Affording A Second Home

All the conventional wisdom around what you should spend on housing seems to be around 25% of post tax income.  This seems horrible to me as it doesn't control for windfalls, earnings growth, etc that a lot of us have.

To have say 10mm worth of homes, how should we think about if we can actually afford that? 

My thinking is that the down-payment should be no more than 10% of net worth and that the mortgage + taxes + maintenance can be like 33% of a conservative estimate on post tax income over next 10 years as well as a conservative return on investments say 5-8%

So to afford 10mm in housing, you would need 20mm net worth for down payments and then say mortgage and everything is 50k/month or 600k a year you would expect to have income of 2mm a year over next 10 years as well.

Comments (17)

 
  • Intern in RE - Comm
Jan 9, 2021 - 11:49am

This is a fairly boring topic. With all the excitement going on in the off topic thread recently, no one cares about how much house you can afford. 

 
  • Investment Manager in HF - Other
Jan 9, 2021 - 11:53am

I'm not sure what you are looking for. I also don't understand "insulting" (if that's what you are doing?) the board, yes it is mostly a younger group of people on this message board. But even if it wasn't, I wouldn't recommend using a message board to try and understand if you can afford $10mm in homes, there are so many variables at this income level that it is going to be highly dependent on personal situation (other obligations, income level, savings, and of course risk tolerance, etc), as someone else said it isn't an interesting conversation. 

It is pretty clear, either requires high income levels (and risk tolerance in expected future earnings) or a lot of wealth. 

 
Jan 9, 2021 - 11:51am

corporate business people approach real estate in hilariously inefficient and uncreative ways

heister:

Look at all these wannabe richies hating on an expensive salad.

https://arthuxtable.com/
 
  • Associate 2 in IB-M&A
Jan 10, 2021 - 6:58pm

There is no "conventional wisdom" on this topic. Some people say it should be 25%, others 30%, some say pre-tax, others say post-tax....who gives a shit. Everyone has their own lifestyle expectations and spend their own money how they see fit, 9 times out of 10 conventional wisdom goes out the window when impulse and "I want this" takes over. The real conventional wisdom is do what you want just don't make it someone elses problem.

 
Jan 11, 2021 - 1:45pm

thebrofessor

ok I'll bite. you're a RE expert, tell me more, I'm curious. RE is out of my wheelhouse aside from helping be a sanity check for my clients who spend one weekend in Kiawah and decide they wanna buy a condo that I have to talk them out of.

I was being a little tongue in cheek, because the original question was so ridiculous.  The idea that you should back into the value of a real estate purchase by making hypothetical calculations about your future income and then deciding on a purchase price is absurd.  Local taxes vary enormously.  Ditto utility rates and we haven't even gotten into the specifics of what types of utilities (underground septic tank?  on a w/s line?  etc).  The OP should set a budget, find a property within that budget that they like, and analyze what the expected costs of that specific property are in contrast to their expected income.  If you're trying to solve for the question of "how much (non-primary residence) property can I afford," I would argue that the responsible answer is anything you can buy outright.  This all ignores the somewhat aspirational assumptions OP has - in today's interest rate environment, a low risk 8% return is pretty aggressive thinking.  Even 5% sounds high to me.

Lets attack it from a slightly different angle.  One of your clients wants to buy a third television for their home.  They want an expensive top of the line model.  Would you tell them to look into what their future earnings are and then buy the TV on a payment plan based on that calculation, or to find what they can currently afford?  I would assume the latter.

There are tons of other complications here, because that property can be income-earning for parts of the year when you're not there, etc, but that was outside the scope.  OP is coming at this bassackwards, and if you want to think about buying a home from the perspective of slotting into a percentage of your anticipated income, then you fall into the same trap that a lot of people did in the run up to the financial crisis.  I don't think you should buy a second home all cash, but I do think that you shouldn't buy a second home that you couldn't purchase on your own.  Otherwise you're one unemployed stint away from handing back the keys

 
Jan 11, 2021 - 2:01pm

An MD at my firm was selling his house and one of the buyers said they would buy it all cash, MD said the guy had to have been an idiot to do something like that with interest rates as low as they are and market returns as high as they are.

 
Jan 11, 2021 - 2:05pm

RandyButternubs

An MD at my firm was selling his house and one of the buyers said they would buy it all cash, MD said the guy had to have been an idiot to do something like that with interest rates as low as they are and market returns as high as they are.

Yeah, to be clear, I don't think anyone should buy real estate all cash.  Obviously take out a mortgage.  But to reiterate, the OP was basically trying to back into the maximum possible house they could afford with leverage.  I think that's pretty stupid.  Sure, take out a mortgage - but if you can't comfortably afford the luxury item you're purchasing, maybe it's time to scale down or to wait a bit longer.  If you're a first year analyst at a bank and you use your 50k bonus to buy a 150k Patek Phillippe on a payment plan because you'll have many more such bonuses coming, you're going to get raked over the coals for being an idiot.  This is no different.

 
Jan 11, 2021 - 2:11pm

I bought my last home in cash and then figured out the financing later on.  It is a smart move in that dealing with the procedures of lenders can be a nightmare if you have a timeline on a home.

 
Jan 11, 2021 - 1:16pm

I advise people on this sort of thing all of the time. here's my $0.02 if you want to approach this logically - first determine if a purchase actually makes sense and you shouldn't just rent it. most people who have fuck you money don't approach things logically and simply have more money than patience so will buy real estate that ends up giving them a negative RoR or at least a sub optimal RoR

1. if you are buying it as an investment you use 2 weeks a year, treat it with the exact same scrutiny you would any other investment - what is the net CAGR after expenses, taxes, debt service, etc., and how does that compare to other uses of your cash? in theory, if your cash on cash CAGR is 2% (similar to a deal a client showed me for a beach property), you'd be better off investing your cash in something and just renting the place 2 weeks a year

2. if you want to use the property, keep the same calculus but maybe don't be as greedy in CAGR. if you're going to use it 6mos out of the year, you're not going to have an enviable CAGR, I just advise people to do the math so you know going in what your costs are going to be. often times this will cause you to buy smaller, rent more, or some combination of the two

if you've determined that buying is the move, I'd approach cash flow just like you would for any fixed something, be it your primary residence or your secondary - could you still keep it if your income went to $0 for a time or down 20%+ for an extended period of time? what if you have a few bad years of withdrawals and lose that anchor investor you've never thought twice about keeping? what if your star analyst starts up their own shop and poaches half your business and you spend years fighting in courts based on the NDA that may or may not apply? if you've got an investment portfolio that you could liquidate to cover it or you have several years of expenses in cash ready to go if an emergency arises, go ahead, but I think we've all seen too many times people have a few good years, extrapolate that indefinitely, and then upgrade their lifestyle in lock step.

a more prudent move would be as follows. say you want to establish FL residency and escape winters so you're thinking MIA. how about instead of buying a $5mm place on the golf course, you get a $1mm condo in a good location to see that you actually use it, see which areas of town you like better (maybe you hate Miami once you start living there, but now it's fun for conferences and a week or two a year), and that way you're not stuck with a house that can't quickly sell. plus, that has the added benefit of being easily left behind, you don't have 5,000 sqft of furnishings and decorations you have to unload.

and yes, my post is leaning towards anti-second homeownership. this is because of my personal experience with clients who rarely use their second homes and don't rent it out enough/receive enough in rents to justify the cost.

 
Jan 11, 2021 - 1:26pm
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