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October 15, 2008

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"let's say you CAN qualify and HANDLE the payment on a $400,000.00 home"

Key words in there are CAN HANDLE.

This is exactly the type of overly simplified and perverted thought process that created then crashed the housing bubble. The reference to a "refinance strategy" would be hilarious if it wasn't so sad. Millions of homeowners have used the refi strategy to buy other crap. Now they are broke and upside down on their mortgages. I am surprised either of you had the nerve to publish such a post in today's environment.

How stupid can you be? That is the same as assuming that the stock market will go up, so you should borrow money to invest in it. Even worse, more expensive houses have higher costs, including upkeep, heating / cooling, and taxes.

God forbid the house actually decreases in value. But that never happens. Oh wait, it does! Also, for most people, the extra happiness imparted by granite countertops is much less than the happiness of not worrying about bankruptcy and foreclosure. Also, money problems cause most divorces, while lack of a big house causes very few.

Taking the emotion out of it, even the calculations are wrong.

1) If you can handle an extra $8,000 down at closing @ 8% - in the $300,000 house that would be about 12% - giving you a better APR on your mortgage and possibly even pushing you to a 15 year instead of a 30.

2) The $400,000 house comes with a higher APR (because of the lower down payment), higher heating, cooling, and decorating costs, more taxes, and a higher monthly payment (because of the amount financed). This may also push you into the 30 year category, instead of the 15 year category.

I make twice what I did when I bought my first house...... qualifying me at nearly $400,000. Guess how much house I'm buying next? $250,000. In this market, it's "on sale" and though it's average value will probably be around $400,000 in 6 to 8 years, I'm only buying @ $250,000 on a 15 year note.

Tell that to the hypothetical family who "invested" in the $400,000 house @ 30 years and see what they have to say....

You know what they say about assuming things right?

Where did you find this guy, FMF?

Bad assumption #1 - that you will be more comfortable in a $400k house than a $300k house.

Bad assumption #2 - basing possible future appreciation on historical averages.

Bad assumption #3 - the seller will pay the closing costs on the purchase.

Bad assumption #4 - completely ignores the closing costs when the buyer sells the $400k home. At 6% commission, there goes $32,100 of your supposed $135k gain. Not to mention he ignores the increased property taxes, insurance and other costs to a more expensive home.

Kevin --

Never let it be said I didn't open up this blog to "different" ideas. ;-)

I know what it's like to live pay check to paycheck. I know what it's like to have a lot of obligations each month (debt, bills, etc). I HATE it. It brings stress to my life. I'd rather live in a smaller, less-nice, home and have less financial worries than try to buy 'more' house and have 50% of my income going to a mortgage payment.

Besides, I don't believe houses are good investments. In their 70-year price history, their appreciation is about on par with inflation. It's seems that it'd make more financial sense to buy smaller and invest elsewhere.

Now, if you can keep your mortgage payment at about under 35% of your take home... Go for the $400k house.

Why not buy more than you need, if you can afford it? Isn't that what we do every single day?

Before you start chastizing the author, take a good look at yourself. Every single one of us posting on this message board doesn't need internet or a computer (if you are at work, get back to work!). If you can AFFORD more than you need, then it's your right to buy more. Why else do we work so hard everyday? If you work hard to make more money then you are entitled to more of everything, within your means of course. That includes giving more to charity.

Buying more than you need didn't cause the housing bubble, buying more than you can AFFORD on stupid credit terms did. Warren Buffett drives, last I heard, a Cadillac. That car is way more than he needs and he isn't taking heat from it. He lives in a big house in a well-to-do community with his wife. Way more than he needs, still no heat.

So before you start jumping on the "That's a horrible idea" bandwagon, look at yourself and everyone else, buying more than you need happens every day.

Umm - during the 5-7 years you live in said property, won't you need to cool and heat it? Does the increased cost of electricity and heating oil/gas still give you the same profit? You'll also need furniture in any extra rooms you get too - that eats into your profits.

We bought a house that is just the size we need - no "extra" space, no room for [email protected] or clutter - just us, the stuff we love, and the cost of maintaining it.

For us, we did the right thing. We sleep well at night.

Thank you Tom, my thoughts exactly.

I strongly disagree. So what happens if you get into that 400,000 house and the value drops out like so many have recently experienced? No, over leveraging yourself this way is never good.

