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Designing Your Home Ownership to Retire Earlier

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The following is a guest contribution from reader and blogging friend Chris Mamula, a pending early-retiree in his 40’s. Chris has been writing on personal finance topics for several years. His efforts first came to my attention with his insightful review of my second book. In this post, Chris explores how to craft home ownership to support an early retirement, requiring less retirement savings while improving the quality of your life….

For many years, my wife and I made two assumptions about owning our home to facilitate our early retirement:

  1. We should live in a low cost of living area, pay our home off quickly, and own it outright. We could then essentially eliminate our housing expenses during retirement.
  2. Our home would be a safe investment because it would increase in value while simultaneously providing our family shelter.

Over the past year, I began studying real estate investing as a way to diversify our current portfolio that consists primarily of paper assets. As I learned, I thought about ways to incorporate real estate investing principles to reframe how we would approach buying our next home.

First we challenged our original assumptions. Real numbers told a different story about the cost of home ownership. Then we made the conscious decision to approach our next home as an investment in the life we truly want. This allowed us to decrease retirement savings needs by six figures while simultaneously enabling the lifestyle we desire.

The True Cost of Home Ownership

One of the most important decisions we made when getting serious about planning our early retirement was tracking our expenses. We have been doing this for the past three years and the information we gleaned from this process has been eye opening.

The US Bureau of Labor Statistics reports that on average the three largest areas of spending for most households are housing, followed by transportation, and then food. We originally assumed that because our spending is drastically different than the average household, these statistics did not apply to us. Our actual numbers told a different story.

Last year our biggest expense again was food, followed by housing and then transportation. Our numbers show that we do spend far less than the average household on housing and cars, and our overall spending is also subsequently less than average. However, even with a paid off home and cars, our three biggest areas of spending are the same as most everyone else.

The other thing that we have realized by tracking and analyzing our spending is how intertwined our housing decision is with other spending and quality of life. You may have a lower initial purchase price on your home by living away from work or popular attractions. However, it is easy to then make up for that with increased time and money traveling to work and entertainment.

This was certainly our case. Our transportation costs were driven by my hour round trip daily work commute and the fact that we live at least an hour one-way from our favorite hobbies: skiing, hiking, and rock climbing. Getting to good skiing or climbing in bigger mountains has required a full day drive to New England or a cross-country flight west. We typically take 2-4 such trips each year.

Next we looked at our assumptions that our home was a safe investment.

Is Your Home An Investment?

We built our home in 2005 for approximately $250,000. Since then we have done several costly upgrades totalling over $20,000. This brings our cost to over $270,000 before accounting for routine maintenance, property taxes, mortgage interest, and other expenses associated with home ownership.

Twelve years later, comparable homes in our area are selling for $240,000-$260,000. Even without factoring in real estate commission and taxes on the sale of our house, we have virtually no chance of recouping our initial capital investment, let alone making money on the transaction.

At the same time, as compared to our diversified paper portfolio that can be sold off strategically to our benefit, our home represents a large undiversified percentage of our capital tied up in one place. Needing to sell it when we want to move adds stress when watching our local market stagnate while most of the nation’s real estate prices soar.

As we planned what we wanted our life to look like in early retirement, we realized that if we wanted our home to be a good investment, we would need to approach it as investors.

Looking At Home Ownership As An Investor

As I read about real estate investing, one principle that I found useful in my introduction was Robert Kiyosaki’s concept of assets vs. liabilities. Kiyosaki says that your home is a liability, not an asset. His definitions essentially boil down to cash-flow. He defines an asset as anything that creates a recurring cash inflow to you, while a liability is anything that creates a cash outflow.

This definition is certainly oversimplified and not comprehensive or accurate from an accounting perspective. However, it has been extremely useful to help me challenge my assumptions. This concept helped create a different framework going forward as we looked at our home as a potential investment that could change our retirement equation.

Considerations When Buying A New Home

As we began to look for a western mountain town to live in for our early retirement, we did not throw out all conventional wisdom.

On a macro level, we narrowed down our list of potential ski towns first by affordability of housing. We wanted to go somewhere that we could use the equity from our current home to purchase our new home with cash or a very small mortgage.

On a micro level, once we honed in on Ogden, UT we tried to get the best price possible on our home based on local market conditions.

However, we went a step further. Rather than making unnecessary assumptions, we paid close attention to knowing our own personal numbers regarding how our housing decision would affect our overall expenses and lifestyle.

Going back to Kiyosaki’s asset vs. liability principle, we looked at how we could limit the liability of our purchase and possibly create a cash flowing asset.

Limiting Liability

We recently purchased our new home for $240,000. It has nearly identical finished square footage and lot size to our current home in Pennsylvania. It is an older house, but has been extensively remodeled in the past ten years.

The major items (roof, windows, furnace, plumbing, electric, etc.) are the same age or newer than in our now 12-year-old “new construction.” We therefore are assured that we will not have to carry a mortgage once we sell our current home, and the carrying costs (utilities, maintenance, etc.) for the new house should be very comparable to our current home.

