00:58:54.700 | The real estate fund is absolutely a much more conservative investment than an individual

00:59:01.540 | house in that it is spread across a huge range of real estate by definition, whereas a house,

00:59:10.380 | any house, is focused on one piece of property in one specific location. It's a very -- I'm

00:59:18.580 | drawing a blank on the term I'm looking for, but it's a very focused kind of investment

00:59:22.900 | when you own a house. If you're lucky, that might mean that you outperform the fund. Just

00:59:31.340 | like picking an individual stock might outperform an index fund over some period of time. But

00:59:37.060 | if you're unlucky, or over a more extended period of time, you run into a much greater

00:59:42.220 | risk that it will underperform the broader-based index of REITs.

00:59:48.180 | >> Also, you have a specific asset allocation strategy. From reading your blog, I know you

00:59:56.980 | stick to a strategy 50% stock, 25% real estate, 25% bonds. Is that right?

01:00:02.740 | >> That's correct.

01:00:03.740 | >> When you sold your house --

01:00:05.780 | >> By the way, I do that -- I don't necessarily recommend that for everybody at all times,

01:00:11.260 | but for somebody my --

01:00:12.260 | >> I lost you there.

01:00:13.260 | >> Can you hear me all right?

01:00:14.260 | >> Now you're back.

01:00:15.260 | >> What I was saying is that allocation you just described is in fact what I personally

01:00:26.740 | do, but it's also a function of my age and my retirement status, not necessarily what

01:00:33.620 | I recommend for everybody. When I -- back until a few years ago, I was strictly in the

01:00:40.380 | stock index fund, because that's the more powerful growth tool. But as you get older,

01:00:46.980 | sometimes you want or you need more stability. You need to smooth out the ride a little bit.

01:00:53.860 | You want to protect yourself against the truly awful things that very rarely happen, like

01:00:59.700 | a Great Depression, which was deflationary, which is what bonds help you with, or the

01:01:06.180 | kind of thing that some countries have gone through, like Germany in the '30s, the runaway

01:01:11.180 | rampant inflation, which is what hopefully real estate will hedge against.

01:01:18.500 | >> That's a rational way to do it. I think a lot of Americans could learn from that,

01:01:23.540 | because I know there are many people who have $100,000 of equity in a home, and yet a much

01:01:32.860 | -- they haven't decided that -- let's just say they have $100,000 of equity in a home,

01:01:37.340 | and frankly, I don't need to be too cautious. Many people have $20,000 in stocks. I don't

01:01:44.060 | think they decided that I want to have this 80 -- whatever the number is there -- 80%

01:01:49.780 | in real estate and 20% in stock, and yet that's what they have.

01:01:54.420 | In today's culture, if you look at the consumer confidence numbers and things like that, you

01:01:58.900 | see that as goes the fortunes of the real estate market with Americans overexposed to

01:02:06.500 | real estate, so goes the national sentiment. In Florida, where I live, the dramatic decline

01:02:14.340 | in real estate values or prices and a dramatic increase over recent times in real estate

01:02:19.500 | prices. It definitely affects the national mood, and the reason is because people are

01:02:24.700 | so exposed to real estate as an asset class.

01:02:28.300 | >> Yeah, absolutely. When it collapses, it caught everybody or a lot of people off guard

01:02:37.420 | and it cost them a lot of money. Because it tends to be a leveraged investment, as we

01:02:43.180 | talked about earlier. They'd lost all of their money. They wound up owning something that

01:02:49.860 | wasn't worth what they owed on it. That's a really ugly situation to be in.

01:02:56.500 | >> You owned your house free and clear. I did not.

01:02:58.820 | >> I did not initially. I borrowed money to begin with, but at some point, I don't know,

01:03:06.060 | maybe five, six years ago, I decided to pay it off.

01:03:10.500 | >> How would you have done this analysis if you did have a mortgage?

01:03:14.820 | >> Let's take a look at that. I was going to do something else first, but we'll jump

01:03:20.380 | down to that. Let me just find my numbers on that here. Yeah, here we go. I'm just going

01:03:30.940 | to read through this a little bit, because when I wrote it, I was probably a little clearer

01:03:35.780 | than I can actually verbalize it now. What about mortgage interest payments? If you have

01:03:42.500 | a mortgage, and many do, you simply need to add an extra couple of numbers to the formula.

01:03:48.260 | We'll take a look here. Suppose I had a 20% equity, or if I put 20% down on the house,

01:03:54.820 | and using my $330,000 house as the example, so 20% of that is $66,000. I've got an 80%

01:04:03.140 | mortgage then for the balance, which is $264,000. Now my opportunity cost is $2,310. We get

01:04:13.500 | that, and we're using the same refund. That's 3.5% dividend that the $66,000 could have

01:04:22.380 | been earning if we didn't pull it out and put it as a down payment on the house. Now

01:04:27.340 | we have a little bit more in the way of cash expenses. We still have $2,500 in heating

01:04:32.780 | oil. We've still got the $7,000 in maintenance, repair, and insurance. We've still got to

01:04:37.460 | pay the $8,500 in real estate tax. Now we also have a mortgage loan. By the way, I simplified

01:04:43.820 | this number. As most people know, when you make your mortgage payment, it's a combination

01:04:49.180 | of the interest you owe on the loan and, at least initially, a very small portion of paying

01:04:54.340 | off the equity. That changes over time. If you pay it down, you're paying less and less

01:04:59.700 | interest, more and more equity, until after 15 or 30 years or whatever your term is, you're

01:05:05.460 | finally done with the thing. I'm going to assume that we've got a 4% loan, and I'm just

01:05:10.780 | going to look at interest. 4% on that $264,000 is $15,120. I'm going to estimate that as

01:05:21.500 | our interest payments on the loan. Now the other thing that comes into play, of course,

01:05:27.060 | is that when you have a mortgage, you do get a tax deduction, or at least potentially you

01:05:31.380 | get a tax deduction. I say potentially because there are a lot of things that can determine

01:05:37.100 | whether or not you actually get one and how much it will be. What your tax bracket is,

01:05:43.060 | is one, and I put that in here. For the sake of this analysis here, I picked a 25% tax

01:05:50.980 | bracket, which, by the way, is a pretty high tax bracket. The 15% tax bracket goes up to

01:05:56.580 | about $70,000 these days. Then if you look at all the standard deductions and exemptions

01:06:02.460 | you might have, if you're married and you've got a couple of kids, you're earning over

01:06:07.740 | $100,000 before you move into this 25% tax bracket. We'll use it as an example.

01:06:14.700 | The other caution I want to make, and I'm kind of digressing a little bit here on mortgage

01:06:18.980 | deductions because there's so much myth built around them, is that the standard deduction

01:06:26.300 | at the moment, which is the deduction you get before you itemize, for a married couple

01:06:31.900 | is something on the order of $11,700. It's a very large number. Until you have enough

01:06:40.900 | deductions to itemize, which means more than that standard deduction, more than $11,700,

01:06:47.460 | having a mortgage isn't going to help you one way or the other. It's also not going

01:06:52.540 | to help you except to the extent it exceeds that amount of money, unless you have other

01:06:58.100 | deductions that take you up there.

