Tuesday, July 24, 2012

Rule #8 Your Home is not an Asset.

This is one of the topics where people tend to get a little bent out of shape with respect to our perspective on what makes something an asset or a liability.

If you buy something that pays YOU to own it, it is an asset. If you buy something that YOU PAY (net) to maintain or own, its a liability. Those are two definitions that WE use to describe almost everything we own or think about buying.  By these definitions a bought home is not an asset, it is a liability.  A lot of people have bought in to what they've been told by Realtors, Banks, Big Box Home Centres and HGTV - that their home is the biggest asset they own...  It certainly is one of the biggest purchases that people make, but is in an asset?  A home, whether it be a condo or a stand-alone house, does have intrinsic value, but the bricks, wood, fencing, and countertops if neglected or without maintenance, are most likely depreciating in value over time.  The only thing that is truly increasing in value is the land value.... because God's not making any more land.  It is a scarce and limited resource.

Then there are the monthly costs.  Lets have a look at a $300000 house that someone might purchase... What kind of expenses does a house of that size have? That home owner would now have to pay the following things... these things are pretty much non-negotiable... they must be paid: Mortgage, Property Taxes, Insurance on the home, Utilities, and General Upkeep.  If you buy a house or condo with monthly fees, you can add those in as well, but lets assume there are no monthly condo fees. We'll also ignore Land Transfer fees and all the other costs that it takes to make a Real Estate Transaction.

If you add all those costs up, the house costs about $2150 per month to keep it in your name. Of that $2150, only about $400 of the monthly mortgage payment will go on the principle in the first few years or so.  Lets also not forget the 25% downpayment or $75000 that needs to be put down in order to keep the CMHC fees low... I hate extra fees.  After the $400 is deducted from the $2150, that adds up to about $1750 of monthly costs.  So for the initial $75000 that you put up, you now will pay $1750 a month in costs that will fill other peoples pockets.  Its actually quite an expensive liability that you've purchased.  This is not to say that you shouldn't buy a house, because we all have to pay to live somewhere, but if you think of it as a liability and a lifestyle choice as opposed to an asset, you begin to view it quite differently.

Another path you could take with that $75000 would be to invest it in something that has a higher growth rate than a house, and pays you either a rental cheque, distribution or a dividend as a shareholder.  It should be reasonable to rent a house for the same amount... lets say $1750 all in and then save the $400 per month that would have gone on the house principle and invest it somewhere instead.  It certainly adds more flexibility if you wish to move within a few years and don't want a significant amount of your equity tied up in a house.

What about appreciation of my home/property?  Well, the average appreciation of real estate has been about 3.5-4.5% per year in Canada for the last few decades.  This is in contrast to the 2-3% typical inflation we have in Canada.  What this says is that either housing has been very undervalued in Canada and the market values are steadily catching up, or housing prices are, or will be, overpriced and due for a correction.... I tend to believe in the latter case.  Much of this market appreciation has occurred due to historically low interest and bond rates, which control mortgage rates, and the sustainability of low rates is always in question.  There are hotspots like Toronto, Vancouver, and Calgary that may be due for a correction, and local markets will vary, but lets not fall into the trap that real estate values always go up... because as we've seen with our neighbours to the South, house appreciation is not a given.  If you are banking on the house appreciation game, then you are also playing the timing game, and timing can be a difficult game to play....

There are lots of reasons people might want to own a house: pride of ownership, control over where they live and for how long, the ability to modify a home to make it their own.  These are all good reasons to buy a home for your own living... But by my definition, it is not an asset.

from tinyhouseblog.com

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