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I was reading this question about The Millionaire Next Door, after recently finishing the book myself. I remember that the book warned against living in a "High Status Neighborhood," in keeping with the theme that many millionaires became rich by spending less.

This confuses me, because as far as I can tell, paying a mortgage in an area with more expensive homes tends to yield more equity for you as a homeowner. I know they mention that the purchase price of a home should be no more than twice one's annual income... but if I'm following this rule and still living in a "high status neighborhood," am I doing something wrong? How can I calculate the tradeoff between having a cheaper mortgage payment and owning a more valuable home?

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    "they mention that the purchase price of a home should be no more than twice one's annual income": they obviously don't live in the UK! Commented May 24, 2022 at 14:25
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    You are mixing up two things - the neighbourhood, and your home. You will often have an advantage if your $500,000 home is in a neighbourhood where it is the cheapest home, vs. the same home in a neighbourhood where it is the most expensive home.
    – gnasher729
    Commented May 27, 2022 at 10:57
  • Always had a good job. There is absolutely nothing that I could buy for twice my annual gross income, and even less for twice my annual net income. Maybe a one bedroom flat needing renovation in the worst possible neighbourhood surrounded by druggies.
    – gnasher729
    Commented May 27, 2022 at 10:59

2 Answers 2

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While a home can be an investment, it is also an expense. When you own your home, you are effectively landlord and tenant at the same time.

The investment return on a house consists of price appreciation (which historically is in line with inflation) plus net rental income. As a homeowner, your rental income is "imputed" rather than real, because you are effectively paying it to yourself.

When considering a house, look at its market rental value and ask yourself whether you would choose to live there at that rate if you were renting. If not, it suggests that you are buying a more expensive house than you need, and you will not actually benefit from the full value of the imputed rent. Thus, you are missing out on a key component of what makes housing competitive with other investments.

Money spent on a more expensive house than you need is partially wasted, in the sense that even if the house appreciates in price, the expected appreciation is lower than that of other investments like stocks where you could have put the extra money.

Landlords count on full market rent (with reasonable allowance for vacancies, etc.) as part of the value proposition that justifies investing in a house when other investments like stocks are also available; this is part of the market mechanism that determines house prices. So when buying a house, you are tying one hand behind your back financially if, by living there, you are not getting value equivalent to that rent.

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  • Your logic makes sense to me, but I’m seeing the opposite result. We bought a house and started a stock portfolio last year. The stocks have tanked and the home value has increased significantly.
    – JacobIRR
    Commented May 22, 2022 at 0:07
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    @JacobIRR That's a small sample of time (1 year), and people could not predict in advance whether returns would be above or below average. If they could, prices would have already adjusted to neutralize the prediction. Looking forward, we can only go by the average return (observed in the long term). Large short-term deviations are fully expected to occur but are only known after the fact.
    – nanoman
    Commented May 22, 2022 at 1:00
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    @JacobIRR In other words, your observation would be like seeing a coin come up heads a couple of times in a row, and concluding that it's a biased coin and you should bet on heads continuing. The data just isn't sufficient to conclude that.
    – nanoman
    Commented May 22, 2022 at 1:13
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    @JacobIRR home prices are generally lagging stock prices. If the stocks don't recover soon you'll see a dip in home values next year.
    – littleadv
    Commented May 22, 2022 at 7:27
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    "look at its market rental value and ask yourself whether you would choose to live there at that rate if you were renting": maybe I wouldn't; but I'm not renting it, so this hypothetical isn't valid. Specifically, if the rental price is significantly above your mortgage payments, that can drastically alter this equation. Commented May 24, 2022 at 14:30
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I believe the advice against "living in a high status neighborhood" is less about the difference between a cheaper mortgage and more about the "high status" lifestyle and keeping up with the Joneses. For example, you wouldn't just be expected to have the lawn mowed regularly, but that you spend more on lawn care to make it look nice. And you can't be the one guy in the neighborhood driving the beater Civic surrounded by Porsche SUVs.

So sure, if you're willing to be the black sheep of the neighborhood, go live in that high status area, but most people will spend more to live that high status life.

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    As a German, anyone buying a Porsche SUV is a certified idiot. Buy a Porsche or buy an SUV, it's your business. But Porsche SUV is not a car anyone should ever want to be seen dead in.
    – gnasher729
    Commented May 27, 2022 at 11:02

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