01:06:59.820 | What do I mean by that? Let's suppose that you've got this $15,000, and I'm going to

01:07:04.340 | round it, $15,000 in interest that you can deduct. What you're really able to deduct

01:07:10.660 | is that $15,000 minus $11,700, which was your standard deduction. Now, if you give charitable

01:07:18.220 | contributions or you have other kinds of deductions, your real estate taxes, that all comes into

01:07:22.780 | it. Little digression as to why there's a bit of myth around this whole tax deduction.

01:07:28.580 | For the sake of running the numbers, I assume you're in the 25% bracket. I assume that you've

01:07:34.580 | got enough other deductions to take you over that standard deduction. You're going to get

01:07:39.900 | 100% of that $15,120 as a deduction. That's going to save you, at the 25% bracket, $5,905.

01:07:54.620 | So now, what we have is a total cost of $29,525 to own and operate the house.

01:08:03.380 | Versus $24,000 to rent.

01:08:05.860 | What's interesting to me when I ran these numbers is how close that number is to the

01:08:12.420 | number owning at mortgage-free, which was $29,555. So, I mean, it's within a handful

01:08:20.500 | of dollars of being the same. Versus the $24,000 in rent. So again, you're looking at a little

01:08:27.580 | better than $5,500 premium. In this particular example, my house and my projected rent to

01:08:35.380 | live in that house.

01:08:36.380 | I hope that makes sense.

01:08:37.380 | >> Trevor: Yeah, it does. I was just looking at the numbers here again. I'd encourage people,

01:08:46.380 | when you're done driving or whatever, go click through to this post. It's worth reading.

01:08:50.900 | It is definitely interesting because one of the reasons why I especially like this article

01:08:56.620 | here is that you did take into consideration the tax deduction savings. You were generous

01:09:03.020 | with your numbers.

01:09:04.020 | >> Tom: Thank you. That's a good point. I was trying to do it on the generous side.

01:09:10.620 | Not all those caveats I just put in as I was talking about it are not in the post because

01:09:15.300 | that would kind of muddy the water. But the truth is that the tax deduction for most people

01:09:21.060 | would not be as generous as I indicated in the post.

01:09:25.060 | >> Trevor: That's where, in our tax code, many people don't truly understand how the

01:09:29.820 | tax code works. But if you look at a Schedule A and you say, "What are my deductions?"

01:09:34.260 | For many people, the major deduction is mortgage interest deduction and charitable deduction.

01:09:41.540 | There are other deductions allowed depending on your situation. But those are the primary

01:09:47.380 | ones that people jump to.

01:09:49.020 | If we just ignore, for the sake of simplicity, if we just ignore real estate tax deduction

01:09:54.700 | or if we just ignore everything else and just focus on mortgage interest deduction, with

01:09:59.900 | an $11,000 standard deduction, that means that if you were only deducting your interest,

01:10:08.020 | your interest payments need to be in excess of $11,000 for you to be worth, to come out

01:10:13.740 | ahead doing anything but the standard deduction.

01:10:16.660 | So if you calculate your mortgage payment, we're talking at minimum, I can't remember

01:10:21.300 | my calculator, I could run it, it would take, what is that, $200,000 loan?

01:10:26.100 | >> Tom: It's a pretty big loan. The other thing is, the important thing for people to

01:10:33.020 | understand is that until you get past that standard deduction, let's round it up to $12,000

01:10:38.820 | to make the math easy, you don't get anything for your mortgage.

01:10:42.500 | So if your mortgage interest is $15,000, you're actually getting a tax deduction on $3,000

01:10:49.900 | that would be above and beyond what you would have with the standard deduction not owning

01:10:54.780 | the house.

01:10:55.780 | >> So I just ran the numbers on a 4% interest rate and I say 30 year loan, fixed rate, 4%,

01:11:04.340 | you would need a $210,000 mortgage balance for your total even payment to be higher than

01:11:10.660 | $1,000 a month, $12,000, and I'm assuming in the beginning that most of that is interest.

01:11:15.700 | So those are rough numbers, but if your mortgage balance is not in excess of $210,000, ignoring

01:11:23.900 | other deductions you can take on the Schedule A, you're going to be in a situation where

01:11:28.620 | you're going to be in standard deduction territory.

01:11:32.740 | Many people take the standard deduction thinking, "I'm getting my real estate deduction."

01:11:37.660 | Well, no, it's just you handed your CPA, your tax preparer your taxes and he said, "Oh,

01:11:42.260 | we'll run this calculation, this one saves you $5,000, this one saves you $11,000 on

01:11:45.900 | your standard deduction, we'll take the standard deduction."

01:11:48.260 | >> You know, I actually have a post in the works about this very thing because you heard

01:11:54.740 | me already refer to the real estate tax deduction as a myth, and it is a bit of a myth in the

01:12:02.420 | way it is presented to people.

01:12:04.420 | It's a reality in that there is such a thing and for some people, including me, because

01:12:08.660 | of my income and also the other thing that I hesitate using the word "helped" because

01:12:14.540 | real estate taxes around here are so high and they are also deductible.

01:12:18.140 | So when you pay $8,500 a year in real estate taxes, which I did, well that gets you up

01:12:23.780 | to a level where you get over that $11,700 standard deduction pretty quickly with your

01:12:31.020 | mortgage interest.

01:12:32.020 | But setting that aside, there is this myth that is created that, "Oh, you know, when

01:12:37.060 | you own a house, you're going to get this great tax deduction, that's going to save

01:12:41.180 | you thousands of dollars."

01:12:43.380 | Well maybe, depends on you, depends on your tax bracket, depends on what other deductions

01:12:49.180 | you have, depends on where you live, depends on your real estate taxes, depends on all

01:12:52.740 | kinds of things.

01:12:53.740 | And I suspect most people, if they really looked at what they were getting, weren't

01:12:58.260 | getting what they really thought they were getting.

01:13:00.340 | And then if you go to, by the way, the very higher income people, that deduction fades

01:13:05.260 | away.

01:13:07.180 | So there is kind of a sweet spot where if you're making enough money but not too much

01:13:12.660 | money and you have a big enough house but not too big a house, maybe you get a pretty

01:13:17.620 | sweet deduction, but maybe not.

01:13:20.820 | >> Trevor: No, and that's exactly the point.

01:13:23.340 | So when you go to the phase outs on income, if my memory is correct, you can deduct interest

01:13:32.580 | on up to a million dollar principal mortgage and $100,000 on a second mortgage or home

01:13:37.820 | equity loan as long as it's used on the property.

01:13:41.020 | Is that the right number?

01:13:42.020 | Do you remember?

01:13:43.020 | >> Mike: I'm not sure.

01:13:44.020 | You're more up to date on it than I am.

01:13:45.460 | >> Trevor: I think it's a million and a hundred thousand.

01:13:47.700 | So if you say, "Okay, someone has a million dollar mortgage," and that's probably like,

01:13:53.100 | off the top of my head, it's probably about five, something like five to six thousand

01:13:56.740 | dollars a month at a four or five percent interest rate.

01:13:59.960 | So there you've got $60,000 a year of payments and when you do $60,000 a year of payments,

01:14:07.140 | now you're into a significant amount of that interest.

01:14:12.460 | >> Mike: You're in that sweet spot.

01:14:14.460 | >> Trevor: Exactly, but you've still got to look at the income limit.

