Last week while I was in the middle of crunching numbers from the IRS estate data, my phone rang. Jerry, a friend of a friend, immediately began sharing his concerns about his “real estate situation.” Jerry is a computer programmer, and his wife is a part-time dental technician. The couple’s annual adjusted gross income is about $100,000. They have three children.
Just prior to the meltdown in the real estate market, the couple purchased a new home in a newly developed subdivision for $495,000. Within the last year, three brand new homes similar to Jerry’s in the same subdivision were sold for $300,000 each as foreclosures. Ouch! says Jerry. His dream of reselling his home “in a few years at a substantial profit” has vanished. But his mortgage balance of over $300,000 has not. All I could do was to tell Jerry not to panic. And I honestly believe that things will improve, especially since Jerry’s home is located within a public school district that has a national reputation.
Other than the profit motive, why did Jerry and his wife trade up from a $280,000 home to one priced at $495,000? Here are his three reasons. First, a mortgage broker told them they could afford to make the payments. I commented on such advice in The Millionaire Next Door as the equivalent of asking a fox to count the number of hens in your chicken coop. Second, the people in the neighborhood seemed to be similar to Jerry and his wife in terms of demographics and socioeconomic characteristics. Third and most important, the couple’s $100,000 income was more than they had ever earned in any year during their first 20 years of marriage. Now, at the six figure level, they viewed themselves as “rich.” And, according to Jerry’s logic, rich people don’t live in $280,000 homes/neighborhoods.
Attention, Jerry. Rich, wealthy, affluent- no matter. It is all about net worth. Again and again, I have stated “income is not net worth, not wealth; wealth is not income.” And this couple’s net worth is less than $150,000. While Jerry was telling me his story I looked over the numbers I had just tabulated from the IRS 2007 [the latest data available] estate data for those decedents with an estate valued at $3.5 million or more. The median market value of a decedent’s home was $469,021. That is less than 10% of their median net worth. And on average these decedents had nearly 2 1/2 times more of their wealth invested in investment real estate than in their own personal homes. What if Jerry had known this beforehand? Would he still have bought a home priced higher than the value of the typical millionaire decedent? It would depend on whether Jerry wanted to act rich or actually be rich some day.