Property taxes in Utah are far lower than in Pennsylvania. This comparable house has annual property taxes of $1,600 compared to our current $3,300 property taxes. This means a direct $1,700 annual reduction in liability of home ownership.

Choosing to live in a mountain town will also drastically reduce our indirect expenses associated with our current residence while increasing access to our favorite activities. On a day to day basis, we will now have only a 20-30 minute drive to world-class skiing in the winter. In warmer months, local climbing, hiking and paddling days will now mean walking from our front door to the trailheads or a short 10 minute drive to water activities. This will give us increased access at decreased cost compared to our current hour plus one-way drive to resorts, trailheads, or lakes.

Our travel expenses will decrease greatly. We will also have six additional world class ski resorts in the canyons around Salt Lake City an hour south and Jackson Hole about three hours north. We can drive in our own car and total cost will be the price of a day lift ticket. Previously, we have spent $2,000-$3,000 for a long weekend to fly across country, rent a 4WD vehicle, and pay for hotel rooms before ever purchasing expensive day tickets.

Likewise in the warmer months we will be less than a day drive to many of the west’s great parks including 6 national parks in Utah and the Grand Canyon to the south, and Grand Teton and Yellowstone national parks to the north. This will eliminate the expense of long trips to get to outdoor destinations.

Lowering our property taxes and reducing our transportation and travel expenses should save us in total at least $5,000/year based on our prior years’ expenses. Using the inverse of the 4% rule, we would need to save 25 times our annual spending to support that spending with a traditional stock/bond portfolio. Therefore, reducing this liability means needing at least $125,000 less retirement savings while improving quality of life.

Creating an Asset

Originally, when thinking about moving west we were focused on controlling or even decreasing the liability of home ownership by simply buying a smaller, cheaper home than our current residence.

As we thought about what is really valuable to us, we wanted to have the space to host family and friends. In particular, we wanted to have a place for my parents, who are retired and have a close relationship with our daughter, to stay comfortably for extended periods.

Real estate investor/educator Chad Carson writes about a powerful strategy for new real estate investors that he labels “house hacking”. As he describes the strategy: “A house hack basically means that you buy a small multi-unit real estate property, live in one unit, and rent out the others.”

While we had no desire to live in a duplex or triplex and be landlords to our neighbors, we applied the lessons of house hacking to our personal situation to allow the lifestyle we desire.

We recently became regular customers and big fans of Airbnb for the comfort and value they provide when traveling with our family. We considered being Airbnb hosts.

We thought that if we could find the right property, it could provide us with a smaller, lower-cost main living space that we desired, a comfortable place for family and friends to stay with us as desired, and a potential cash flowing asset when not in use.

As stated above, our newly purchased home has roughly the same square footage as our current home. However, the layout is far different. The new home provides a much smaller primary living space. We also have a separate two-bedroom, one-bath space with a kitchen and living room with a private entry.

Using the extra space as an Airbnb, it should net a minimum of $100/night rented. If we extremely conservatively assume we could rent 50 nights/year (approximately 50% of weekends, no weeknights), we would make $5,000/year. Doubling to 100 nights/year is a reasonable estimate and would yield $10,000/year.

Returning to the inverse of the 4% rule, earning an extra $5,000-$10,000/year would be the equivalent of not having to save $125,000-$250,000 dollars for retirement.

From the standpoint of an investment, this is the equivalent of a 2-4% cash-on-cash return on our primary residence. Unlike our prior assumptions, we are not relying on any appreciation to make money. Any appreciation in home value will only enhance returns.

If we decide we hate being Airbnb hosts and never make a penny from this plan, we have controlled our downside risk by limiting our liability. We also avoided using any leverage to further limit downside risks.

A Message Bigger Than A House

This post introduced some real estate investing ideas that may be new to you. It also demonstrated the application of the concept of using personal spending to calculate retirement saving needs. However, focusing only on specific technical points would miss two much more valuable lessons.

First, to enable the life we truly want we needed to master basic simple fundamentals of personal finance. Tracking our expenses is Personal Finance 101 that “everyone knows,” yet few people actually do.

Our faulty assumptions were the result of the fact that we did not track our expenses for the first decade of our careers. Knowing our personal numbers now allows us to see how much we spend, where our money goes, and what drives our spending. This in turn enables planning in creative ways.

Second, if we want to live a life different than the standard 40-hour work week until age 60 or 70 there are multiple ways to do it. Conventional wisdom is that early retirement requires taking large risks and requires complex technical planning. You must make and then save massive amounts of money or live a life of extreme frugality.

Planning our early retirement has taught my wife and me that simply taking the time to choose what is important to our family and thinking about creative ways to get it can change that entire equation.

As this example showed, we were able to conservatively decrease the retirement saving needs for our family by $125,000 just by decreasing the liabilities associated with owning our current home. By using our new home as an income producing asset, that number very conservatively becomes greater than a quarter million dollar difference in retirement saving needs.

At the same time, this decision will enable us to live the lifestyle we desire, adds no financial risk to our current situation, and requires no sophisticated financial products or techniques. If you design your home ownership as an investor, it can turn into an asset that will help you retire earlier!

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