So, my pil are down this weekend. They're fine. We get on ok, generally speaking. They are supportive, loving gps. I'm lucky.
Fil retires next year. They live in a £500k house. He's a partner in a small law firm. Not wealthy but well off.
They keep mentioning about where they're going to live. Tonight the conversation was like this (dh in bed, not feeling well btw):
Fil: So, I keep saying to your dh, we'll come and live in your spare room.
Me: A ha ha ha (nervous). Our spare room is very small.
Mil: Oh yes, I remember your dh saying when he was young, "Don't worry Mum and Dad, you can live with me when you're old. I'll put you in the garden shed if I have to."
Fil: And I said to him, "But your wife might not like it. And he said, "Oh don't worry. She won't mind," He's a good boy, your dh."
Mil: And I remember his sister saying nothing. She was 15 and your dh was 13 and he would say this and she would just be silent on the sofa. Typical dd. She's always been difficult. We could never live with her.
Fil: No, we couldn't. She was a difficult teenager and now she's a difficult adult.
Me: Well, everybody's different, aren't they?
God. I'm being primed for their retirement home, aren't I? Fil retires next year and they're trying to sell their home and they want to move in with us! Why do they think it's a good idea? I couldn't bear the idea of living with my grown up dcs! I'd go potty.
To be fair, their dd is difficult - fallen out with many family members, racist etc. I like my pils. They are kind, loving albeit ignorant people who will, like anyone, make me go bonkers if I have to share my home with them. I don't want to live with my parents or dh's parents. Ever.
Plus my marriage would not survive them living with us. Whose marriage could? It would just be something else to argue about! 
Thing is, they know we are designing and building our own house next year and they have also hinted several times about annexes, extra rooms for long term visitors etc.
What should I have said instead? Please help! Should I drop Fil a gentle email saying that I think it's not going to happen? They are both fit - 59 and 65 years old - but no interests other than the gcs to the level of obsession. I cannot have them living with us. I will go mad. I need to nip this notion in the bud. What's the best diplomatic approach do you think?