Am I missing something? You're assuming a 33% appreciation over the course of five years? You think that's the actual historical appreciation of real estate (over anything but the last bubble)?

From a purely practical point of view I'd have to say no, I really shouldn't be buying 33% more house than I need. I don't have any grand financial reasoning for my conclusion, just a few observations I've made over my decade of apartment living.

- Heating/cooling/electricity/whatever will cost more. Last time I checked, bigger spaces require more energy. Maybe I should check again, you never know they may have changed the laws of thermodynamics when I wasn't looking.

- You WILL buy enough crap to fill the house. Nature abhors a vacuum, and if that vacuum is a domicile of any kind it will be filled with crap.

- You have to keep it clean. I don't really like cleaning and I still can't get the cat to pull his weight around the apartment. I can only imagine how much more effort I'd have to spend doing something I don't like if I bought more house.

- The money I spend on the extra house is money I can't spend on other things. Like furniture for the house.

- If I take out a bigger loan, then I have to pay back more money. Coming from a family that emphasizes being debt-free, buying more will be really hard to talk myself into.

Thanks for the laughes.
there are 40 of 110 houses in foreclosure in our subdivision cause they could qualify and could handle the payments.
You should have seen the Garage sales of stuff bought on credit before the midnight moves.

About the only way this sort of analysis makes sense to me is if you're buying a better location versus a bigger house. A better school district could be worth an extra $100K, particularly if you've got more than one kid. Being closer to work could also be a big savings in both money and time.

Tom - I bought some chewing gum today that I didn't really need. Are you seriously trying to shove that purchase and mindset into the same category as a 15 or 30 year mortgage on $400k purchase, with plans to refi down the road to harvest amazing investment returns? Try some other argument - yours lacks credibility. If the post author has the net worth of Warren Buffet and is targeting his idea to others similarly situated, I take it all back.

As I read this I made some assumptions:
More $$$ equals more square footage
More $$$ equals higher property taxes
More $$$ equals higher maintenance costs.

From the comments everyone else did too.

However, I had to stop as I thought about my situation. My family lives in the 'burbs due to the higher cost of housing near where my wife and I work. That extra hundred thousand would not necessarily cause any changes in any category except my address.

Moving closer to work would create a higher housing purchase cost. BUT, the size of my house wouldn't be any different; my property taxes might be the same or lower due to a big difference in the tax rates; and my maintenance costs wouldn't be any higher because the only thing driving the difference in price is the location. Overall, my costs could go down since I would be spending less on fuel and have more free time due to a reduced commute distance/time.

That all being said, my possible savings wouldn't generate enough change for me to afford a move to the higher cost, but closer, home.

Just another way to look at the situation....

I have difficulty looking at a house as an investment. For those that do, more power to you and I hope it turns into a profitable venture for you. My house is nothing more than my home, and it always will be just that to me. So, I don't think I could engage in the author's strategy.

All that being said, I think how much house you buy is a personal decision. As Tom said, if the person can afford it, what's wrong with it? I bought way more house than my husband and I needed at the time (a 4-bedroom house with an unfinished basement that left us room to grow), and I don't regret it one bit because I could afford it. When I bought it, I knew I could really stretch and an even bigger and better house, but I also knew I was not going to buy the smallest (or "least") house I needed. Here were my thoughts when purchasing my home:

1. If I have kids, I do not have to "trade up" for more space or bedrooms. If I do not, my husband and I will either find a use for the spare bedrooms or leave them empty.
2. If one or both sets of our parents ever need or want to live with us in their late golden years, they can easily do so without inconvenience to us.
3. Absent a job change that takes us out of the metropolitan area we live in, I will not be paying realtor's commissions, transfer taxes, or moving expenses multiple times.
4. I knew that, absent a horrible twist of fate that both of us would be laid off at the same time for a long stretch, we would always be able to afford the house. I got a fixed-rate mortgage that we could afford our first year easily. That's not to say things would never get tight. In fact, they did, when eight months after moving in my husband lost his job. Nevertheless, because our mortgage was reasonable, we made do with just my income until he got a new job--nearly a year later.
5. For those of you concerned with utility costs, I made sure to buy a home that was newer and had all the energy efficiencies available at the time. Thus, my house costs less to heat and cool than my parents' house--which is a third the size of mine. Size does NOT necessarily mean higher utility bills. It's all about energy efficiency.

