Given our primary residence is likely one of our largest assets, buying responsibly is prudent. At the same time, living a better lifestyle by owning a nicer home as we get wealthier is also something many people desire.
Therefore, let's try and figure out what our appropriate primary residence value should be as a percentage of net worth. I've got a certain percentage in mind that will help maximize lifestyle.
The percentage will also provide enough investment exposure and minimize financial worry for being too house rich.
Keep Your Primary Residence Value A Reasonable Amount
One great thing about a bull market is that the unnecessary big-ticket stuff we buy declines as a percentage of our net worth over time. If we can survive the initial liquidity crunch after purchasing a house, things tend to turn out well.
You could actually make more from your house than your salary too. Given the house price is usually much greater than your salary, even a small percentage increase in your house price could surpass your cash flow savings.
For example, let's say you have a $100,000 net worth that is all in your company's stock. You inexplicably purchase a $50,000 BMW even though you only make $80,000 a year. That's unwise because you just spent 50% of your net worth and 62% of your gross income on a car. Driving a beater or taking public transportation would have been more appropriate.
However, let's say your company hits it big and your company stock grows to $5,000,000 in 10 years. If you still own your car, its original purchase price only ends up being less than 1% of your net worth. Meanwhile, you were able to enjoy a fun vehicle for 10 years. Therefore, purchasing a $50,000 BMW 10 years ago turned out to be a good gamble.
I want to do the same type of thought exercise with a house. How much should we really “gamble” to live a better lifestyle today?
Using net worth as a variable to determine how much home one should buy or continue to own is a useful exercise.
The Average American Has Most Of Their Net Worth In Their Primary Residence
The typical American has over 70% of their net worth in their primary residence. As a result, the typical American got blown up during the 2008-2009 Global Financial Crisis.
As the housing market tanked, so did the fortunes of ~67% of Americans who owned homes back then. Granted, stocks and other risk assets also got crushed.
From the Global Financial Crisis, we've learned that it's prudent to be diversified. We also learned that having the majority of your net worth in one asset with debt is not the best idea.
At the same time, during a housing bull market, going all-in on real estate is fantastic for wealth creation. Therefore, we need to think of a good balance.
The global pandemic has made millions of us appreciate our homes more. Given we're spending more time at home, it's only natural to assign a greater value to real estate. The key is not to overextend ourselves.
The Ideal Primary Residence Value As A Percentage Of Net worth
In my opinion, the ideal primary residence value as a percentage of net worth is no more than 30%. This is a percentage to eventually shoot for as a first-time homebuyer. For veteran home buyers, you can use 30% of your net worth as a barometer for your next house purchase.
For example, let's say you are a first-time homebuyer and have a $300,000 net worth with a $100,000 household income. The bank says you can borrow up to $350,000 to buy a home. You decide to borrow $280,000 and put down $80,000 on a $360,000 home.
A $360,000 primary residence equates to 120% of your net worth. This is a common scenario most first-time homebuyers face. With a $1,300 a month mortgage and an $8,333 a month gross income, you should have no problem affording your house.
With 30% of net worth as the ideal primary residence value, you have a target net worth of $1,200,000 ($360,000 / 30%), based on the original purchase price of your primary residence. Your goal will be the earn, save, and invest as much as possible to boost your non-primary residence net worth equal to $900,000 ($1.2 million target minus existing $300,000 net worth).
If you can save $10,000 a year for 26 years and earn a 8.3% annual return, you'll be able to accumulate a $900,000 non-primary residence net worth. If you boosted your savings by $20,000 on average, you could accumulate a $926,000 non-primary residence net worth in only 19 years, assuming the same 8.3% annual return.
Depending on how much your primary residence appreciates in value during this time, you may have to shoot for an even higher net worth. Challenge yourself to keep actively building wealth.
Grow Into The Value Of Your Home
If you end up following my 30/30/3 house-buying rule, then you will most likely achieve the ideal primary residence value as a percentage of net worth within 15 years. The idea is to buy responsibly and grow into your home as you get wealthier. This way, you get to live a better life while using other people's money.
If you buy your first home at 30, by 45 you should be sitting pretty. Your wealth should have grown tremendously during this time period. So should your home's value. Within 15 years, you should feel very at ease with the ongoing cost of owning your home.
Your 40s and 50s are when you will likely start to tire from the work grind. Your risk tolerance may also decline given you may have parents and children to care for. As a result, having your primary residence equal to the minority of your net worth is a prudent goal.
