If you want to live in a nicer house, sometimes it's smarter to spend money on the one you're already in. Ed McKnight explains.
For decades, Kiwis have been sold a simple idea about the property ladder: start small, climb the ladder and your properties will only get bigger, better and in nicer neighbourhoods.
But it’s no longer as simple as it seems, and climbing the property ladder could be costing you more than you realise.
How the property ladder is supposed to work
The idea is simple: buy a first home, wait for it to rise in value, then sell, make a profit and trade up to something bigger and better. Repeat until you reach the dream home.
But every rung on that ladder comes with a price tag most buyers don't think about.
Each time you sell and buy again, you pay real estate commission, legal fees, and moving costs. A rough rule of thumb is that it costs about 5% of your property’s value to sell and move house.
And those costs are getting heavier, because houses have become more expensive in relation to incomes. So you’re spending a bigger share of your pay every time you climb to the next rung on the ladder.
You can see this most clearly with real estate agent fees. That’s because they charge you a percentage of the sale price to make it happen.
Thirty years ago, the agent's fee on the median house cost about 10 weeks of the average income. Now it's closer to 18 weeks.
Sell a $600,000 home, and you could easily lose about $30,000 in transaction costs. Do that several times across your life, and the cost of climbing towards the bigger “forever home” can run well into six figures.
That money does not always feel like a direct loss, because you effectively add the cost onto your mortgage. But it’s still money you would have had in your pocket. Now it's on your mortage and you're paying interest on it.
You also need to take into account the fact that if the home you're selling has appreciated, so has the home you're buying. One homebuyer recently told me that, after years of incrementally trading up, she found herself in a dream home.
One night, after a glass of wine, she looked online to see what her first home was now worth. Its worth was the same as the dream home she'd just bought. Sure, she had a nicer house further out of the city. But all that "trading up" hadn't put her in a better financial position.
That does not make the property ladder a bad idea. It just means it should not be treated as a law of financial success.
The cheaper alternative to climbing the property ladder
If your goal is to improve your lifestyle, there's a cheaper alternative. Stay where you are and improve your current house.
If you’re going to have to slap $31,000 on the mortgage to pay the real estate agent, maybe it’s better to spend that $31,000 on renovating.
A $31,000 renovation isn’t going to get you something off Grand Designs. But you might find it's enough to brighten your sense of your current home's value.
Of course, there are still times when moving makes sense. For example, getting into a better school zone, moving to a new city for a higher-paying job, or simply buying a home with enough bedrooms to house a growing family.
And if you're likely to stay in the next home for seven years or more, those transaction costs are spread over a longer period. This makes the move easier to justify.
But the false promise at the heart of the property ladder is that every move is a move up.
Sometimes it is. But sometimes the cost of climbing quietly outweighs the benefit.
Ed McKnight is an Auckland-based economist and property investment advisor.
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