Should I buy a house in the Bay Area?

You’ve worked hard. Maybe you’re married. Maybe you’re thinking about kids. Maybe you’re thinking about how your parents owned a house when they were younger than you are now. Maybe owning your own home is the American Dream, or at least, it’s your dream.

Whatever your reasons are, buying a home in the Bay Area is a huge personal finance decision. Like I’m about to borrow one million dollars huge.

(should be read as…)

I don’t know whether buying a home is the right decision for you, but I do know how to help you figure it out.

There are exactly two fundamental reasons why you should buy a home: economic and personal. We’re going to cover both starting with the economics.

Your House Is A Liability

“Your house is not an asset. It’s a liability” -Robert Kiyosaki, Rich Dad Poor Dad

Conventional wisdom would have us all believe that buying a home is an investment. Instead of lighting money on fire for rent, you turn those payments into equity by paying down your home’s mortgage.

Conventional wisdom is wrong.

Let’s set aside accounting textbooks and focus on what matters to your actual life. Your investments, aka your assets, are things you own that will make you money in the future. A stock that pays a dividend (or that will pay a dividend in the future) is an investment. Your savings account that pays you interest is an investment. Even your stock options in the company you work for is an investment (you just pay for it with your time).

But your house won’t make you any money in the future because you need to live in your house! It’s a liability. Liabilities are things that will cost you money in the future. Your car is a liability. Your student loans are a liability. Your pet is a liability (even though you love Fluffy!). So is your house.

But wait! I might sell my house in the future and buy a different house. If it appreciates, it will make money, so it’s actually an asset.

Wrong! Wrong, wrong, wrong!!! If your house appreciates, guess what? The next house you’re going to buy also appreciated. If the next house you’re going to buy is more expensive than the one you sold, that appreciation actually worked against you, and now you own a bigger liability.

No, no, no, you don’t understand. I’m going to buy a house, fix it up, and then sell it for a profit. Because of all of the work I’m going to put into my home, it will appreciate more than the next home I’m going to buy.

Wrong! Wrong, wrong, wrong!!! So now you’ve gotten into the house flipping business. You are going to buy a house for a price that a professional house flipper passed on at that price. No, the flipper didn’t miss your deal of the century. He saw it, and he didn’t want to buy it at the price you paid. How do I know this? Because if the flipper doesn’t flip a house and make a profit, he goes hungry. It’s his actual, real life job. You’re just doing this as a hobby because you want to buy a house. I know who I’m betting on.

And now that you’re out of excuses, just fucking admit it. Your house. Is a liability.

The Math

Okay, you’re stressed out, pissed off, annoyed at my writing style, or all of the above. Don’t say that I didn’t warn you. And it’s going to get worse before it gets better…

We can bucket your houses expenses into three buckets:

• Down payment: usually 20% of the total cost of the home
• Mortgage + property taxes + insurance: your monthly payment on the house
• Maintenance: repairs on your home

On a typical $1M home in the Bay Area, your costs are going to look similar to this:

• Down payment = $200,000 (20% down)
• Mortgage + property taxes + insurance: $4,700/month (4.0%, 30 year loan)
• Maintenance: $800/month (1% home value per year — remember at some point you’ll need to buy a new roof, water heater, deal with water damage, etc)

So you paid $200,000 up front and $5,500/month. An equivalent rental in SF would cost about $3,500/month. Your house cost you $200,000 down plus $2,000/month over renting.

Now in fairness, you are accruing equity in your home. In 30 years, the cost of the mortgage goes away. If years down the road, you decided to move outside of the Bay Area, you’d probably make a lot of money on the equity you’ve accrued plus the appreciation. But these are really big ifs.

In the meantime, if you invested the $200,000 plus $2,000/month in the S&P 500 over that same 30 year period, it would be worth about $4,000,000 (assumes a 7% rate of return).

Source: investor.gov

That is a steep price to pay for not having a mortgage in 30 years.

The consolation prize is that renting in the Bay Area is actually quite a good deal when you look at it this way!

Personal Motivations

This post started with a lot of really good reasons for buying a home. Things like…

• I have family here and I want to stay close to them
• Owning a home has been my childhood dream
• I’m starting a family and I never want to be at risk of moving

I’d imagine you know what yours are. These are all very legitimate things to care about. I have my own reasons for wanting to own a home. So does my wife.

But the real key here is to separate the economic reasons from the personal reasons. In the Bay Area, the economics don’t look very good, but the personal reasons are real, and they may be worth the price you have to pay. If they’re worth the price, you shouldn’t have any regrets about buying a home.

Having Your House and Eating It Too

Okay, you white knuckled your way through this post this far, so you’re going to be rewarded with options for turning your house into a better economic investment than the math above would indicate. Here are your options…

• Buy a multi-family property (or convert a single family property into a multi-family) and collect rent
• Move outside of the Bay Area at least 5 years in the future
• Do a live in flip

Multi-family Strategy

Let’s say that $1M home you bought is actually a duplex, and you can rent half of it for $3,000/month. Now, instead of paying $200,000 down and $5,500/month, you’re really paying $2,500/month. That’s cheaper than renting an equivalent unit for $3,500/month. You still had to put a lot down, but now the math is easier to stomach.

What’s the catch? The catch is that now you’re a landlord, and you have someone else living in your house. You need to do your homework and decide if you’re okay with the increased responsibility and stress this will bring into your life. You also need to be very confident in the economics of your rental unit. Eg, did you assume it would be occupied 100% of the time?

Move Strategy

If you move from owning a home in the Bay to living pretty much anywhere outside the Bay, the cost of real estate is going to decrease dramatically. If your $1M home appreciates to $1.3M while you live in it, you now have a $200,000 profit. Even better, that profit is tax free because you lived in the home you sold.

Oh, careful reader, you thought I did my math incorrectly? Wrong! Wrong, wrong, wrong!!! Closing costs are about 8% of the sale, most of which is paid by the seller.

For this to work, your home has to appreciate, and it needs to appreciate enough to cover your closing costs . This is why I’d only consider this strategy if you’ll be in your home for at least 5 years. That’s usually enough time to recover from a market correction, even a bad one like in 2008.

But this approach still carries some risk. You could “get stuck” in your home.

Live In Flip

This is similar to the move strategy, but you don’t have to move. Instead, you actually improve the property and “force appreciation” on your home. Essentially, you’ve become a house flipper, but you’re working on your own home. This strategy works well if you are legit good at DIY home improvement, or you have a general contractor in your family who owes you some favors.

Also, usually your best deals in the Bay Area are usually going to come on homes that are tenant occupied rentals… Yup, that means you get to kick out a tenant when you buy your home. “Normal flippers” can’t do that because you actually have to live in the home to be able to legally kick out the tenant. You’re also going to need to pay the tenant to move. But the most fun part is that you have to decide whether you’re emotionally okay telling someone to leave their home so it can become your home.

With all of that said, it’s still very possible to invest a lot of money fixing up a home but not forcing a higher amount of appreciation in the home. Ie, if you spend more in repairs than you get back in appreciation, you’re screwed! So do your homework and be careful.

What Should You Do?

Only you know. Your parents down’t know. Your friends don’t. I definitely don’t know. You need to weigh the personal and economic motivations against one another.

The economic factors generally don’t look very good in the Bay Area. The personal ones can be quite meaningful though. There are strategies you can use to mitigate the economic forces at play, but they all carry a lot of risk.

But here’s the silver lining, at least you know how to make your decision. Knowing that you really thought through the details vs acting on impulse will make you a lot more comfortable with your million dollar decision