01:14:17.140 | So the key is running the numbers yourself for your situation.

01:14:22.120 | I would challenge listeners.

01:14:23.740 | I've asked people from time to time, maybe you have too, Jim.

01:14:27.060 | So interesting, I've asked people, "How much tax did you pay last year?"

01:14:31.480 | And I have learned, and I'm just asking friends and other people, I have learned that most

01:14:36.360 | people can't say the number.

01:14:38.400 | They usually say, "Oh, how much did I get?

01:14:39.960 | Oh, I got back $3,000," or "Oh, I owed a thousand bucks."

01:14:44.040 | But very few people ever look at the number, which I'm going to look up while we're talking

01:14:49.800 | here, I'm going to look up the 1040.

01:14:50.800 | I think it's line like 61 or something.

01:14:53.320 | Very few people know what the actual number of tax was that they paid.

01:14:58.940 | So I challenge listeners, go back and look at how much actual tax did you pay, and also

01:15:06.580 | look and say, "Calculate that as a percentage of income and figure out what your actual

01:15:10.980 | effective tax rate is."

01:15:12.980 | And with that number, you'll be able to run your own actual calculations, which will be

01:15:17.980 | hugely helpful.

01:15:18.980 | And I think most people will be surprised that their tax rate is probably not as high

01:15:23.520 | as they think it is.

01:15:24.520 | - It's really not.

01:15:25.520 | - And, you know, I mean, as I alluded to earlier, and again, it's a little complex because tax

01:15:33.460 | rates vary depending on whether you're married.

01:15:36.580 | But if you're married and you have a couple of kids, as I said earlier, unless you're

01:15:41.660 | making end to six figures, your tax rate is 15%.

01:15:46.920 | On the federal level, now, granted there's state and local taxes that all add to that,

01:15:51.160 | but on the federal level, it's probably more modest than you think it is.

01:15:58.120 | But the other thing I wanted to do before we go on is I also did another post.

01:16:03.320 | I have an interest in Ecuador and I have kind of toyed with the idea of at some point moving

01:16:08.760 | to Ecuador.

01:16:10.600 | And I did, after I did the post we've been talking about on rent versus own and running

01:16:18.080 | the numbers, I did a follow-up post having come back from a trip I made to Ecuador last

01:16:25.080 | fall and I looked at some property down there and I thought it'd be interesting to run the

01:16:29.040 | numbers on property down there.

01:16:32.800 | And if you'll indulge me, I'll share an example.

01:16:35.760 | And this is an example where actually the numbers indicate that it would be less expensive

01:16:41.600 | to own than to rent.

01:16:45.100 | So if you're interested, I'll do it.

01:16:47.480 | - I am, keep going.

01:16:49.120 | - So one of the, I'll just pick one, we can do others if you want, but one of them, there's

01:16:54.680 | a, my favorite city in Ecuador as it happens is a city called Cuenca.

01:16:59.600 | And one of the places I looked at in Cuenca was a condo.

01:17:03.600 | And it's a two bedroom, two and a half bath condo, it's got a veranda, it's about 1500

01:17:08.200 | square feet.

01:17:09.200 | And the asking price is $162,000.

01:17:13.280 | And based on what I could ferret out, and I'm hedging myself a little bit because it's

01:17:20.520 | hard to be sure about exact things.

01:17:24.360 | Based on what I could ferret out, to rent this same condo would cost about $800.

01:17:29.880 | Now maybe if you're buying it, you could negotiate a lower price, maybe you could negotiate a

01:17:36.840 | lower rent, but we'll use the asking price and the stated rent value for running our

01:17:44.760 | numbers.

01:17:45.760 | So we say, okay, let's start out, let's assume that we're gonna pay cash for this thing,

01:17:51.160 | so we've got, which would be my situation, so that's the situation I'm using.

01:17:57.440 | So I take $162,000 out of my refund, and I buy this condo.

01:18:03.480 | And now of course, I have an opportunity cost because that $162,000 had been earning me

01:18:10.840 | at that 3.5% that we talked about earlier, $5,670 a year.

01:18:18.520 | So immediately I have $5,670 a year poorer by virtue of buying this thing.

01:18:26.200 | Now the annual, excuse me, I just had to take a drink of water there.

01:18:34.760 | The annual cash expenses, because this is in Ecuador, are significantly less.

01:18:41.000 | There are no heating and air conditioning costs because there is no heating and air

01:18:45.480 | conditioning because the climate is perfect.

01:18:49.240 | Buildings in Ecuador don't have heat or air conditioning, they're not needed.

01:18:53.240 | So that cost goes to zero.

01:18:55.640 | The homeowners association fee on this particular condo is $94 a month.

01:19:01.560 | That's $1,128 a year.

01:19:04.080 | And the real estate taxes, remember for a second, my real estate taxes here in New Hampshire

01:19:08.920 | were $8,500 a year.

01:19:11.880 | The real estate taxes on this condo for the year are $124.

01:19:20.480 | So obviously the cash costs have come way, way down.

01:19:25.880 | So the total cost of owning and operating this condo is $6,922.

01:19:32.400 | Most of that, $5,670 of it is in that opportunity cost.

01:19:39.680 | The actual out-of-pocket cash cost is $1,252 a year.

01:19:48.520 | So a little slightly better than $100 a month.

01:19:51.840 | I mean it's just much different and you look then at what it would cost to rent that place

01:19:57.880 | and that, as we decided, was $800 a month.

01:20:01.280 | $800 times 12 is $9,600.

01:20:05.200 | So if you subtract from $9,600 the cost of owning it, which again was the $6,922, now

01:20:12.680 | you're looking at an annual premium to rent and that premium is $2,678.

01:20:20.640 | Do you think that that may, just as I'm listening to those numbers, do you think that might

01:20:26.280 | be partially due to the difference in the financing system between Ecuador and the United

01:20:31.280 | States?

01:20:32.280 | In that the United States, just about anybody who's reasonably credit worthy can borrow

01:20:37.520 | money for a home.

01:20:38.840 | I haven't been to Ecuador yet, but many of the countries that I've traveled in, in Central

01:20:43.480 | and South America, the financing system there is much more stringent and so many people

01:20:50.640 | who are buying are cash buyers or are wealthier.

01:20:55.200 | Do you think that might be one of the factors?

01:20:56.960 | David Morgan: Well I don't know if it's a factor.

01:20:59.200 | It is certainly what you described is a real thing, but I'm not sure it's a factor with

01:21:06.920 | these numbers.

01:21:07.920 | I mentioned early in our conversation when we were talking about the depression and how

01:21:14.040 | mortgages became popular in this country and why, I mentioned that there were parts of

01:21:19.160 | the world where people routinely, if they're going to own a house, they pay cash for it.

01:21:25.080 | In Ecuador and a lot of South America for that matter, it falls into that category.

01:21:30.080 | There is more as I understand it, and by the way I'm way out of my area of expertise talking

01:21:34.400 | about this, so this is just my basic understanding from conversations I've had is that there

01:21:41.040 | is mortgage money available.

01:21:42.280 | It is very expensive.

01:21:43.720 | Let me define that by saying the percents I've heard are 17, 18, 20% for a mortgage,

01:21:52.480 | so very, very expensive and lots of money put down, so most people tend not to do that.