To each his own, I say. As long as you can afford it without overextending yourself, you should do what you wish. Everyone has different priorities. If you know what yours are and are true to yourself with them, you shouldn't have a problem.

I think in a perfect world, your strategy is good. However, real estate also decrease in value. RE does not always go up as we experiencing this now

OK, lets say you put $30k down and had a 30 year fixed mortgage at 6%. Lets say that insurance, property tax, maintenance are all proportional to the cost of the house.

If I make some guesses on rough numbers then we'd be looking at 5 year cost comparison of:

$300k house
mortgage = $78347 paid interest in 5 years
insurance = $600 annual x 5 years = $3000
heat/cool = $1500 annual x 5 years = $7500
property tax = $3000 annual x 5 years = $15000
maintenance = $900 annual x 5 years = $4500
TOTAL expenses in 5 years = $108,347
Tax deduction = $93347 * 30% = $28,004
Expenses less tax deduction = $80,343

$400k house
mortgage = cumulative interest $107,401
insurance = $800 annual x 5 years = $4000
heat/cool = $2000 annual x 5 = $10,000
property tax = $4000 annual x 5 = $20,000
maintenance = $1200 annual x 5 = $6,000
TOTAL expenses in 5 years = $147,401
Tax deduction = $127,401 * 30% = $38,220
Expenses less tax deduction = $109,181

SO you are paying ballpark of $28,838 more total over 5 years for the $400k house.

THe article assumes that the houses would go up 33% in 5 years. Thats a fairly reasonable assumption really. From the 1960's to today homes appreciated about 6% annually. But of course the details will vary from market to market and some regions are better and some are worse.

In my opinion, its about a wash financially. You spend more on the bigger house in expenses but you would end up with higher appreciation once you sell it. But you'd get the benefit of living in a larger home.

Jim

Regarding home appreciation:

In 1940 median homes in the USA were $2,938 and today median houses are $206k. That is an annual growth rate of 6.4%.

You can refer to: Historical Census data:
https://www.census.gov/hhes/www/housing/census/historic/values.html
and current Realtor data:
https://www.realtor.org/research/research/metroprice

Jim

Are you sure this post isn't from 2005? (saw a lot of this back then)

"Fit your needs" house vs. "can handle the payment house" is not really an argument that can be debated with such subjective terms. I say buy the most house you "can handle" (I did 'cause I plan to be in it for 40+ years), but I'm guessing my idea of a "can handle" is much much more conservative than the poster.

My biggest problem with this article is the first conclusion made from buying a bigger house -- that you'll be a lot more comfortable in the 400K house than a 300K house. Contrary to popular opinion, bigger does not always mean better, and having more stuff does not always mean being more comfortable. I could go on with this, but I think most people here get the idea.

Stuff does not equal happiness. And anyone who thinks it does is sadly mistaken.

@Mr. Toughmoneylove,

What isn't credible about it? The question was buying more house than you need, but can still afford. It can be likened to anything you buy. Nowhere in my argument am I advocating a refi strategy. I'm advocating buying more than you need. A main point in the post was that if you can afford to buy more, why not if it'll make you more comfortable and your life a little more enjoyable. Why else do we buy crap we don't need? That chewing gum you bought... why did you buy it?...did you enjoy it? Purchases of unneeded goods over a 15-30 year mortgage equal that $400K category you referred to. You as well as anyone should know that this crisis didn't come about because people were buying things they could afford and didn't need. The Warren Buffet analogy was extreme, but it gets the point across. Also, you don't even have an argument against mine. If someone can afford something, they should be able to buy it without being judged... what is there to argue?

1) From what I'm seeing, you HAVE to put more than 8-10% in this credit market. I think it's a stupid assumption to think it's possible or reasonable to only put down 8-10%.

2) This guy actually believes in 5 years that his house is going to appreciate that much with the market like it is now? That's almost laughable.

3) Who gives a flying flip what the "return on investment" is for the house you plan on dying in? You're never going to cash out! I never got why some people look at it that way.

There is one thing this guy has going for him though, he is focused on wealth building, which is the first step in actually accomplishing it.

