In the last post, I touched on my personal residence conundrum. Although I’m currently on a leave of absence from work right now, I do plan on returning back once my health recovers.
Assuming I do, I should easily be able to qualify for a home loan to purchase my own personal residence. I could even go as low as 10% downpayment. I’m not saying that’s what I’m going to do, but let’s just entertain the idea for kicks and giggles.
If you were in my situation:
- 30 years old
- Single (would like to get married in the future, unsure about kids for now)
- Wanting to early FI and travel the world within one year of today
- $1MM+ in debt (mortgage loans)
- Owned 2 local properties
To make simple, I’m going to select three options that all present reasonable commute times to my own work office. They are all located in equally good locations, central (enough) to Santa Clara.
Which of the following houses would you buy?
Option 1: The Bachelor Pad
1 Bedroom / 1 Bathroom
760 Sq. Ft.
This condo would make for a great bachelor’s pad! It’s modern, spacious (but cozy), and just about turnkey ready. I could move in immediately, and there would be very little work to do. I would simply have to furnish the place with just the basics… Since it’s located in a pretty good area, property values should hold steady through the years, with a good chance for appreciation. And if the need ever arose to turn the unit into a rental, I imagine that it wouldn’t be too difficult to do.
But do the numbers work? Let’s find out… Since this unit would start off as a primary residence, I’m going to run the math with just a 10% downpayment, which is what I would most likely choose to do.
As a rental, this unit would be cash flow negative on Day 1, even without budgeting reserves for vacancy and maintenance…
But as long as I was living in the unit, I would be out about $2,500/month after PITI and HOA. That’s a pretty steep price to pay, even in the Bay Area!
Further, I could easily find myself in a bind in the future, since this unit is only 1 bedroom and 1 bathroom… There’s no room for expansion, so if I’m thinking about things like kids or family down the road…
On the other hand, this unit is perfect for someone like me who adheres to the ERE/early FI principles of being frugal and living below their means. For one, I don’t like to accumulate too much junk, so by reducing my living space, you leave me little choice!
This unit would make life considerably more simple… and oftentimes, simple is good! If I could just find an amazing early FI counterpart to go along with the plan, I think I could make things work in this unit. If we split the bill, the monthly rent of $1,250/month for each person then seems a lot easier to digest…
Option 2: The Dream House
3 Bedroom / 2.5 Bathroom
1,652 Sq. Ft.
This is a dream home?!? Well, no one said it was going to be easy to have it all in the Bay Area… I like that this property is a newer construction single family home (SFH), built in 1998. Most of the single family homes in Santa Clara were built in the 1950’s, and those are pushing upwards of $800,000 now.. For around the same price, you can get one of these newer units, but of course you would have to sacrifice lot size in the process.
With this house, you can almost have it all… It’s big enough, so it leaves open the possibility for future expansion with kids in mind. The location, similar to the previous unit, is fantastic and very central to jobs, shopping centers, restaurants, etc.
The only real drawback with this house (outside of the price) is that the schools are not so great. But if you covet the best schools, be prepared to shell out over $1MM… and also be ready to continuing working for the next 20-30 years! 😉
Here are the cash flow numbers for the Dream House:
If I was going to occupy this property myself, paying out $4,800/month would obviously be out of the question. I make pretty good money, but my pockets don’t run that deep! The only way to make things work in the interim, would be to rent out the other 2 bedrooms.
Market rent, I’m guessing would be around $1,400/month, for a single bedroom that is shared and not its own unit. By renting out to two other people, I could reduce my own rent down to $2,000/month, which is not bad, and an improvement from the Bachelor Pad…
As you can see, this is why buying a “dream house” personal residence can be so difficult. The market is what the market is! So, just because a home is priced at close to $1MM, it does not necessarily imply that the rents will scale up accordingly. With that said, this home would offer much more potential for future price appreciation, as opposed to the Bachelor Pad, which is a condo.
In comparison, Rental Property SH #2 was purchased for $521,000 and it currently rents for $3,100/month, which is only $200/month less than this unit! Unfortunately, properties such as Rental Property SH #2 make for GREAT rentals, but probably not the best long-term personal residences…
Like most things in life, there’s always trade-offs…
Option 3: The Middle Ground
2 Bedroom / 2 Bathroom
950 Sq. Ft.
Option 3 provides perhaps the best compromise between the other two options. Similar to the Bachelor Pad, this Middle Ground property is a condo located in the exact same complex. The price per sq. ft. is noticeably higher, but that’s maybe a small sacrifice to make to secure an additional bedroom and bathroom.
When in doubt, let’s run some numbers:
Another cash flow negative property? Well, it’s the Bay Area, what do you expect? 😉
To make things work, I would immediately find a roommate and rent out one of the rooms. Market rent for a 2 bedroom is about $2,600, so I think it would be reasonable to ask for $1,300/month. In the short-term, that would reduce my monthly expenses to $2,100/month.
For a person with an uncertain future, I like the compromise that this unit brings, when compared to the other units. It’s sort of like the goldilocks solution… It leaves room for expansion (unlike the Bachelor Pad), and the debt load wouldn’t be overwhelming (unlike the Dream House).
In the long-term, splitting the bills in half with a significant other would lower my own rent to about $1,700/month.
What Would You Do?
Those are three like-options that I would consider, if I was thinking about purchasing a primary residence today. By no means are any of the above options affordable or a “killer” deal, but when considering an owner occupied home, I tend to place a higher emphasis on location than anything else.
I like Santa Clara for many reasons, and the main one being that it is very affordable relative to the surrounding cities: Mountain View, Cupertino, Sunnyvale, etc.
The location of any of those three homes outlined in this article would work for me; they all would provide a reasonably quick commute to and from work.
So far, I’ve been reluctant to pull the trigger on a perennial residence, because as you can see above, they all make for lousy rental properties! Selling in the future is not always an option either, because no one can predict where prices will be down the line… All it would take is another market crash to eliminate that possibly, and as we all saw last time, that can occur at any moment. Having the luxury of being able to convert a primary residence into a cash flow positive rental would do wonders for mitigating risks.
Regardless, the pure numbers show me that if I was to purchase a primary residence today, my monthly expenses for housing would look like the following:
Bachelor Pad: $2,500/month
Dream House: $2,000/month (rent out 2 units at $1,400/month each)
Middle Ground: $2,100/moth (rent out 1 unit at $1,300/month)
So, in any case, I would be out at least $2,000/month in rent. The reality is, it’s just not that easy buying a primary residence in Silicon Valley. Yes, I could compromise and buy something a lot more affordable, but then I would be sacrificing quality and location… Not to mention, I would be increasing my commute time considerably, which is something I really don’t want to do. If I was open to that idea, I would simply move into one of my own pre-exisiting rental units…
To me, the current numbers suggest that it makes more sense to be “that guy who is renting a room from a homeowner for $1,300/month”, as opposed to actually being the homeowner. And again, this has to do with the fact that rents don’t scale with purchase prices… even in the nicest locations. Otherwise, I would not have a personal residence conundrum.
Yes, owning a primary residence has its fair share of benefits (such as principal paydown and depreciation), but since I already have an ownership stake in 8 properties, that becomes less of an importance for someone in my situation.
But if I had to choose today, I think I would go with the Middle Ground solution; it provides the most flexibility and compromise between the three units.
Still, I’m not so certain that I should (or want to) be taking on even more debt…
If you were in my shoes, which home would you purchase and why? Or, would you also continue to do nothing?