01:21:58.920 | So it is a market where if you're going to buy, you're probably going to be paying cash,

01:22:05.880 | so you just don't have the option of mortgages, but I don't think that necessarily affects

01:22:11.700 | the cost structure we described.

01:22:14.400 | It might serve in tapping down the value of property because one of the functions of having

01:22:19.680 | readily available money to borrow is it tends to drive up the cost of an asset, so one of

01:22:26.520 | the reasons that houses have gotten so expensive in this country is because it's become easy

01:22:31.400 | to borrow money to buy them.

01:22:33.360 | If mortgage money didn't exist, houses would be a lot less expensive.

01:22:38.200 | Simply supply and demand, there'd be a lot fewer people buying them.

01:22:42.560 | >> Yeah, and it also would, where my mind would go, would be that when you hear numbers

01:22:50.160 | like that, you immediately go and say, "Well, let me consider this from the perspective

01:22:54.080 | of an investor."

01:22:55.080 | I know in the past you also have been a real estate investor in individual properties,

01:22:59.640 | right?

01:23:00.640 | >> A long time ago.

01:23:01.640 | >> Okay, so that's where many people, this is one of their strategies, which is a fine

01:23:05.680 | strategy towards financial independence, is owning investment properties.

01:23:09.880 | When you get into spreads like that, where you can command very high rents as compared

01:23:13.560 | to the purchase prices, that can be a great place to consider that situation.

01:23:20.800 | It's unique down here in South Florida where I live.

01:23:23.520 | We're actually in a unique market because the rental prices are substantially higher.

01:23:33.640 | Rents are in high demand because a lot of rental units were not being built, and also

01:23:38.600 | a lot of people that were formerly homeowners are now renters.

01:23:41.960 | The rental market is very substantial.

01:23:46.440 | The numbers, there's an interesting spread, and it's changing because the market down

01:23:49.840 | here is different than a lot of the country.

01:23:52.880 | It changes month by month, but right now the house prices have been in the past a little

01:23:58.520 | bit flat, held down by financing the challenges of getting properties appraised, but yet the

01:24:04.720 | rents were increasing.

01:24:05.720 | It's actually been a really good time, not just because of low interest rates, dip in

01:24:11.000 | the market type of thing, but just rent versus own calculations here in South Florida have

01:24:14.520 | been different.

01:24:15.520 | The market dynamic.

01:24:16.520 | >>Ted Dixon Well, you know, and that sort of goes back

01:24:20.080 | to one of the fundamental principles that we've been talking about here, and that is

01:24:23.960 | the fundamental principle is not don't ever own a house, which I think some people who

01:24:30.800 | read the essay that you read for our audience and didn't read anything else I've ever written

01:24:37.080 | might have come to that conclusion.

01:24:39.320 | The principle is to understand what the numbers say about the house you're looking to buy

01:24:46.480 | at that particular moment in the particular location where you're looking at it.

01:24:50.480 | And I also want to back up, and you heard me say earlier that looking at property and

01:24:57.480 | owning a house, or in this case owning a condo, from a strictly a financial point of view,

01:25:03.800 | I would want it to not only be less expensive than renting, I would want it to be significantly

01:25:10.080 | less expensive to compensate me for the risks.

01:25:14.080 | Now let's take Ecuador as an example, but before our listeners all charge down to Ecuador

01:25:19.440 | and buy condos.

01:25:20.440 | You know, we were talking about the price of this place being $162,000 and the rent

01:25:27.480 | being $800.

01:25:28.480 | One of the challenges if you're going to buy property in Ecuador is that there is not a

01:25:34.560 | multiple listing service.

01:25:38.000 | And so the price of a property, the asking price of a property is surprisingly difficult

01:25:45.560 | to nail down.

01:25:47.320 | It's very possible that had you gone to look at this condo that I just described with a

01:25:53.560 | different realtor an hour after I was there, they might have told you this is $142,000.

01:26:01.280 | They might have told you it was $180,000.

01:26:04.340 | So you have to be very, very careful when you're buying property in Ecuador because

01:26:09.800 | it's very hard to know what the going price really is.

01:26:17.120 | And that of course, you know, it takes time and experience and what have you.

01:26:21.280 | There are a lot of Americans that I met down there charging down, everything seems cheap

01:26:25.240 | and they buy right away without understanding that what seems cheap to them might be significantly

01:26:32.760 | overvalued and they have to remember that when they go back home to California or to

01:26:39.240 | New Hampshire where I live, when the time comes to sell this condo that they just bought

01:26:44.400 | in Ecuador, they're not going to be selling it in California.

01:26:46.680 | They're going to be selling it in Ecuador.

01:26:49.200 | And if they pay too much for it because the price is very flexible in that part of the

01:26:55.120 | world, they're going to have to find another foreigner to pay that price.

01:27:01.280 | So you definitely, it's not as easy as the numbers make it sound.

01:27:07.680 | You need to look at more than just the numbers when you're looking at buying property in

01:27:12.720 | Ecuador.

01:27:13.720 | There are some unique considerations.

01:27:14.720 | And it's the same thing with rent.

01:27:16.120 | If you went to rent that place, you know, I go in and they say it's $800 a month, you

01:27:20.920 | might come in behind me and because your agent is a different agent, it might be a thousand

01:27:26.360 | or might be 600.

01:27:28.760 | So it's, you know, you have to know the market that you're operating in.

01:27:37.080 | That's great advice.

01:27:40.080 | Prior to going into the mortgage, you had something that you wanted to talk about?

01:27:43.280 | I got a couple of other things as we kind of get close to wrapping up.

01:27:46.560 | But did we talk about what you wanted to talk about?

01:27:48.760 | If I had something else, I don't remember at the moment.

01:27:51.880 | So we'll roll into whatever you want to talk about.

01:27:54.120 | All right.

01:27:55.120 | So I wanted to give just a couple of quick things.

01:27:57.120 | First, I wanted to talk about a couple of quick things on taxes.

01:28:04.200 | So advantages and disadvantages.

01:28:06.620 | You had an interesting comment on your blog.

01:28:11.800 | And the commenter was asking you about your tax calculations.

01:28:16.600 | So the major tax calculation, just for the audience, number one is mortgage interest

01:28:21.040 | tax deduction.

01:28:22.640 | That's valuable when you own a home.

01:28:24.840 | But on the flip side, if you were an investor, you could take a deduction for depreciation.

01:28:32.640 | And then, so that's one option.

01:28:35.720 | Disadvantage to owning the house as a rental unit is that your appreciation is going to

01:28:43.760 | be taxed when you sell the house, unless you do a 1035 exchange into a, sorry, for real

01:28:50.640 | estate, a 1031, a 1035.

01:28:51.640 | I can't remember.

01:28:52.640 | I think it's 1031.

01:28:53.640 | I don't recall either, but what you're talking about is if you don't actually sell it, if

01:29:00.440 | you can exchange it for another piece of real estate.

01:29:03.240 | Yeah, a like kind exchange.

01:29:05.240 | I always get 1035 and 1031 confused.

01:29:09.640 | So you do a like kind exchange into another property, but the advantage is that in the

01:29:13.720 | US, if you are able to own the property and live in it, you can defer up to $250,000 of

01:29:23.240 | gain for an individual and not its tax rate or $500,000 for a married couple.