However, if your net worth grows much quicker than the average person and your home’s value, then you may consider buying an even nicer home. This is a predicament many people are now facing thanks to a bull market since 2009. Many people find they live in their homes for less time than they originally planned. Enjoy Your Forever Home For Now; It Will Likely Change
Upgrading Your Home As You Get Wealthier
During a YOLO economy, the propensity to spend more on a better life increases. In early 2020, my increased awareness of death and destruction all around propelled me to pay up for a nicer home.
Given many of us value our homes so much more since the pandemic began, it's natural to feel OK spending a higher percentage of your net worth on a home. In addition, many of our investments have gone up as well.
But given our net worths are already up a lot, I encourage you to stay disciplined and stick to the 30% figure when buying a new home. A larger net worth already gives you the green light to buy a nicer primary residence.
Many of us will never be as frugal as Warren Buffett. He bought his primary residence in 1958 for $31,500. Today, his Omaha house is worth roughly $300,000.
Sure, Warren's house is massive with 6,570 square feet. But compared to his $100 billion net worth, $300,000 is nothing. So let's throw Warren's primary residence example out the window. Anybody who references Warren Buffett is not arguing in good faith.
Realistic Home Upgrade Example Using My Net Worth Guide
Instead of using Warren Buffett as an example for how much home to buy based on our net worth, let's use a more realistic example.
Let's say your net worth was $3 million on January 1, 2020. You own a wonderful 2,650 square foot, 4-bedroom house in Charleston, South Carolina that was worth $630,000 in 2020. You've lived in your home for eight years and bought it for $380,000 in 2012 when your net worth was just $500,000.
I use Charleston, South Carolina as an example because it consistently comes up as one of the best cities to buy real estate in America. Below is an example of your existing primary residence now worth ~$750,000 in 1H2021.
Fast forward to today. Your net worth is up 60% due to strong investment returns and savings. With a $4.8 million net worth, you're itching to buy an even nicer home.
Living in your home for 10 years is a very respectable amount of time. However, you want more land for the kids to run around on. You also want a pool and a hot tub! Besides, with your current residence valued at $750,000, it only makes up 15.6% of your net worth.
Your New Primary Residence For $1,250,000
Based on the target primary residence value equal to no more than 30% of your net worth, you can now buy up to a $1,440,000 house. If you sell your current house for $750,000, you're only spending $690,000 more if you go to my target maximum.
That said, buying a house that's almost double the value of your current house feels like too much. Therefore, you look for a $1,250,000 house that equals 26% of your greater net worth instead. Anything cheaper and spending all that time and money moving probably isn't worth it.
You've found your $1,250,000 new primary residence in the picture below! So much land to play games!
Invest The Difference If You Did Not Buy
One of my favorite things to do as a savvy investor is to invest the difference based on what you could have bought. Not buying what you could have bought often feels like a win, especially if you're a frugal person.
In the above example, you can use the leftover $190,000 that you saved from not buying a $1,440,000 house and invest it a real estate ETF, a REIT, or in real estate crowdfunding. This way, you get to live in a nicer home and maintain an appropriate amount of real estate exposure as your wealth grows.
In 2017, I reinvested $500,000 of my San Francisco rental house sale proceeds into real estate crowdfunding. My goal was to diversify, maintain real estate exposure, and simplify my life.
As a new father, I no longer wanted to deal with this property's tenants and maintenance issues. At the same time, I wanted to keep earning passive income because my post-work lifestyle depended on it.
Check out Fundrise, my favorite real estate crowdfunding platform where you can invest in diversified institutional real estate funds. For most investors, investing in a fund is the way to go.
The Ideal Amount Of Time To Live In Your Primary Residence
Even though investors have made a lot of money since the pandemic began, it doesn't make sense to move every couple of years, no matter how much your wealth has grown. Moving is a pain in the ass. Further, transaction costs eat away a large percentage of potential profits for short-term holders.
Therefore, I say it's worth reassessing whether you want to buy a nicer primary residence every 10+ years. The duration is very similar to the ideal length of time to own a car.
Ten years gives you a long enough time to get settled in and enjoy your home. Ten years is also a long enough time to ride out most real estate cycles. If your net worth compounds by 7.2% a year, it will have doubled in 10 years as well. At which point, you are more than welcome to upgrade if you like.
