November 14, 2013

Why You Shouldn't Use a % of Purchase Price to Estimate Home Maintenance Expenses

"A general rule of thumb is that home maintenance will cost you 1% of the homes purchase price."

Have you ever heard this rule or something similar?   It seems kind of common.   Some people might make it a broader estimate like 1-3% or whatever, but you get the idea.     When I wrote the article What does home maintenance really cost? several years ago I had cited such rules as one opinion on the matter.

But theres a big problem with those fixed % of cost rules:    The cost of the land.     

The biggest difference in housing costs in the US are based on the value of the land.   Land in San Francsico is at a very steep premium compared to someplace like say Bismark, North Dakota.  If you had the exact same house in S.F. city limits versus Bismark it would likely cost over half a million dollars more in S.F. based on the difference in the value of the land. 

OK so lets illustrate the problem here.   Lets compare two identical houses.   One is in San Francisco and costs $750,000 and the other is in Bismark and will run you $150,000.    The house itself is only worth $125,000 and the rest is the value of the land.   The little lot in S.F. is worth $625,000 and the Bismark lot is only $25,000.   All right... so lets use the 1% rule to decide our home maintenance costs.   That 1% rule would dictate we spend $7,500 a year to maintain our house in S.F. but only $1,500 in Bismark.   Clearly it doesn't cost 5 x as much to replace carpet, paint, fix appliances and maintain the roof for your house in S.F. as it does in Bismark, ND.   But using the 1% rule would make us believe so.     

Lets make the example even worse:  Lets compare a 2 bedroom condo in S.F versus a McMansion in Texas.   The Smith family buys a 1,200 sq. ft condo with 2 bedrooms in S.F. and spend $500,000.    The Jones family buys a 3,600 sq. ft. house with 4 bedrooms in Lubbock, TX for $370,000.    Following the 1% rule we'd get a maintenance budget of $5000 for that condo and $3,700 for  the  McMansion.   The 1% rule would have us believe that a 2 bedroom condo would cost about 1/3 more to maintain than a 4 bedroom McMansion 3 times the size.   Clearly thats not the case.

(note: my examples are ignoring different costs for labor and materials in different cities.  That matters but not in a way that validates the 1% rule.)

The 1% rule or similar rules based on proportion of the purchase costs of a home are skewed by the differences in land values across the nation.

The size of the house, the age of the house and its features are going to matter a lot more than the purchase price of the property.

Most houses in the USA are in the $100,000 to $300,000 range.    You can probably estimate just as well by figuring a rough $1000 to $3000 maintenance budget and do just as well as any 1% or 2% rule would give you.

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