01:29:28.640 | So this brings into play a couple of like opportunities that we could potentially exploit

01:29:34.800 | the tax code, which could be helpful for some people to factor into their thinking.

01:29:39.360 | So first of all, you had an interesting comment on your blog about a mental exercise that

01:29:45.440 | you ran back in the days of being a landlord and a renter at the same time, where you thought

01:29:51.760 | about it would be better if you just rented to somebody else and that they rented from

01:29:56.080 | you.

01:29:57.080 | Explain kind of the thought process that people could just understand that conceptually and

01:30:00.680 | what your experience was like being a renter and a landlord at the same time.

01:30:05.400 | You are testing my memory because that goes back probably 30 years when I was doing that.

01:30:13.440 | But as best I recall, you alluded to it a couple of times.

01:30:17.680 | One of the other pieces of pushback I got from the post that you read was, "Well, what

01:30:27.360 | if I own an investment property?"

01:30:29.720 | Investment properties are different and they are different for a lot of reasons.

01:30:33.320 | They are different because they are treated differently in the tax code.

01:30:37.600 | You mentioned that you can depreciate them.

01:30:40.600 | And they are different because they are generating income.

01:30:43.680 | Just like my refund generates income, in a way my house doesn't.

01:30:48.320 | Well, an investment house does.

01:30:51.360 | And for what it's worth, before I go further, I think that investment real estate is if

01:31:00.080 | you are prepared, if you do your homework and you do it well, investment real estate

01:31:07.480 | can be a very lucrative thing to do.

01:31:11.880 | What a lot of people seem to miss, or at least they miss in terms of the conversation of

01:31:15.920 | whether it's a better investment than mutual funds or some other investment, is that investment

01:31:22.640 | real estate is also a part-time job.

01:31:25.680 | And so if you are going to compare it to other kinds of investments, you have to say, "Well,

01:31:30.480 | okay, I'm going to own this rental house and that's going to be a better investment than

01:31:34.720 | your mutual fund.

01:31:35.720 | Well, okay, I'm going to own this mutual fund and I'm going to get a part-time job fixing

01:31:39.240 | cars because I have that skill.

01:31:40.560 | Actually, I don't have that skill, but it's an example."

01:31:43.720 | So you have to understand that for most people, when they go into small-scale rental investments,

01:31:50.760 | they're also taking on a part-time job.

01:31:52.640 | If you want to do that, it can be a great way to go.

01:31:57.440 | I never particularly enjoyed that part of it, which is one of the reasons that I'm not

01:32:01.840 | a real estate investor anymore.

01:32:03.320 | But when I was investing, I was living in Chicago and I accepted a job promotion that

01:32:10.000 | moved me to Cleveland.

01:32:12.320 | And so I left the properties behind and when I moved to Cleveland, because I didn't particularly

01:32:18.080 | want to own a house and my wife and I didn't have any children, we rented.

01:32:22.920 | We rented a beautiful condo that somebody else owned and we had a wonderful view over

01:32:27.880 | Lake Erie and it was terrific.

01:32:30.800 | So I had all the advantages of renting, all the carefree lifestyle of renting at the same

01:32:34.680 | time.

01:32:36.400 | I had this real estate investment, which was doing pretty well for me, and I had tenants

01:32:40.480 | and all that kind of stuff.

01:32:42.120 | So it was kind of the best of all worlds, but it was still a bit of a headache and a

01:32:47.880 | bit of a hassle and a bit of a concern being long distance that, "No, it doesn't bother

01:32:52.880 | everybody.

01:32:53.880 | It bothered me."

01:32:54.880 | So now I'm much more content to own the REIT Mutual Fund and not have the hands-on real

01:33:01.240 | estate.

01:33:02.240 | >> Yeah.

01:33:05.240 | And the other nice thing about the REIT Mutual Fund, it's liquid.

01:33:08.040 | You want out of real estate, one click of the mouse and you're gone versus 5% coming

01:33:12.960 | and going and however many months on the market, in your case, three years on the market.

01:33:17.800 | >> And you know, people, well, first of all, it wasn't consistently three years on the

01:33:21.320 | market.

01:33:22.320 | We went on and off, but three years in the present.

01:33:23.920 | But that's a great point, Joshua, because people don't often appreciate the value of

01:33:31.440 | liquidity.

01:33:33.480 | And there's enormous value in having liquidity.

01:33:36.680 | And the other comment I'd like to make on that is that I think one of the reasons that

01:33:42.880 | people have it in their heads that their house is an embedded investment than, say, a total

01:33:48.360 | stock market index fund, is that on any given day, you can go to your computer and you can

01:33:58.840 | click on that fund and you can find out exactly, to the penny, what the shares you own in that

01:34:06.160 | fund are worth at that particular moment in time.

01:34:10.200 | That's kind of a cool--

01:34:11.200 | >> And I'm going to interrupt you.

01:34:12.200 | What they're worth based upon the fact that that price is simply reflecting what somebody

01:34:16.800 | is willing to pay you at this particular time.

01:34:19.760 | >> Right, but that is by definition what they're worth.

01:34:21.840 | What anything's worth is by definition what somebody is willing to pay you.

01:34:25.080 | >> Correct.

01:34:26.080 | >> And just making the only reason I do think that that's something a lot of people don't

01:34:29.640 | think about, because they look at that price and they say, "Well, that's the ultimate underlying

01:34:34.480 | value."

01:34:35.480 | And I would say, "No, that's just simply what they're worth as reflected by the current

01:34:38.360 | price."

01:34:39.360 | But the underlying value of the investment in the world that you're talking about is

01:34:43.280 | going to be driven partly by what someone's willing to pay you, but also by the profits

01:34:46.920 | of the underlying companies.

01:34:47.920 | Sorry, that's a tangent that we get down.

01:34:50.360 | >> Right.

01:34:51.360 | And that's an important point.

01:34:52.360 | And actually, I can't think of which one, but on one of my posts I talk about that.

01:34:57.640 | The analogy I use is a glass of beer.

01:35:00.840 | You have the beer and then you have the foam on top.

01:35:04.920 | And the beer itself is the real, hardcore, tangible value of a stock, and in my particular

01:35:11.360 | what I was talking about.

01:35:12.880 | And the foam on top is all the trading noise that goes on day to day over the course.

01:35:19.280 | And most frequently, your beer is in a mug so you can't see exactly how much foam there

01:35:25.200 | is compared to how much beer.

01:35:28.400 | But anyway, backing up.

01:35:29.400 | >> I wish I hadn't interrupted you.

01:35:30.400 | I'm sorry.

01:35:31.400 | >> Yeah, no, that's just it.

01:35:32.400 | But backing up to it for a second.

01:35:33.400 | So if you own the Total Stock Market Index Fund, which is my preference, BTSAX, you

01:35:41.840 | will know at almost any given point precisely what somebody will pay you for it.

01:35:46.440 | Let's all use that terminology.

01:35:48.000 | What it's worth, what somebody will pay you for it at that moment in time.

01:35:52.280 | And that's a cool thing to know, but it can also be a scary thing to know.

01:35:56.440 | Because if it bumps up tomorrow or for the next week, you'll have this feeling of euphoria.

01:36:02.820 | If it drifts down for some reason over the next day or week or months or whatever, it

01:36:08.240 | can be terrifying.

