Downsizing? The true cost of going smaller when you retire
Real Estate and Downsizing
Today I’m going to share with you the costs on both sides of downsizing or staying in your home, and things you should be considering.
So let’s first set the stage with our couple who has raised kids and purchased a 4200 square foot house back in the 2000s decade. They paid $150.00 a foot for this house, or $630,000.
They’ve raised kids in the house and the kids have graduated from college and begun adult lives of their own. They’re looking around the house and thinking, “Gosh, some things are starting to need some work; I wonder if this is the time we should consider downsizing?”
They’ve known others that have taken this step, and gotten some positive feedback; but the question is, is this the right thing for their family?
So let’s look at the housing market, which has been pretty good. Their realtor friend shares that they could sell their house for $375 a foot, which is a value of $1,575,000. That is a gain of almost $950,000! Certainly they could use the money to find exactly what they want.
But there are some things to take into account here as they consider what they will do. We know that their cost basis in the home is $630,000, and we know that under current tax law the 1st $500,000 in gain on their primary residence is not taxable. But the taxable amount of their gain would be $445,000; at 15% that’s a capital gains tax of $66,750.
Additionally, they will most likely have realtor expenses in the sale, so let’s just assume that is 6%. This amounts to $94,500.
So once we do the math on the sale, our empty nester couple will net $1,413,750 on the sale of their home.
This is a pretty decent amount to go shopping for a smaller home, but if our couple wants to continue living in a desirable area, chances are that the per foot price of a smaller home is going to be more than what they sold their home for.
Let’s assume as they begin looking for homes that they were considering a 2500-foot home at first, but then decided they needed one more bedroom. They wanted to be able to have space for two kids to come home, or to have spare bedrooms that also doubled as a Home Office and a yoga space. So their needs went up to 2800 square feet of space.
So as our couple begins to look for homes in the area they wanted to live in that are 2800’, they found that their square foot price was roughly $430 per foot. This is a cost of $1,204,000 just to get in the home.
Now while they made more than it cost them to get into their new home, they did make some space sacrifices. They now have 66% of the space they had in their old home, and to get that smaller space it cost them 85% of what they sold the previous home for.
Our first big Takeaway is: it will cost more than you think for the downsized house.
So once they are in the new home, what will they likely need to do? Hang some drapes! They begin the process of decorating – not going all out mind you, but doing some things to update their previous interiors – maybe some new drapes, maybe a new master bed and a couch that better fits in the Great Room. This probably costs them $20-25,000.
Now they are still ahead from a profit standpoint, but the difference is dwindling.
So, our second takeaway is: once you are in the home, there will be some things you have to spend on to make it just like you want it.
At this point, hopefully we are considering the pros and cons of not only downsizing, but also the pros and cons of keeping our larger house. What would that look like?
As we enjoy our retirement years, chances are we’re traveling and are concerned about upkeep. Well, what are the primary things that need upkeep? Most likely it’s the yard and house cleaning. So if we assume $400.00 a month for the yard and $300 a month for house cleaning, that puts us at $700.00 a month for upkeep. That’s $8400 a year, so not a small number.
But, what is the maintenance on our new downsized home? We more than likely still have a yard which may cause us to need to hire our yard service, or we may have a homeowners association cost. Let’s assume $300.00 monthly for this, and since we have a smaller home now, let’s assume $250 a month for house cleaning. That’s $550 a month or $6600 a year – a difference of $1800.
So, our third take away is: there will be cost to maintain the smaller house just like there are costs to maintain the larger house. And it is more to maintain the larger house, but maybe not materially more. This is a judgment call, but let’s now consider real estate appreciation over time.
As we know, real estate is commonly considered to appreciate at roughly 3% annually. What this means then is that our new home ought to appreciate, but our larger home ought to appreciate as well.
If our couple’s existing home is worth $375 a foot now, that means this home ought to appreciate roughly $47,000 next year. But here’s the thing: this is a compounding number.
So what this means if we run the existing home out 15 years into the future, we would by and large have property appreciation of roughly $879,000.
Let’s compare the same to our couples downsized home. At $430 a foot for 2800 square feet, the rough appreciation annually for this home in the first year would be $36,000.
If we run this number out for 15 years, that would put cumulative appreciation at roughly $672,000.
This is a difference for the two homes of $207,000 of appreciation. In other words, all things equal, you would be $207,000 ahead in value by staying in the larger home!
Now we mentioned that it would cost more to maintain the larger home, but using our assumptions of an $1800 annual cost difference for yard and house cleaning, the 15 year cumulative compounded extra cost for maintaining the larger home amounts to $33,500.
So, the takeaway is giving consideration to hanging on to the larger home makes sense.
Also worth noting: it may be you hold on to your larger home for the rest of your lives. If you go to Glory one day, and your kids inherit your home, under current tax law they will receive a step up in basis on the home, meaning they will not pay the Capital Gains tax you would pay if you sold your home today or into the future.
It’s important that all of these thoughts blend into a life well-lived, and tax, space, costs, etc. certainly play into living well.
Conclusion:
Now, there are certainly going to be cases where trade-offs are needed, and it’s not so black and white – but going into this process prioritizing what makes the most sense in the long–term will be important.
Only you are going to be able to decide what makes the most sense, but as you approach your retirement years we are going to want to have where and HOW you live CAREFULLY built into your plan.
Because how you live and your plan for the future should represent FREEDOM.
Now if you’re watching this, and this is resonating, and you’re saying, “Chris, I think that I’d like some help with this”, reach out to us for a no-obligation intro consultation. We’d love to hear from you.
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