“Home is the nicest word there is.”
– Laura Ingalls Wilder
“The best investment on Earth is earth.”
– Louis Glickman
HOUSE PRICES AND PARENTING
The median home sale in San Francisco exceeds S1.8 million.
So, you can imagine my reaction when my kids (my child plus their spouse) decided they wanted to buy a house there a few years ago.
I understand why they wanted a home. Owning a home is an important goal. It provides security, happiness and is critical to building long-term wealth. And they both worked good jobs in the San Francisco Area. So, it was logical.
But the cost was hard to comprehend. Think about that current San Francisco home price. A twenty percent down payment is $360,000, while the median family income in the country is about $68,000 per year. So, if a typical family could save all its income, it would still take over five years just to put the down payment together.
Now, that is expensive.
And you had to wonder about value too. It is not as if buyers get a castle for that price. I can tell you that bathrooms in some SF homes often have plumbing a century old and bedrooms so tiny it feels like you have to sleep standing up. Even utter junk and hovels are expensive in San Francisco.
But buying a home is part of the American Dream, and I decided to look into it and see if we could work together and get it done with some family help and minimal subsidies. After all, over 40 percent of parents help their kids buy homes. It is part of our job these days.
But the old saw is correct: insanity is inherited. You get it from your kids.
AND MORE ABOUT THAT HOUSING MARKET
Then, as now, houses were subject to insane bidding wars. Asking prices bore no relationship to the final price. So, it was hard to know what to bid. And if you did win a bidding war with up to a dozen others, the prices were rising quickly. Buyer exhaustion was the norm. Winning bids twenty percent over the asking price was common.
Often bidders were from the tech industry, known for its high salaries. At the time, it cost over $230,000 per year to live comfortably in San Francisco—not extravagantly, just comfortably.
So, while the kids could have ordinarily bought something around $850,000 on their own, that level of purchase did not come close to meeting their needs or for the family they hoped to raise. That $850,000 was enough for a one-bedroom condo, or maybe two.
WHAT THEY WANTED IN A HOUSE
There is not anything on their list that was unreasonable. What my kids wanted in a first house is what a lot of people want:
- Safety—the neighborhood needed to be safe. That is a challenge because safe areas can be directly adjacent to unsafe ones.
- Size–Three bedrooms. Or two bedrooms with expansion capability.
- A home, not a condo, and with a yard
- Appealing architecture—they liked Victorian or Edwardian architecture, but a good design was the primary criteria, not a specific architectural style.
GOOD PREPARATION IS EVERYTHING
Fortunately, as hard as this purchase was to pull off, the basics were right. Of course, when I mention the items listed below, I am talking about my finances and my kids’.
Here are the basics of being prepared to make a purchase:
- Good credit history for everyone involved, particularly a history of paying loans back.
- Two incomes for my kids—(from a lender perspective, more income is better).
- Minimal debt; and lots of saving—no carried credit card debt, no car loans, no personal loans. My kids were still driving the old car I gave them and following the theory that all vehicles should be driven until the wheels fall off. Their car was first purchased during the first term of George W. Bush, back when VHS was standard. See here to learn about transport costs and why they are so critical for your budget and the ability to qualify for a home loan.
- Direct relationship with a real estate agent—we needed that going in. Marginal transactions are hard to pull off because they are at the financial edge of feasiblity. Fortunately, my kids already connected with a strong real estate agent who could advise them.
- A solid relationship with a lender—this is where I came in. Because I had completed several transactions previously, we already had a reliable lender once we were ready to go.
- An understanding of context—to get some help paying the mortgage, we had to consider the possibility of gaining income renting a room or getting Airbnb income. Unfortunately, that is incredibly complicated in San Francisco. So, while this additional income was not completely necessary, the potential extra income was helpful. However, we needed to do a lot of research first to avoid the pitfalls.
- Doing homework—it takes a while to understand the market. And I recommend doing that right up front using the internet. Then, when it is time to go and see houses in person, you already have the essential background and knowledge.
- Remaining flexible about areas and properties—sometimes, what you think you want is not what you get. Remaining flexible is vital if you wish to make the decision that works for you.
A REASONABLE MONTHLY HOUSING COST IS CRITICAL
It is essential to buy a place that you can afford. But different lenders have different borrowing guidelines to make that determination. And people don’t all have the same attitudes about taking on debt either. So there must be an intersection between the debt that a debtor is comfortable with and what a lender is willing to lend.
Lending underwriting standards vary. Some lenders will not lend more than 30-35% on total housing expenses—mortgage, taxes, insurance, association dues, etc. Others will allow close to 40-45%.
Here are other things to consider when families must collaborate to be able to purchase a house:
- Terms of the loan—these can vary, and be tailored to an individual family’s needs. For instance, my kids opted for an initial low rate over the first seven years to help qualify for the highest amount they could afford. Besides offering a low initial seven-year rate, most people stay in their houses for only about seven years, so a seven-year term seemed reasonable. As it turned out, the kids only stayed there for two years, so a standard 30-year rate and term would have been a waste of money.
- Parent loan—many parents do this. But understand, to do it legally, the interest rate charged must be the market rate. And the cost counts against the housing qualification ratios for the primary lender. Nonetheless, it fits many families and is an intelligent way to finance—if a parent wants to loan a child money and has enough in their bank account to do it. If that path is an option, some services take care of the paperwork, servicing, etc.
- Gift—some parents do this. We could not afford it. You have read about people who buy their kids’ houses or give them large financial gifts. That was not feasible for us.
- Co-signing—not for the faith of heart unless you completely trust your own kids. What this means is, they use your credit to help qualify for the loan, since the loan is too large using standard underwriting standards. Put another way, they may be payin more than they could afford, and if they do not pay their mortgage, you both suffer credit downgrades. As a parent you are on the hook for the mortgage, not just your kids.
A FAMILY PARTNERSHIP—AND WHAT THAT MEANT
Given the massive cost of real estate in San Francisco, it was clear that we had to collaborate to pull off a purchase.
Like any partnership, both sides must trust one another and be entirely businesslike in their dealings. That includes families. In other words, neither parents nor their kids should ever consider behaving in a way that is different from how they would in a typical business relationship. I will probably post much more about this subject in the future, but here are the essential elements:
- There needs to be written contract provisions in place if there is a loan involved or any other kind of use of money between family members. Word-of-mouth deals are out. And both parties need to have track records as being scrupulously honest in the first place. Let’s face it, not all family members are reliable.
- Either party needs to be willing to live with a worst-case situation and have a plan about what to do if the worst happens— a default, loss of a job, or the problem with a natural disaster (earthquake). And again, if that risk is unacceptable, a real estate collaboration with family members should not be considered. For an example of this kind of worst-case thinking upfront, see here.
- There is a shared risk, and consequences if one party does not do what they are supposed to. For instance, I am not a fan of agreements between family members where one (usually the children) has no real property investment and no financial penalty for acting irresponsibly.
NEXT POST—HOW WE PULLED IT OFF
We did eventually pull off a roughly $1.6 million purchase. The way that transaction was structured will be described in detail in the next post.
Disclaimer: consult with a financial fiduciary before taking any steps outlined here. Not all advice is suitable for your circumstances or investment style.
Image: Aaron Kato
License: Unsplash