01:36:10.040 | And so you tend to see that as a risky thing.

01:36:14.240 | The truth is that from point A today to point B, say, 10 years out, it is almost inevitably

01:36:20.080 | going to be much higher and it will make you a lot of money, probably much more money than

01:36:23.800 | your house will.

01:36:24.800 | Now, you look at your house.

01:36:26.600 | You cannot in any precise way know what your house is worth day to day.

01:36:32.840 | Now it fluctuates.

01:36:33.840 | The reality in the real world, it fluctuates day to day.

01:36:37.000 | I mean, your house today is not worth exactly what it's going to be worth tomorrow or the

01:36:42.600 | day before.

01:36:43.600 | So it does fluctuate, but there's no way that the market can precisely tell you what

01:36:48.160 | that fluctuation is going on is.

01:36:50.760 | And therefore it appears not to be there.

01:36:52.840 | And it appears to be a much more stable kind of investment.

01:36:56.440 | And I think that's one of the reasons that people are so psychologically comfortable

01:37:00.680 | owning houses.

01:37:01.680 | Intellectually, they may understand all the risks that we talked about in the post you

01:37:06.800 | read.

01:37:08.120 | But emotionally, because it doesn't seem to vary unless we get this huge down draft

01:37:14.200 | that we had where just everybody was aware that their house was going down in value because

01:37:19.200 | they could see it in their neighbors.

01:37:20.640 | But most people day to day don't know or care what their house is worth.

01:37:25.440 | And if they did, there's no real precise way to look at it very day to day.

01:37:29.720 | I mean, yeah, you can look at similar houses, but that's not the same level of precision

01:37:34.680 | that you get in the reporting that's in the stock market.

01:37:38.040 | And therefore that mutual fund looks a lot more volatile than the house in ways that

01:37:43.320 | it really isn't.

01:37:44.320 | Does that make any sense?

01:37:46.320 | >> It absolutely does.

01:37:47.800 | And I think that's key.

01:37:49.560 | One of the biggest influences on people's decisions is, I mean, it's a whole study of

01:37:56.000 | behavioral finance.

01:37:57.000 | And I think that you are accurately assessing one of the major differences between real

01:38:06.560 | estate and stocks.

01:38:08.680 | And it comes down to how people perceive risk.

01:38:13.040 | Some people would -- you would probably be one to say who would be able to accept that,

01:38:18.760 | hey, owning one house in one town in one neighborhood, that's incredibly risky.

01:38:24.640 | Both from something happens to the neighborhood, something happens from that to that house,

01:38:29.040 | something happens to this region.

01:38:31.280 | That's very risky.

01:38:32.280 | >> Something happens to my life that makes me want to not live in that particular area

01:38:36.600 | anymore?

01:38:37.600 | >> Absolutely.

01:38:38.600 | Versus, I mean, I don't know how many companies VTSAX, which you've mentioned owns, but it's

01:38:43.880 | several thousand companies.

01:38:44.880 | >> It's about 3,300.

01:38:45.880 | >> Okay.

01:38:46.880 | So there we go.

01:38:47.880 | 3,300 companies.

01:38:48.880 | So you would look at -- some people would look at that and say, I would much rather

01:38:56.880 | own a tiny little piece of 3,300 different companies, which all own plenty of real estate

01:39:02.040 | themselves versus one little house.

01:39:04.520 | But other people say that would be so risky to own that, those 3,300 companies, because

01:39:10.480 | what if that goes up or down?

01:39:12.440 | It's a matter of understanding what's actually there.

01:39:16.560 | And you mentioned -- it was mentioned in your post, and I didn't kind of point it out at

01:39:21.480 | that time, but one misconception that I'd like to mention and see if you agree, people

01:39:27.400 | have this idea that houses always go up in value significantly.

01:39:33.120 | And if you look at the numbers on that, even corrected, you can look at these numbers and

01:39:36.920 | you can correct it for the massive increases in the '90s and the 2000s.

01:39:45.120 | But if you look at it on average -- and before we -- I have the numbers.

01:39:48.440 | I've got the numbers here that you link to in your post so people can follow through

01:39:52.200 | to this.

01:39:53.480 | But if you think about it, what a house is, is it's a place to live, ultimately.

01:39:59.320 | So it has a certain amount of utility.

01:40:01.520 | So the value of that place to live is going to be driven by what the underlying wages

01:40:05.840 | are.

01:40:06.840 | So it doesn't matter if I can only afford $1,000 a month just because you want a million

01:40:12.040 | dollars for your house, I can't help -- I can't help you.

01:40:16.140 | But if I'm making a million dollars a year and you want $100,000 for your house, I'm

01:40:20.200 | probably comfortable offering you $110,000 if I know there's another buyer.

01:40:26.200 | That's why you have places with such high real estate values as compared to other places.

01:40:32.100 | If you look and chart the real estate values versus the wage values, you'll find some correlation.

01:40:36.520 | So California real estate would on average be higher priced than Mississippi real estate.

01:40:42.320 | And the per capita income of California versus Mississippi -- I haven't checked these numbers,

01:40:46.360 | but I feel pretty comfortable saying there's a correlation with California having a higher

01:40:50.600 | per capita income.

01:40:52.240 | So ultimately the true price of real estate in general is going to be driven by the inflation

01:40:59.120 | rate and the inflation of wages.

01:41:01.100 | So you link to the article and it says that by Michael Bluejay on his website -- so I

01:41:06.760 | just use his data -- the price of new homes increased by 5.4% annually from 1963 to 2008

01:41:15.100 | on average.

01:41:16.760 | Obviously that's new homes, but that's what we've got.

01:41:19.240 | So first he points out that the average new home size grew from 983 square feet to 2,349

01:41:27.760 | square feet over that 50 year period, or about 1.6% per year on average.

01:41:34.680 | So he takes out 1.6% from 5.4, factors that in, and that's a 4.2% annual growth rate.

01:41:42.520 | When you compare that to inflation, it's 4.4%.

01:41:46.700 | So to me, inflation under his numbers were higher than the growth rate of homes.

01:41:52.900 | Not to say that you can't make a lot of money in real estate, but it doesn't come from mass

01:41:58.420 | appreciation.

01:41:59.900 | It comes from buying at a deal, or it comes from forced appreciation.

01:42:04.860 | And those are the key levers that if you're going to buy real estate would be valuable

01:42:09.300 | to look at.

01:42:10.300 | Number one, is there a way that you can get a deal significantly below the market price,

01:42:13.600 | maybe a distressed sale, maybe a foreclosure, maybe somebody that just needs to move, or

01:42:18.100 | is there a way that you can force appreciation into the property and make the property much

01:42:21.660 | more valuable?

01:42:22.660 | You buy a cheap run down one and fix it up.

01:42:26.000 | But it's not because necessarily real estate goes up in value.

01:42:30.300 | It's because of the individual -- it goes up in value so much that it's basically the

01:42:34.280 | inflation rate that it tracks, but it's the individual property.

01:42:38.680 | I went on for a little bit, but comments, thoughts, do you agree, disagree?

01:42:41.880 | No, I absolutely agree.

01:42:42.880 | In fact, as you were talking, it triggers my memory that before 2008, before the housing

01:42:49.960 | market collapsed, there were people expressing concern about the rise in housing prices,

01:42:57.920 | because housing prices were rising pretty dramatically for a while there.

