Why Did We sell Our home? (Part 2)
This post is a follow-up to my last post on why we sold our home. In that post I discussed the opportunity to sell our home at a premium price and, despite the fact we loved our home, we concluded that selling our home would better enable my wife and me to change our lifestyle to include more travel. In this post I will outline how selling our home changes our financial picture to support this goal of more travel. For people nearing retirement, whether you plan to sell your home or not, this post should provide some ideas to think about.
First, I should point out that we do not have any children. We don’t need a big house so children (or grandchildren) can come to visit. If having your children visit often is important to you, then maintaining a larger than necessary house might make sense. But that is not our situation. In explaining our financial considerations regarding our home sale, it is important that you go back and read my previous post, “How Much is Your Home Really Costing You?” This post provides a process, using the 4% rule, to determine how big a claim your home and the associated expenses are making against your total investable assets.
Without going through the calculations, our home and all the associated expenses was making a $900,000 claim against our assets. If your home is claiming $900,000 of your total assets, unless you have a significant employer-provided pension, you would need to have a net worth greater than about $2.5 million to be able to sustain a lifestyle similar to the lifestyle you enjoyed while working. Remember, the 4% rule says that $1,600,000 ($2.5 million – $900,000 = $1.6 million) can only provide $64,000 per year for living expenses. This figure would not have to pay for the costs to maintain your house (those costs are included in the $900,000 figure), but health care costs, investment management fees, income taxes as well as all other living expenses must be paid out of this $64,000 figure.
If your home makes a $900,000 claim against a $1.5 million net worth, your remaining assets ($600,000) will only generate an additional $24,000 per year to pay for all other non-housing related living expenses. For most people living in a big city, $24,000 even after adding social security benefits, will not allow for a very active lifestyle.
Unless you are very wealthy, it is important that your home value and associated expenses be in proportion to your overall total investable assets. I think most retirees, who plan to have an active retirement lifestyle, should limit the claim their home makes against their total assets (assuming it is mortgage free) to around 35%. This percentage is similar to what a lender limits your monthly housing cost against your total monthly income when you apply for a home loan. There is a reason lenders have this limitation.
As an example, if you have a net worth of $2 million and you do not have any employer provided pension, your home (and second home if you have one) and all associated ownership costs claim against your total assets should be limited to around $700,000 (35% x $2 million). If the total costs to own and operate this home (i.e., your taxes, insurance, utilities, and maintenance costs) is $10,000 per year, then $250,000 needs to be set aside to fund these annual operating costs (using the 4% rule). Therefore your actual home value should be limited to about $450,000 ($700,000 – $250,000).
Of course, this is just a general guideline. Some retirees do not plan to have an active lifestyle. If your main interest in retirement is visiting grandchildren and doing some gardening, then the above home value guideline will not apply to you. But I would make certain that a non-active lifestyle is truly how you see your retirement.
In our case, selling our house greatly increased our cash flow and is enabling us to do a lot of things we might not otherwise be able to do. I will describe our particular situation in the following paragraphs.
By selling our house and renting a one bedroom apartment, we certainly downsized our living quarters. When we move onto our sailboat this fall, we will not have any rent or home ownership costs. Therefore, the $900,000 claim that our home was making against our net worth is now available to pay for living expenses. Applying the 4% rule means that this $900,000 will free up an additional $36,000 in annual funds to spend ($900,000 x 4% = $36,000). In our case we will probably need to spend an additional $6,000 per year of expenses to live on our sailboat, but that still leaves about $30,000 of additional funds per year to spend on travel and other recreational activities.
Living on a sailboat is probably not what most people want to do in retirement. We will spend 6 to 8 months on a sailboat this coming winter; however we do not want to live year round on a boat. This sailing trip is just one of the many different activities we have on our “Bucket List.” So what will we do about housing when we get back from the Bahamas late next spring?
Right now we do not know. We will see how we feel at that time. But we do have one option available to us. If you read my recent post, “My First Real Estate Investment in 13 Years,” you know we have just purchased another investment property. This property is set up as 2 one bedroom flats. If we cannot decide where we want to live, we can always occupy one of these apartments. By next spring if we decide we still like living out of a suitcase, this option will be more likely. If we decided to occupy one of these apartments, how would this impact our cash flow as compared to before when we lived in our Annapolis, MD home?
As stated above our Annapolis home, including all ownership costs, was making a $900,000 claim against our total assets. This translates into $36,000 funds available to spend per year for the rest of our lives. Our recent investment property purchase I described in the post titled “My First Real Estate Investment in 13 Years,” only required about $225,000 to acquire including all settlement and upgrade costs. $225,000 of assets translates into $9,000 of annual funds available for spending. Of course this building will also have annual ownership costs.
I have estimated that this building will have annual ownership costs of $8,000 (the property is mortgage free). After researching the recent utilities costs for the building, I have estimated that our utilities costs would be an additional $1,600 per year if we occupied the smaller of the two apartments. So our total costs to own and live in this property would be $9,600 per year. However, this is a two-unit building. The larger of the two apartments will rent for $950 per month or $11,400 per year.
Since we will be away a large part of the year, we would retain a property manager to handle any issues for the tenant-occupied unit or the building in general. The property manager charges 10% of the monthly rent, so that leaves $10,260 ($11,400 x 90%) of income available to pay for other costs of ownership. This $10,260 will cover our entire $9,600 building and utilities expenses. In other words, if we occupy one of the apartments in this 2-unit building, we will have no annual out of pocket costs for a place to live.
If we have no annual out of pocket costs for a place to live, then the $225,000 acquisition cost for the building is the only claim against our assets for housing costs. Therefore, we have reduced our housing cost claim from $900,000 to $225,000. As such this living arrangement increases our cash flow by $27,000 per year ($36,000 – $9,000). This is equivalent to an extra $2,250 per month to spend as we wish.
To be sure, this apartment is not nearly as nice of a place to live as our former home in Annapolis, but remember our goal was to spend more time traveling and less time at home. We plan to be away at least 6-months per year. Additionally, occupying this apartment would fulfill one of our other lifestyle goals; to be able to walk to everything. This apartment is within a 10-minute walk to the grocery store, the post office, the drug store, the hardware store, the newsstand, the theatre, the liquor store, a couple coffee shops, and half-dozen restaurants. Another benefit of occupying this property is that it has a very small yard, so we would have very little yard work to worry about.
Our lifestyle change is certainly not for everyone, but finding ways to increase cash flow is something that most people will need to consider as they near their retirement date.
Before ending this post, a word to those of you who think you are above having renters live on your property to help offset living expenses. The current temporary apartment we are renting in Annapolis is an auxiliary unit to a property that is worth at least $2.5 million making just their property tax bill over $30,000 per year. The owner is currently in Europe on his boat sailing around the Mediterranean. They are not above having renters help them offset their living expenses.
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