One topic of interest that I haven’t commented on my blog is my recent obsession with real estate.
Rather than going into a huge overview, I think deep diving on particular real estate topics of interest in individual blog posts will be more interesting.
So here’s a question many of my friends are facing recently. You’ve got some money saved up, and you’re looking for a place. You can afford a one bedroom pretty easily, or you could stretch and go for the two bedroom. What should you do?
Well … in fact, the differences in the units themselves tend to be obvious. I’ll outline those here. The subtleties of this question tend to revolve more around your own finances than anything else.
Pros for one bedrooms
1BD’s cost less – Yes, we’re stating the obvious here, but it’s a big one. Less sqft means you pay less! If you don’t need more than a 1BD, why pay more? (There are some good reasons to stretch, actually, but keep reading for that.)
1BD’s can prevent you from overleveraging – Related to the above … if you want some real estate exposure in your asset portfolio, but you don’t want to overdo it, 1BD’s may be your best choice, regardless of how good 2BD’s are. People who maxed out their net worth to buy a home took a huge dive in the wrong direction when the market swung negative in 2008. Being forced to cash out at the worst possible time is very bad.
1BD’s are easier to maintain – Less square footage means you have less personal overhead. Ask anyone who’s lived alone in a big house … it takes time and effort to keep all the rooms clean! If you want to lead a leaner lifestyle, all you really need is a kitchen, washer/dryer, living room and bedroom (or a studio). It’s natural and easier to keep the areas you use most often in working shape.
Pros for 2BD’s
You can get a roommate to help with the mortgage – Being a mini landlord is a great way to build your income stream. And, if you rent out the extra room, you have the advantage of really being able to keep an eye on the place, ensuring the quality of the tenants and the property stays high! Remember, living alone is an American conceit/luxury. It’s not a human right, and you will waste a lot of after tax money for the privilege.
You can grow into a 2BD – 1BD’s tend to be transitional living spaces … after you graduate college, and before you start a family. A family wants at least a 2BD so that the kids don’t wake up the parents constantly! Transaction costs for real estate are quite high, so selling out of a 1BD into a 2BD because you need the space can set you back a bit. This is why, unless you are a professional, I’m a fan of buy and hold when to comes to real estate.
You can maximize the mortgage interest deduction – Since 2BD’s cost more, you get closer to the magical mortgage interest deduction limit of $1,000,000. There are a plenty of reasons not to spend more than you can afford, but, if your loan exceeds $1MM, you’ve got one more reason to hold back the spending.
A fully owned 2BD can be carried by renting just one of the rooms – Later in life, if you fully pay off a two bedroom unit, you can keep one of the rooms rented and use the other room as a pied a terre. You’ll still make a bit of money each month (aka not be cash flow negative, which is a real no no when you retire) and you’ll still have a great place to swing by as you hop around the world. It’s impossible to have that kind of arrangement with a 1BD, unless you have a VERY understanding tenant. 🙂
Dual income families can be more stable renters – With the premise of 2BD’s being more attractive to families in mind … if you eventually decide to rent out the entire unit, having two sources of income instead of one is great insurance against the possibility of not being able to come up with the rent. Not to mention that, in many respects, having a family tends to correlate with stability and wanting to keep the place clean … just like you would if you were living there!
Given the choice between a 1BD or a 2BD of nearly equal size, what should you get?
Go for the small 2BD. The 2BD adds tons of flexibility, as mentioned above.
If you have a nearly unlimited investment budget, should you get many 1BD’s or many 2BD’s?
I would buy many 2BD’s. At worst, you rent the rooms out individually like 1BD’s. At best, you have all the benefits of being able to attract whole families and older/higher income tenants instead of just singles or DINK’s (dual income, no kids). That’s a good segment of the market to gain access to.
I’ll end by saying that, in my opinion, relative to the cost, 2BD’s have a slight general advantage over 1BD’s. The questions of personal financial leverage and commitment, however, still dominate the equation for most people. Don’t spend more than you can afford, and don’t sacrifice other very high reward opportunities that your money could be in just to stretch into a 2BD!
But getting a roommate completely changes the equation in terms of buying a 2BD. It can be OK to stretch the loan a bit if you are buying in an easily rentable area, because that extra rent coming in is offsetting your real leverage. I highly recommend getting a roommate!