Jim's analysis is pretty good. The biggest problem is with the assumption you can get such a generous mortgage these days. Because that's the only way this works, is if you have massive leverage and the upswing is right. Without the leverage, despite the numbers you are talking about around a 6% return. (And I'm not sure how much you want to count on historical numbers at this moment. Most of these weren't tracked accurately until the late 60s and do any of us feel confident about how much of the historical return is an anomoly of the bad credit practices/bubble?)

@ Tom who was @ Mr. Toughmoneylove,

Tom,

Almost your entire posting on this blog lacks credibility. Your whole arguement relies on everyone agreeing on the defintion of happiness. Also, there is a plethera of assumptions about the future value of "this" particular house. We're not discussing the Warren Buffets' of the world, just your average "Joe Six Packs'" here. The people who are to settle down, possibly move to another location for work or what ever. You should never go into buying a "Home", a place to raise your family, watch your kids and neighorhood kids grow into functional adults, with the expectation of "cashing in".

I told you, controversial stuff brings those comments!!

1) Buy the most house you can afford, preferably the largest house with the most bedrooms.

2) Convert all spare (non-bed)rooms to bedrooms.

3) Rent out as many rooms as you can.

4) Laugh all the way to the bank.

@Bobby,

" You should never go into buying a "Home", a place to raise your family, watch your kids and neighorhood kids grow into functional adults, with the expectation of "cashing in"."

I never took any position about cashing in. I said I agree with buying more house than you need as long as you can afford it. How does my argument for that position lack credibility? I completely disagree with buying an expensive house only to assume you can "cash in" in the future. What I agree with is, if you feel that buying more house than you need will enhance your lifestyle and you can afford it, then buy the more expensive house. Same goes for any purchase. As long as consumers live within their means, they should be free to inflate their lifestyles as their means grow and not be judged.

The argument relies in no way on everyone agreeing on the definition of happiness. It relies on an individual's definition because it's those individuals who are purchasing the house or product.

I don't think it would be a good idea to buy more house than you absolutely need unless it is for investment and it is an unbelievable market. In this type of market nobody but investors are really buying houses

That is the same thing people thought before their loan to value tanked. Don't encourage irresponsible behavior. I am supprised FMF let you post something like this.

what is interesting is that this kind of discussion or viewpoints would not have been happening a year ago. people wouldn't be talking about more house, affording a x mortgage, etc. that is good.

i also target some assumptions.
1. the biggest problem with treating your personal home as a depository for cash as an investment is you have to sell the home in order to profit from the appreciation. even then, you have to live somewhere after you sell.
2. i'm not sure what you get that is different between a $300k and a $400k home. Realistically, you might have upgrades in the home or the cost difference is based on one side of the street versus another (location), but the homes aren't going to drastically differ, especially in terms of size.
3. lifestyle reasons: if you do get a larger house that suits "lifestyle" it is undoubtedly true then that you will be buying more "lifestyle" stuff. If your purchase is based off of "lifestyle" rather than utility, then you will invariably spend more to maintain that "lifestyle". that cost wasn't figured into the equation.
4. you also have to consider higher total cost of home ownership in a more expensive house from higher taxes, to higher insurance, to higher heating and cooling (if it is indeed a larger house), etc.
5. pushing yourself a little bit: are you crazy in this economy, you want to push yourself a little bit? even in a better economy? pushing yourself is a slippery slope in terms of what you can really afford. pushing yourself means that you are foregoing other financial goals in order to tie down money into a not easily liquid asset, a house.

@ Tom, I think,

Because that's what the author is telling us to do with our house. READ, buy more house sell more house. In the meantime, enjoy the bigger house. According to the author, you'll enjoy having a few extra square feet. That's my point, not a financial investment, but an investment in you family.

It seems that many people saw "spend $400k instead of $300k" and immediately jumped on the spending-more-money-is-a-bad-idea bandwagon. And I will have to admit, when I read about assumed appreciation and the rather unrealistic 8% down payment, I was turned off a bit. But despite all the negative comments, I think there were some educated points that might have me swing the other way with this one.

1) $400k vs $300k doesn't have to mean more SF, taxes, utility bills. The idea that you could use the extra $100k to improve your location is an interesting idea that could help the $400k debate.

