There are two types of financial decisions: Good financial decisions and educational decisions. We’ve purchased four homes and did well with one, did okay with one, lost our rear end in one, and our current one we’re cautiously optimistic on. The biggest lesson we’ve learned in home ownership is the power of scarcity.
The first component of a house is land. A homeowner/developer must have enough land to build a house. The problem with land? They’re not making more of it. Now if you’re driving through parts of the US, (ahem – New Mexico, Texas, Nevada), you’re thinking that land isn’t scarce. If you live in an urban area, open land for purchase is either really expensive or just doesn’t exist. Even worse, sometimes you have to buy a house on land just to tear it down! Now that sounds costly.
We stumbled into scarcity in our first house. I had just started my first job and my wife was in her second year of vet school. It was 2004, we wanted out of an apartment, and financing was easy. We could afford a townhouse, but there were only two townhouse developments near the college and both were 20-30 year old properties. These houses were in high demand because most of the new construction was three-story condominiums close to the college or very expensive single family homes. New townhouses were going up, but were a 15-20 minute commute away. Land was tough to come by because school was in the mountains. We identified two developments, got familiar with market pricing, then waited. We occasionally went out to the two neighborhoods, looked around, and scoured newspaper ads every week. Zillow was just a creation in someone’s mind then, it was mainly newspaper and clunky websites from the local real estate companies.
We eventually found a for sale by owner, quickly determined they wanted a fair price, then sent our real estate agent to work. Their negotiating point was a 90 day closing, which we were happy to oblige with and the deal was done. It was a wonderful house we owned for three years, enjoyed a convenient location, and realized 30% appreciation because of the timing. The original plan was to keep this as a rental, but when we were 25 and sitting on a negative net worth, it was difficult to give up that kind of appreciation. (It turned out to be a good choice, as prices have finally recovered to what we sold it for 12 years later.) We were rock stars in housing!
The Atlanta Lesson – 2007
The profits were rolled into the next house, a whopping five bedroom house in the suburbs of Atlanta in which would become the most expensive lesson we learned: Don’t buy the tract built subdivision house! Atlanta was ground zero for the housing bubble. The city didn’t see the type of price appreciation that other cities, but saw a rapid expansion of new home construction. Atlanta is a generally flat city surrounded on all four sides by farmland and pine trees. The city is also permanently stuck at 1-2% economic growth until they can improve transportation.
We were amazed at just how much house we could get if we moved nine miles away from my office, which was already just outside the city limits. When we combined the down payment plus the fact I could borrow almost 4x my new salary, we could buy a house bigger than anything our parents had. Success in America! (Except that all our neighbors were 10+ years older and I just signed up for a terrible commute)
There was all that farmland and all those pine trees. Atlanta had miles and miles of roads heading out of the city with new subdivisions showing up on all of them. The area experienced a 5+ year boom in building, to the point where a large portion of their economy was based on jobs related to new residential construction. The music stopped when money stopped flowing freely and unemployment rocketed over 10%. Our house we bought was suddenly worth 30% less. Not just 30% less than what we paid, but 30% less than the cost to build it!
To complicate matters further, we had taken on a bit of debt relative to what we made the first two years in the city, so we started aggressively paying down the mortgage to not be underwater (might have been better putting that money in an S&P 500 fund in March of 2009 eh?). We had also been burned so badly by the price shock, but didn’t really have the liquidity to buy rental real estate. We missed out on a once in a generation opportunity to pickup rental real estate in the city and retire much earlier. (Check out some of Paula’s stuff at Afford Anything, the deals were incredible!*)
It wasn’t all bad, the house was near a national park with 16+ miles of trail running, had a great screened in porch, and a nice back yard for the hound dog. We lived in that house for seven years and sold it for $30,000 less than we paid. It also came with $40,000 or so in large ticket maintenance over that same time and turned into our most expensive financial lesson.
After the Pain
We’ve taken a similar strategy to our first house since that Atlanta experience. We briefly bought another house in a college town and made another few hundred mistakes in learning how (not) to renovate a house, but but the losses were minimal because of the land it sat on and underlying rental potential.
Our current home we bought was after living in the area for almost a year and understanding the city. We determined the place with the most valuable land were a residential areas that sat between/around the largest employment districts. The neighborhood(s) had 1920s to 1950s original houses, then somewhere in the mid-90’s homeowners and developers started buying individual houses and doing “raise and rebuilds”. Homeowners and builders would replace a 3br house on an expensive lot with 4,000sqft monstrosity of a house (really, who wants to pay $30,000 in property taxes a year!). We found a particular six block area within a 15 minute drive of my office and started looking for houses. The immediate problem was most of the small houses that would come up for sale would either immediately be sold to builders, or the sellers were asking such a premium over lot value for a house in disrepair it just sat there unsold. The rare small house that was taken care of and priced fairly wouldn’t hit the market. A couple of realtor’s that farmed the neighborhood would put up a “coming soon” sign then the house would sell.
We took our time and walked the neighborhood multiple times per week. Eventually a coming soon sign came up one street over from our rental and we bought a nice 1950’s house that’d been well maintained and had reasonable sellers. They were happy to get a small premium over lot value and move on to their next house. The commute to the office and into downtown is fairly easy and we’ve been putting minimal miles on the car. I’m cautiously optimistic about this house holding its value because every month one to three of the small houses in this neighborhood are torn down and replaced with one of these:
Time will tell if this works out as we intend on selling this home and moving when we declare early retirement, but we’ve become firm believers on the power of scarcity. If you buy a home in an area with scarce land and near employers, you can avoid/soften the chances of a huge hit in real estate.
*I believe Paula is fearless. If you listen to some of her interviews and what she did for the rental properties, its really impressive the lengths she went through to preserve capital to make the next purchase. We were in Atlanta during that same time and chilling in a 5br house and watching Cable TV. I don’t want to take anything away from the amount of hard work and sacrifices that she or others like Adventuring Along chose to make in their 20s. The high returns in real estate were a once in a generation opportunity, but high returns are only part of the equation and probably only accelerated their retirement dates by a few months. Most others, including us, have benefited from one of the best bull market runs in the history of the S&P.