01:43:02.680 | And one of the concerns that these analysts would talk about was the correlation that

01:43:09.040 | you just referred to between the cost of a house and the average income of the people

01:43:15.560 | who lived in the area that potentially had to buy the house.

01:43:20.000 | And they were noticing that the value of the price of the house was far outstripping the

01:43:25.640 | growth in wages.

01:43:26.640 | And of course, there were several reasons that that continued, at least for a while.

01:43:31.920 | One of the big ones was that lenders were getting more and more generous with their

01:43:36.400 | lending terms.

01:43:38.120 | So you needed less and less income to qualify and more and more -- or less and less money

01:43:43.680 | to put down.

01:43:44.760 | So you can suddenly borrow 95 or even 100 percent of the property.

01:43:49.720 | So that allowed housing prices to increase even more beyond where the wages would have

01:43:58.240 | indicated.

01:43:59.240 | But that can't go on forever.

01:44:00.720 | And that's also one of the factors that caused it to crash, because eventually there's just

01:44:05.840 | nobody who can afford them.

01:44:07.400 | And ultimately, the price of a house is going to be tied to the wages of the people who

01:44:12.120 | live in the area that would consider buying that house.

01:44:15.560 | There was another point I wanted to make, and it slipped my mind.

01:44:19.720 | Maybe it'll come back to you.

01:44:22.200 | Yeah, maybe as we talk it'll come back.

01:44:24.680 | Yeah.

01:44:25.680 | I've got a couple of things here, just kind of as we wrap up.

01:44:29.440 | Believe it or not, we're at, what, an hour and 45 minutes.

01:44:32.560 | Yeah, an hour and 45 minutes.

01:44:35.520 | I don't mean to do these two-hour podcasts, but it seems that I get interested in a conversation

01:44:40.760 | and we get back and forth.

01:44:42.800 | And I've enjoyed it, so I hope the audience has as well.

01:44:45.200 | Well, you can tell it's hard to get me to talk.

01:44:48.080 | Me too, right?

01:44:50.000 | So I had just a couple of thoughts, and I want to read -- and then maybe these will

01:44:54.240 | spark some thoughts, and then I'll let you have the last word.

01:44:58.280 | But just some suggestions for folks.

01:45:00.280 | Number one, I'm going to repeat how you said to do the analysis.

01:45:03.840 | Four things.

01:45:04.840 | Number one, calculate your opportunity cost.

01:45:06.700 | What could you be earning on the money if you were going to invest it?

01:45:11.080 | Number two, calculate your utility costs.

01:45:14.320 | Compare those.

01:45:15.320 | Number three, calculate your maintenance, repairs, and insurance, especially with emphasis

01:45:21.160 | on maintenance and repairs.

01:45:23.400 | If you have real data, use that, so your numbers are from real data.

01:45:27.760 | But many people won't have that.

01:45:29.600 | Estimate and probably estimate higher than you think.

01:45:31.200 | And then number four, take into account your taxes and use those four things to figure

01:45:36.120 | out what the actual cost is between renting and owning.

01:45:39.320 | Now, the key thing is, however, the individual situation.

01:45:43.200 | So number one is opportunity cost.

01:45:46.400 | If somebody weren't willing to say, "You know what?

01:45:48.560 | I've got this.

01:45:49.560 | I'm going to use your numbers.

01:45:50.560 | $330,000.

01:45:51.560 | I'm going to put it into the Vanguard REIT fund, but instead I'm going to buy a boat,"

01:45:55.200 | well, now you've got a totally different calculation.

01:45:57.400 | Or if they said, "You know, I'm just scared to put money into a REIT fund," or, "I'm

01:46:00.800 | scared to put money into an index fund that doesn't fit what I'm trying to do, so I

01:46:05.160 | need to put it in the bank and now I'm going to earn .01%," different calculations.

01:46:10.160 | So that's a huge, huge calculation.

01:46:12.680 | Number two is your utility costs.

01:46:14.700 | So in your calculation in the post, heating was included in the rental but was excluded

01:46:22.080 | in the house that you owned.

01:46:24.160 | If you could do something to a house where you completely changed your heating costs

01:46:28.240 | or your utility costs, maybe you could build in something like passive solar design to

01:46:32.280 | stay warm in the winter or to lower your cost or, I don't know, wood stove or whatever

01:46:36.240 | the version is up there in New Hampshire.

01:46:37.720 | I live in Florida.

01:46:38.720 | We don't worry about cold.

01:46:42.160 | That would affect it.

01:46:43.160 | Number three, maintenance, repairs, and insurance.

01:46:45.100 | This would be where you would have to calculate one individual property.

01:46:48.600 | Is this property going to need maintenance and have higher amounts or is this thing a

01:46:51.920 | gem?

01:46:52.920 | What's the insurance cost going to be?

01:46:56.200 | In Florida, we have hurricanes and I-95 runs right through my town.

01:47:01.040 | East of I-95, insurance rates are significantly higher because it's closer to the coast than

01:47:04.880 | west of I-95.

01:47:05.880 | A big deal.

01:47:07.600 | Taxes, got to look at that and you can affect that based upon where you're going to own.

01:47:11.520 | So example is I live close between the Palm Beach County and Martin County line here in

01:47:15.800 | South Florida.

01:47:17.000 | So in Palm Beach County, property taxes are 2% per year.

01:47:20.520 | In Martin County, they're 1% per year.

01:47:22.660 | So maybe by buying smart, somebody could make some differences there.

01:47:27.880 | Then look at the buying decision.

01:47:29.840 | You got to look at what am I comparing.

01:47:31.760 | It could be that if you're comparing a traditional stick-built house to the rent that you come

01:47:36.220 | out better ahead renting.

01:47:37.840 | But if you compare that with maybe some sort of new technology, some sort of alternative

01:47:41.760 | building, maybe very efficient building technology, maybe there could be a different way to do

01:47:47.040 | it.

01:47:48.040 | So think creatively, run the cost for each one and think creatively.

01:47:52.580 | But I've loved this analysis that you've done, Jim, and I think it's been really good.

01:47:57.700 | What thoughts do you have to wrap us up?

01:47:59.100 | - Well, first of all, thank you for that.

01:48:01.580 | And I would agree with what you just said.

01:48:05.340 | You made the comment that a lot of people probably don't know what their actual repairs

01:48:09.960 | and maintenance costs are.

01:48:12.780 | That's probably true.

01:48:13.780 | And if I could make the suggestion, I think that's something that people might want to

01:48:19.040 | start tracking.

01:48:20.040 | I think a lot of people struggle with this idea that maybe their house isn't a great

01:48:25.160 | investment because they really don't know what it costs them.

01:48:28.080 | And it's not that hard.

01:48:29.640 | I mean, you can do it on a computer spreadsheet.

01:48:32.080 | You can do it on a pad of paper.

01:48:34.480 | Again, as I said earlier in this conversation, I believe in keeping things simple.

01:48:39.280 | And just jot down for a year what you spend on your house so you understand what it's

01:48:47.200 | costing you.

01:48:48.260 | And I think that's an eye-opening exercise for people.

