The True Cost of Home Ownership

My wife and I have made a few good financial moves in our life. Our ability to identify nice places to live and buy a home before the local market took off has certainly been one of them. I don’t consider myself some sort of a real estate genius; for the most part, we were just lucky. But the fact is, we, like millions of other Americans, have made good money on real estate.

After a four year stint in the 90s living and working overseas, we decided to move to Austin, Texas. We didn’t know many people in Austin; it just seemed like a cool place to live. We had just had our first child, and settling down in the Washington, DC area, where we had met and where my wife had grown up, just didn’t seem to fit the mold for the family life we were hoping to create. In Austin in 1997, it was possible to buy a house in a nice neighborhood for around $200,000, and to afford it on my income alone as Alice focused on raising our daughter (and two other children who came along in the next few years).

We bought a new construction home in the rapidly growing Steiner Ranch neighborhood near Lake Travis, west of Austin. We lived there until 2005, when a career opportunity had us move to Dallas. We made a nice profit at the time. Today, that house is valued at well over $600,000. In Dallas, we moved into the suburb of Frisco, which over the next decade was routinely listed as one of the fastest growing cities in America. Frisco had two high schools when we moved there. Today is has 12 (and probably more by the time you are reading this). We lived in two houses in Frisco over the next decade, and made a nice profit on each. We then moved across the Metroplex to a more rural area, where we built a custom home on two acres. That house has appreciated by over $1 million since we built it in 2015.

We have worked with a great financial planner for the past 15 years. One of his core pieces of advice was to stay within a 15 year mortgage and aim to have the house paid off before we retire, to enable “rent free” living as we age in place.

Sounds like great advice, right? For some people, it might be. But, as I will explain, for many people, staying in the house you raised your family in, even if it is paid in full, might be entirely the wrong thing to do. There are several reasons for this. As discussed in the previous chapter, an appreciated home may be located in a sedentary and isolated suburban environment, which no longer serves your needs once the priorities of schools and kid’s activities are no longer your reason for being in a place. The context for location changes, and remaining in that place can lead to stagnation and decline in physical and psychological health. We will discuss this in detail in the next chapter.

For now, let’s take a look at what it really costs to live in your primary residence, even one it is “paid off.”

As we all know, you can never really live rent free. The privilege of living in any city, town or village comes with an array of costs. Someone has to pay for those great schools, to fix the potholes in the roads, for the police, the fire department and the local parks. That property tax bill keeps on coming every year. In Texas, where we laud the fact that we don’t pay any State income tax, the bills get paid largely through property tax. Our average property tax rate is 1.8% of the value of the home per year and in many cities and towns is more like 2%-2.5%. While Texas is often touted as a “low tax” State, it is at the high end nationwide for property tax. Only a handful of States have a higher statewide average property tax rate: Connecticut (2.14%), Illinois (2.27%), New Hampshire (2.18%), New Jersey (2.49%), Vermont (1.9%), and Wisconsin (1.86%).^ California has a low property tax rate, averaging 0.76%, but the much higher average value of homes in that State leads to a very high annual dollar amount paid in property tax. Of course, this rate can vary from town to town depending on the local school tax and other factors. Let’s use 2% as an average figure for a “high property tax” State. On a $500,000 home, that’s $10,000/year. On a $1 million dollar home, it’s $20,000. My own property tax on that custom home on 2 acres was well above that $20,000 figure.

And then of course there is the cost of water, heat and electricity. Americans spend a monthly average of $429.33 per month on utilities. Annually, this is an average cost of $5,152, according to the Consumer Expenditure Survey by the U.S. Bureau of Labor Statistics. And of course 50% of homeowners spend more than the average. My monthly utility bills easily ran twice this amount. So, let’s call it, on average, $10,000/year on a large suburban family home. Now we’re up to $30,000/year for property tax and utilities.

Then we need to factor in upkeep. While some items vary widely from year to year, like the cost of a new roof or replacing an HVAC system, it seems reasonable to budget another $5,000 for stuff that needs to be fixed. On top of that there is the cost of lawn care, pool maintenance if you have one, HOA fees and the like. It’s not hard for that all to add up to $5,000 more.

So, we are at $40,000/year to live in a “paid for” house valued at $500,000. It could easily be much more. But you get my point. A $500,000 home has an 8% annual operating cost. You are effectively paying over $3,000/month “rent” to live in a paid-for home. The math improves somewhat as the value of the home goes up, provided that the increase in utility costs and maintenance does not increase linearly with home value — but regardless of how you do the calculation, it is hard to come to a scenario where the annual operating cost is less than 5% of the value of the home. Therefore, unless the value of the home is increasing by at least that amount, you may not actually be making money. Would you pay a 5% annual asset management fee on an asset that increased in value by less than 5% per year?

A financial analyst would be quick to point out that my math here is incomplete. You need to also consider the cost of the alternative. Anywhere you live will have costs for property tax (either explicit, or imputed in the rent you pay), utilities, and most likely maintenance and lawn care. But if you are living in a house that is no longer appropriate for your stage of life, you may be paying much more in operating costs than you are earning in real estate appreciation. And sometimes, that value may go down. The goal is to “right-size” and “right-place” your real estate; you need to own enough home in the right type of location for healthy living, but not so much that you are foregoing financial and personal freedom. You need to look very carefully at what the home you are currently in actually costs, and ask yourself: “if I were to free up some of that equity and downsize to a more appropriate place, how much could I make on that equity if it were properly invested?”

We saw that argument being made by the CPA I met at our town park, who sold her home and now lives in 40’ 5th-wheel RV. Her solution was radical, for sure. But her logic is sound, and she and her husband are having a lot of fun! Let’s assume, for sake of argument, that they sold their home and cleared $250,000 in capital gain. They already owned a half ton pickup truck, and I would guess that the 5th wheel ran them in the range of $75,000. That’s $175,000 that they have now invested. In a properly weighted basket of ETFs, historically they could expect to gain 8-9% per year. That’s approximately $15,000 in the first year, and with compounding it will grow quickly in the years to come. Their monthly operating cost for propane, RV park fees and maintenance might run $2,000, which is probably equivalent to what they had been paying on a mortgage if their home was not paid off. Now let’s assume that they had paid off their home, and walked away with a $500,000 gain. Now, after investing the net proceeds of $425,000, they will earn on average $35,000 in the first year in dividends and capital gains, versus $24,000 in annual costs, and those earnings will compound each year. The RV will depreciate by around 10% per year, and they will likely end up replacing it every 3-5 years. But in the meantime, they are saving thousands of dollars per month.

This is only one model for a radical change that puts the true cost of home ownership into perspective. There are countless other permutations of the model, and this blog will help you to figure out what structure is right for you. But the thing I want you to walk away with is the idea that it is possible you have too much equity in your home, and that there are better ways to deploy the funds.