The Five-Year Rule

The Five-Year Rule

The five-year rule treats the purchase of a property as if it were an investment that you plan to sell in 5 years. You may live there 30 years but we encourage clients to analyze the property as if it is an investment and not just as a home where you plan to live. It is an investment; a major investment.

Approximately every five years we recommend that you evaluate several factors for the next five-year period. The property you are considering to purchase today could be new-construction, 1 to 5 years old, 5 to 10 years old, 10 to 20 years old, or more. It doesn’t matter. Look at the property with fresh eyes at regular intervals.

Unless you are purchasing a new-construction home, you will likely be putting money into whatever house and property you buy within the next five years of ownership. The question is how much and will it be a good investment over the next five years. At the time of each review we suggest that you consider the amount of money you anticipate will be invested into your home if you elect to stay there another five years and compare that estimate to the anticipated appreciation of your property.

It’s clearly a judgement call to estimate the potential future appreciation compared to the property appreciation in the previous five-years. When you purchase a property we can assist you in estimating major out-of-pocket costs for replacement of air-conditioning equipment, water heaters, and even potentially the roof over the next five years. If possible we want to incorporate those anticipated out- of-pocket costs into the contract purchase price of the house.

When appropriate we explain to sellers in an offer cover letter that the lower price being offered reflects the anticipated property expenditures necessary on this property COMPARED to another property that our clients are considering. In a hot seller’s market that contract negotiation may not get very far but the exercise needs to be done for buyers to be aware, up-front, that the there may be significant short-term costs for buying a particular property.

Suppose you bought a property five years ago. Depending upon the age of the property when you bought it, you can expect to spend money on it in the next five years. Will the property need carpet and paint inside? Will the outside need painting? How old is the air-conditioning equipment? A reasonable estimate in the Houston area is for air-conditioners to be replaced every 8 to 12 years. How old is the water heater? Do you plan (or need) to do any remodeling in the kitchen or bathrooms? Are there any obvious repairs that are needed? Is there anything that was “functioning as intended” when the property was inspected at the time you bought it but now due to normal age and usage something significant will need to be replaced soon? Total all that up as an estimate and then look to see how much you property may have appreciated over the past five years.

Can you expect that rate of appreciation to continue to offset your anticipated out-of-pocket costs? If not, do you like where you are now living (location, schools, commute to work, neighbors etc.) enough to put more money into the property than it is likely to appreciate over the next five years? Has your employment changed resulting in a different commute to work or have there been (or will there be) major life changes to consider? Depending upon your property appreciation to date, is it time to take a gain on your current house, take money out of your investment, and buy another? The point of this is to consider every property purchase as an investment in addition to the expected personal enjoyment of owning the property.

This exercise is not intended to encourage you to sell every five years or some other review period; the purpose is help you periodically look carefully at your real estate investment. There can be many good reasons to stay in the house where you now live other than financial. We do encourage clients to perform the same analysis exercise on a regular basis which we teach clients when they purchase a home.

CREDIT: Terry Krejci