2) I am a numbers guy, so Jim's breakdown of costs was very interesting to me. So, even if it were a breakeven decision, then I would think $400k wins. If all things are even, then might as well live in the nicer house.

3) Not sure if anyone mentioned this, but I would think that now is a great time to implement this strategy. Someone said that is a down economy it is a bad time, but I think the opposite. Let's say home prices are down 20%. Then, the $300k home is really a $375k home and the $400k home is really a $500k home (realizing that a house is really only worth what someone is willing to pay for it). My point being that a year and half ago, these houses were $125k apart. If everything is discounted, then shouldn't you buy more? Isn't that why the popular person of the commments section, Warren Buffett, is starting to put a lot of his cash to work in the stock market?

I also think that some of the arguments against this post lack substance. The most common laughable one to me seems to be the "$300k might be better than $400k" comment. While this may be true, I don't think it is relevant. Obviously, if you are going to be happier in the cheaper house than do that. The author isn't saying to blindly buy the most expensive house you see just because it cost more. The idea is that if you find a house you like more, but cost more and you can afford it, then go for it.

And to whoever used Warren Buffett as an example of someone living it up, I think you could find about a thousand better examples. He has lived in the same house for something like 30+ years. He is probably one of the most frugal so-rich-money-doesn't-matter people in the world.

FMF, thanks for allowing posts that might go against your personnal opinion. I think it has openned a good discussion. The original post had me thinking this guy must have been asleep the last two years, but the comments from the readers have me wondering if he might be on to something.

This reads like it was written in 2004. Home appreciation sounds like a return on investment, but it matters little if you are selling and buying into a home of similar value -- as most people do. Unless you downsize you can expect to pay more property taxes for larger home and assume higher maintenance liability.

Happiness matters of course, but there are a lot of people unhappy about having taken on too large of a mortgage.

Amen @ James.
I think the author, although a little "out there" as far as today's economic mindset goes, is on to something. Sure, the figures may be a little off, but the fact of the matter is this: if you can afford a house at X amount, why settle for something less just because it's scary outside?

The biggest concern I have in such an idea is "What happens if you lose your job?" With a smaller house and smaller mortgage, you'd have some extra cash to create a better emergency fund. If you did lose your job, you could survive for a few months. With the larger house, if you lost your job, you'd foreclose... like many people are doing these days for using the exact reasoning this article states.

I hope this guy isn't talking about a first home. Man, there are a lot of things to learn for the first-time buyer. So many new things to take care of! So many new costs. Heck, you might not even know what you really want yet until you don't have it.
I think I'd stick with the old wisdom and buy a nice house that fits your needs, gives you room to customize, and is in a good area that will appreciate over time and offer you the convenience to work, church, etc.

Obviously there's no shortage of homes out there...so you have choices.

As I said before, this entirely depends on being able to achieve the leverage percentages that he's talking about. Be forced to put 20% down and it looks a lot different.

Wait, this wasn't a joke? It's just trollbait then, right?

Jim, do you genuinely not understand that you can't use what happens over the course of 60 years (with shaky numbers on the early side, too) to predict what will happen over the course of any given *five* years? Seriously, seriously, do you not get that the increase in home prices has not been smooth and linear?

I enjoyed the article and the comments.

Most people only see the now, or the most recent past, and that alters their judgement.

I, however think the article is great. Now is a great time to buy a house. Mortgages are readily available. I do them so I know.

The market has dropped drastically, and the odds are that the home price appreciation will increase in the next five years.

for the same reason that buy low sell high is good advice in the stock market, it is also good advice in the real estate market.

Take your emotions out of it. The time to be afraid was two years ago. That is when you should have sold.

Now is low. Time to buy. people have short memories, and housing will go back up.

When the media gets ahold of the bottom in housing, you will see a RUSH of people trying to buy at the bottom. Of course the bottom will have already passed, and those that benefit will be those that bought in when everyone else was too scared. That time is now.

@Bobby,

I'm not advocating his 2nd reason, I'm for his first:

"First reason is lifestyle. I am going to guess you will be a lot more comfortable in the $400,000.00 home than the $300,000.00 home. If you live in the home the typical 5-7 years, that is a big chunk of your life. Why not enjoy it?"

READ, buy more house because you can afford it and it will enhance your lifestyle. That's my point.

