A Million Dollars of Housing

This article is twice a long as normal but it might save you some big money.

Get a pen and paper – I’ve made it easy for you to follow along.


When it comes to housing, I’m tempted to follow the crowd because it’s easier. However, there is a cost to going-with-the-flow and this article will make that visible.

Using the decision framework from my last post we start by considering the default decision. Watch any housing-based TV program and you’ll see the default decision in action.  There are three components:

  • We want to live in X neighborhood
  • We think buying is better than renting
  • We optimize for size relative to maximum budget

I’ve never heard a person brag that they decided to rent a small, convenient place because it was a better financial deal and they were going to live free of financial concern. We certainly don’t bother watching television shows about these people but we might read a blog, or two!

Let’s calculate the financial cost of the default option to “buy the largest place in the best neighborhood we can afford.” We’re going to use my hometown of Boulder, Colorado – one of America’s most livable cities!

I’m 43 and moved out on my own when I was 17. Over 25 years, what might the default option cost me? I’m going to explain in a way that you can calculate your own position. Start with asking yourself three questions:

  • What’s the absolute cheapest that you could live?
  • What’s the cheapest that you would like to live?
  • What’s the implication of the default decision?

At the start of 2012, the three monthly costs are $1,000, $2,650 and $7,400, respectively, and include:

  • Rent or mortgage-equivalent rent (MER) [1]
  • Insurance
  • Maintenance
  • Utilities
  • Taxes and homeowners association (HOA) fees

If you rent then you avoid many of costs of ownership (building insurance, maintenance, taxes, HOA). You also have much greater freedom in your life – freedom allows us to pursue opportunity. We never see the true cost of the status quo within our lives.

To make it real, let’s work through two choices that would apply to a family moving to Boulder.

Option A – $400,000 house in secondary neighborhood. The total cost is $31,750 per annum ($2,650 per month) which includes:

  • MER = $20,000 per annum (5% of $400,000)
  • Insurance = $750 per annum
  • Maintenance = $1,000 per annum
  • Utilities = $6,000 per annum
  • Taxes/HOA = $4,000 per annum

Option B – $1,400,000 house in a prime neighborhood. The total cost is $89,000 per annum ($7,400 per month) and include:

  • MER = $70,000 per annum
  • Insurance = $1,500 per annum
  • Maintenance = $1,500 per annum
  • Utilities = $6,000 per annum
  • Taxes = $10,000 per annum

Keep in mind that the opportunity cost of being “all in” on a house is understated because it doesn’t reflect:

  • The time to manage the house
  • The investments that you miss because you’re locked into a property asset
  • The option value implicit in the ability to change cities rapidly when you’re a renter

Our minds are extremely poor at putting a value on time, lost opportunity and geographic freedom. How can we value the path not taken?

I am able to see these benefits when I consider my key investment decisions and career moves. The ability to move, or invest, quickly has been useful to me in 1990, 1993, 1998, 2000, 2002, 2005 and 2010. [2]

Each “jump” was worth more than $100,000. Sitting here, I struggle to place a value on being able to take future jumps, and assess their likelihood. However, being trained in finance, I can calculate the future value of incremental cash flows.

What happens if I invest the incremental cost of Option B, rather than buy the default option?

  • Upgrading from $1,000 to $2,650 monthly => forsake $966,462 of future value
  • Upgrading from $2,650 to $7,400 monthly => forsake $2,782,239 of future value

The part that catches my eye is the default option (biggest place, best location) costs nearly $3 million for a place that’s exactly the same size in a secondary location. 

To make it easier for your calculations – each $100 per month is worth $58,575 over 25 years at 5%. However, you only get the future value if you save in the present and earn the target investment return. [3]

Our minds are constructed to find faults with stories that go against the default option.  Perhaps you’re thinking:

  • But what about the house – it will increase in value
  • I don’t have to pay the money myself – a bank will lend to me and that “costs” less than my own money
  • The bigger house will make me happier
  • The assumptions aren’t accurate [4]

Perhaps, but these are default options in their own right, which I’ll address over time.

If you frame the happiness/satisfaction decision as broadly as possible then you might find that you can purchase one heck of a lifestyle by purchasing frequent, novel experiences rather than being locked into an enviable, but excessive, housing situation.

Personally, I feel happy when I can exercise, read, write, share experiences with my wife and hug my kids. I have also noticed that my family responds best to time with me when I’m relaxed. [5]



[1] What do I mean by mortgage-equivalent rent? 30-year mortgage rates are ~5% right now in the US so derive your mortgage-equivalent rent by charging yourself 5% of the net capital value of your target house. Depending on your geography, this could be more, or less, than what it would cost to rent your target house. This is an interest only calculation.

[2] I am likely to underestimate the role of luck and I’ll address that later in this series.

[3] Many corporate pensions are using long-term return figures of up to 10% per annum. At 10% annual forecast return, each $100 per month is worth $123,332 at the end of 25 years. Depending on your investment return, $100 per month is worth $50,000 to $125,000 when done consistantly and invested conservatively over the long run. 

[4] 5% is the key assumption and likely understated because, in my lifetime, mortgage rates have varied between 4% and 18%. The exact assumptions aren’t essential to make the larger point that long-term costs lie hidden from consideration.

[5] When seeking to reduce expenditure, I bribe myself by spending a portion of the savings during my adjustment period. In 2011, I funded a trip to Bora Bora by downgrading my travel choices for the year. Balance the pain from adverse shifts by using strategic purchases.