If you have children, it's generally a good idea to provide as stable of an environment as possible. I moved around every 2-4 years as the son of foreign service officers. It was an adventure, but it was also heartbreaking each time I had to leave my friends. Therefore, if you are to upgrade, it may be best to upgrade close by.
Finally, by the time your kids leave the house, you might want to downsize not upsize. Therefore, it's up to you to run the numbers and decide what your best life looks like. Frankly, the best time to own the nicest house you can afford is when your kids are living with you. It's not like you're going to upgrade to an even larger and nicer house once they are gone.
Ideal Primary Residence Value As A Percentage Of Net Worth By Age
The following house buying or house ownership guideline is pertinent for the majority of people. If you are somehow able to strike it rich early on and buy your first or second primary residence for less than 30% of your net worth, more power to you.
- Age 25 – 30: 80% – 200% of net worth – Shoot to buy a primary residence by age 30. For most first-time homebuyers, the value of their house will be way more than their net worth. And that's fine, provided your income continues to grow.
- Age 31 – 35: 60% – 150% – Work to grow your net worth through aggressive savings and investing
- Age 36 – 40: 40% – 100% – Shoot to have your primary residence equal to a minority of your net worth by age 40
- Age 41 – 45: 20% – 50% – Shoot to have your primary residence equal 30% of your net worth by age 45
- 46+: 20% of net worth or less if desired
Again, the typical American homeowner has 70%+ of their net worth tied up in their primary residence. They are house rich, cash poor. Ideally, I'd like for all of us to be house rich and cash rich.
Related: Income And Net Worth Requirements To Buy A House At All Price Points
House Rich And Cash Rich Is A Nice Combo
Be house rich because home values have grown over time. Also be house rich because our homes have provided us a better lifestyle than a rental would have. Eventually, we might end up living for free because our home values have grown so much.
Meanwhile, be cash rich because we have tremendous investments outside our primary residences. These investments not only may generate solid investment returns, but they may also generate growing passive income.
By our mid-40s, our primary residence should almost be an afterthought. It should be a small percentage of your net worth. Getting our living costs out of the way frees up our time and energy for other things.
At the same time, once your primary residence is valued at 10% or less of net worth, you may start feeling like you're being too frugal.
Live Better As Your Net Worth Increases
What's great about using percentages as a guideline is that it's applicable to various levels of net worth.
If you've got a $10 million net worth, the ideal net worth for retirement, owning up to a $3 million primary residence isn't unreasonable. The past several years have minted new deca-millionaires who've been used to being frugal.
If you're rocking a $200 million net worth and feel conflicted about whether to upgrade to a $30 million mega-mansion from a $10 million home, my 30% guideline should help. Suddenly, $30 million seems totally reasonable since it's half the amount you could responsibly afford.
Here's a chart showing the different levels of income and net worth required to buy a home at various price points.
There's no point in investing and working if you don't enjoy your money. Therefore, I say it's good to live better if you choose to continue to work and take more risks.
At the same time, be appreciative of all that you have today. Living in your primary residence for more than 10 years as your net worth grows will help keep you disciplined.
In conclusion, shoot for your primary residence value to equal no more than 30% of your net worth by age 45. If you do, you will find a great balance. In finance, there are few things better than enjoying your home in a stress-free manner while it also appreciates in value.
Real Estate Suggestion
If you're interested in investing in real estate more surgically, check out Fundrise, one of the largest real estate crowdfunding platforms today with over $3.5 billion in assets. Fundrise specializes in residential real estate to take advantage of positive demographics and rising rents.
Gaining the appropriate exposure is more than half the battle in growing your wealth through real estate. You can now start investing in residential real estate across the country, hassle-free for just $10 a month.
Alternatively, if you are an accredited investor, you can check out CrowdStreet. CrowdStreet focuses mostly on individual real estate opportunities in 18-hour cities where valuations are lower and growth rates tend to be higher. Just make sure to carefully do your due diligence on every sponsor to create a select portfolio.
Personally, I've invested $954,000 in private real estate to earn more passive income and diversify my SF-heavy real estate portfolio. Real estate is my favorite asset class to build wealth, especially during times of uncertainty. With prices down due to aggressive rate hikes, I'm dollar-cost averaging more aggressively now.
Both platforms are Financial Samurai sponsors and Financial Samurai is an investor in Fundrise.