Sarah said: "Jim, do you genuinely not understand that you can't use what happens over the course of 60 years (with shaky numbers on the early side, too) to predict what will happen over the course of any given *five* years? Seriously, seriously, do you not get that the increase in home prices has not been smooth and linear?"

Your comment seems rather hostile and belligerent for no apparent reason. I'm quite baffled about your reaction and tone frankly.


Of course I did not mean to imply that house prices always go up every year and its a smooth progression of annual +6% increases and that this will happen forever in the future, I assure you thats not what I meant at all.

I was pointing to previous history of home appreciation in the USA as a reference. Its true the past isn't an indicator of the future. But I think its reasonable to guess that home values in the future may appreciate in similar trend as long term periods of the past.

There is volatility in short periods and theres a chance prices will go down in any given year. But over a longer term period prices generally increase. Most years prices are up. Most 5-10 year periods see annual increases of 4-6%. There is RISK for sure. There are 5-10 year periods where home prices did not go up that much at all. And as I said before price trends differ from region to region. As an example from the Census data from 1950 to 1960 home values in Washington DC went up only 0.6% annually for a 10 year increase of +6%. But on the other hand from 1970 to 1990 home values went up 11% annually in California.

Jim

(I tried to post this comment once and I got a server error, so if it shows up twice then sorry)

Sarah said: "Jim, do you genuinely not understand that you can't use what happens over the course of 60 years (with shaky numbers on the early side, too) to predict what will happen over the course of any given *five* years? Seriously, seriously, do you not get that the increase in home prices has not been smooth and linear?"

Your comment seems rather hostile and belligerent for no apparent reason. I'm quite baffled about your reaction and tone frankly.


Of course I did not mean to imply that house prices always go up every year and its a smooth progression of annual +6% increases and that this will happen forever in the future, I assure you thats not what I meant at all.

I was pointing to previous history of home appreciation in the USA as a reference. Its true the past isn't an indicator of the future. But I think its reasonable to guess that home values in the future may appreciate in similar trend as long term periods of the past.

There is volatility in short periods and theres a chance prices will go down in any given year. But over a longer term period prices generally increase. Most years prices are up. Most 5-10 year periods see annual increases of 4-6%. There is RISK for sure. There are 5-10 year periods where home prices did not go up that much at all. And as I said before price trends differ from region to region. As an example from the Census data from 1950 to 1960 home values in Washington DC went up only 0.6% annually for a 10 year increase of +6%. But on the other hand from 1970 to 1990 home values went up 11% annually in California.

Jim

Troy,

Are you a realtor? Houses are worth 120-150x their annual rent. Any more than that and we're in bubble territory. So call me when I can buy a house that rents for $1500 a month for $180k. I know some places are like that, but we're laughably far from it here in CO

"There is volatility in short periods and theres a chance prices will go down in any given year. But over a longer term period prices generally increase. "

Yes, but don't be disingenuous. That's not what you were talking about. Your projections were given for a five-year period. In fact, you claim that a buyer can get "a simple return of well over 400% in five years on an incredibly safe investment" by buying the example house. To get this return, you are also effectively recommending leveraging at 9:1 or greater.

In other words, you're telling people to take on risky debt and promising them in return a ridiculously high return over a short period of time. (Oh, and you casually throw in at the end a mention of a "refinance strategy," which suggests to me that you are advocating taking on some kind of adjustable-rate mortgage.) This is incredibly dangerous advice, the exact kind of advice that has drowned tens of thousands of people in the misery of foreclosure and wreaked havoc on so many economies across the U.S. Ask the people who've lost their homes how "incredibly safe" a purchase of a house can be.

If you don't understand why telling people to borrow a large and highly-leveraged amount in the hopes of a big payoff over a random five-year period is a bad idea, especially if the gain must happen or they'll be stuck with a rapidly rising interest rate, you shouldn't be advising anyone on their finances.

If you do understand, but persist in giving this advice, you must be a broker or otherwise dependent on the real-estate industry for your income.

Either way, you shouldn't be surprised to be met with scorn.

I think the author's economic argument actually shows against his case. House prices are currently falling (there was a bubble), so the extra leverage that a bigger house provides, currently works AGAINST you. And this is not just short term (underlying drivers are still active, and the decline is so steep that 6% yearly appreciation is unlikely for the next decade or 2).

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