01:48:51.240 | I think too often, because there's so much in our culture, because so much money is made

01:48:56.240 | when people buy houses, the government likes you to buy houses, the real estate industry

01:49:00.780 | likes it, the home building industry likes it, the repair industry likes it, the utility.

01:49:07.280 | There's a lot of forces putting forth the idea that houses are a great thing to own.

01:49:15.560 | And sometimes they are, sometimes they're not.

01:49:18.560 | You need to understand your own numbers.

01:49:21.200 | And that starts with keeping track of them.

01:49:24.740 | The second thing that you mentioned was you might be, instead of buying that fund, you

01:49:29.000 | might go out and buy a boat or you might put it in the bank.

01:49:33.080 | One of the reasons I suggest a proxy is it does matter what you're going to do with the

01:49:36.560 | money.

01:49:37.680 | So when you're running the numbers, and again, remember when I say run the numbers, I'm not

01:49:41.680 | saying run the numbers and find out a house is a bad idea.

01:49:45.280 | I'm saying run the numbers so you know.

01:49:48.400 | And if you run the numbers and you use a different proxy than I do, it might very well, if I

01:49:53.400 | used a different proxy on my numbers, like buying a boat or putting it in a savings account,

01:49:59.960 | it would be a very, very different result.

01:50:02.600 | And maybe a result that would say, you know what, if I'm really going to do that, I'm

01:50:07.240 | better off staying in this house.

01:50:08.960 | If I were the kind of person who was going to go out and blow the money out of Ferrari,

01:50:15.720 | high living, and it would be gone in a few years, then I'm better off staying in the

01:50:21.400 | house.

01:50:22.400 | So it does matter.

01:50:23.400 | That's why I said at the beginning, it's not, I don't care what the academic research shows,

01:50:28.920 | so much as I care what my real choice, choices in my life that I'm looking at matter.

01:50:36.240 | I don't care so much whether I'm better off renting or owning the specific house I own.

01:50:42.120 | I care, am I better owning this house or am I better renting the apartment that I want

01:50:46.440 | to rent?

01:50:47.440 | Because I care about the real world and my real life, and that's what I would suggest

01:50:51.960 | that my formula that I put in this post does for people in a way that a lot of calculators

01:50:56.840 | don't.

01:50:57.840 | And I think that's the way people ought to think about it, is how does this really work

01:51:01.720 | for me?

01:51:02.720 | How does it really work in my life?

01:51:05.120 | Because that's really what matters.

01:51:09.360 | I think those are awesome, awesome, that's such a great place to leave the show.

01:51:18.160 | And you're ringing my bell as far as what I hope this show can provide for people.

01:51:24.000 | It's just simply ideas, but at the end of the day, you've got to look at your specific

01:51:28.760 | situation and you've got to be your own financial advisor and say, "Here's what is specifically

01:51:33.040 | appropriate to my situation."

01:51:38.000 | So that's awesome.

01:51:39.000 | >> Right, and if you can look at my situation and adapt it to your needs, then the post

01:51:45.160 | I wrote has some value.

01:51:47.360 | >> And one tiny tip, just because you said to track it.

01:51:50.120 | This is something that I hope these tips are, this may only help one person, but if it does,

01:51:54.320 | I hope so.

01:51:55.560 | When you're tracking that, it would be a good idea to record the cost, record the money

01:52:03.560 | that you spend on your house, that is repairs to the house, and money that you spend on

01:52:08.040 | your house that's an improvement to the house.

01:52:11.080 | Now I don't, obviously I can't go into what is a repair and what is an improvement.

01:52:14.840 | Just think though, is this a repair or is this an improvement?

01:52:17.920 | Repair is just a straight up expense, but an improvement, if you'll track that separately,

01:52:23.280 | an improvement will add to your cost basis in a home.

01:52:26.600 | So let's say that you buy a $250,000 house and then I'm going to use wide numbers to

01:52:33.440 | show why this is important.

01:52:35.200 | If you buy a $250,000 house, you may spend $50,000 during your period of ownership on

01:52:39.960 | repairs, but if you spend $50,000 significantly improving the property, maybe adding an addition,

01:52:45.680 | something like that, your tax basis increases to $300,000.

01:52:50.440 | Maybe you spent $50,000 adding an addition and you can turn around and you can sell that

01:52:55.060 | house for, running the math as I go, $550,000.

01:53:01.640 | Well if you didn't track that $50,000, you would have had $300,000 of gain.

01:53:08.240 | Well you're going to have to pay tax on some of that gain.

01:53:10.360 | There is a rule with your personal residence, if you live in the house for two out of five

01:53:14.360 | years, previous five years, you can exclude up to $250,000 in profit from the sale of

01:53:20.200 | a home if it's for an individual or for married couples filing jointly, $500,000 of gain.

01:53:26.280 | So most people usually just simply always fall under those numbers.

01:53:30.940 | But there may be, it's possible that due to something, you may have significantly more

01:53:35.060 | gain than that and that increased tax basis, knowing it, may help you to avoid paying tax

01:53:40.080 | on the gain.

01:53:41.080 | So a little complicated there at the end, but hopefully that's a little tip.

01:53:43.660 | Just always mark on your list, is this a repair or is this an improvement, and keep separate

01:53:47.860 | records so that when it comes time to sell the house, you actually know what the actual

01:53:53.320 | accurate tax basis is in the property.

01:53:55.600 | That's a great point.

01:53:56.600 | It always pays to know what something is costing you and to take a little effort to track it.

01:54:02.460 | You're absolutely right in everything you just said about how it potentially can affect

01:54:05.860 | your tax bill when you finally sell.

01:54:09.480 | Jim, it's been fun and I've enjoyed this.

01:54:13.880 | I think we've given people some valuable info and it's been fun.

01:54:17.640 | So I just encourage people to go over.

01:54:19.000 | I'll link to all these blogs that Jim mentioned, these posts that he mentioned in the show.

01:54:24.360 | I'll link to them in the show notes.

01:54:27.200 | Click over, keep writing, Jim.

01:54:28.800 | I know this is kind of a part-time hobby for you, but I really enjoy some of your writing.

01:54:32.640 | I think you give good information and it's accessible yet accurate.

01:54:39.000 | So I'd encourage people to sign up, subscribe to your posts, and keep up the good work.

01:54:42.920 | Well, you're very kind.

01:54:43.920 | I appreciate it.

01:54:44.920 | I had a lot of fun doing this with you.

01:54:47.640 | You're going to send all these people to my blog now just as I'm about to shut it down

01:54:51.160 | and go to Ecuador for six weeks.

01:54:53.240 | You're retired.

01:54:54.240 | You're allowed.

01:54:55.240 | But they can read what's already up there.

01:54:57.840 | Absolutely.

01:54:58.840 | With that, folks, this has been another episode of the Radical Personal Finance Podcast.

01:55:03.680 | I'd love to hear some feedback from you.

01:55:05.880 | Shoot me an email, joshua@radicalpersonalfinance.com, or comment on the blog.

01:55:10.800 | Hoping to adjust this show as we go on into being something that's a valuable resource

01:55:16.400 | for you.

01:55:17.400 | I'd love to hear how it could become that.

01:55:19.080 | So give me some feedback on that way.

01:55:22.040 | Thanks very much.

RPF_0009_-_Why_Your_House_is_a_Terrible_Investment_-_Interview_with_James_Collins_from_jlcollinsnh