by elmads

Introduction

This is a very controversial topic that has been talked about for decades. Two sides argue that a home you live in is not an investment, while the other side begs to differ. The actual confusion here comes from the main subject of this topic.

What do I mean by this? People tend to stray away from the main topic, which is the word “Investment Asset”, and they always mix it with our human needs and emotions. First of all, we have to put a hard line unto it, and differentiate what is an asset and what is a home where people live for comfortability and shelter.

I do understand that buying a home to live in, is both an objective and subjective decision that each individual has to make, but we must also be self-aware with the main reason why we are buying a home. Is it purely for investment purposes? or because you love to have your own home for yourself and your family, including the area where the home is located.

A Home that we Live in as an Investment. . .

For centuries, property ownership has always been the most popular investment for most people. Why not? when real estate is a physical property that we can live, see and touch, plus it appreciates overtime. That’s why almost everyone strives to save money in order to have their own home to live in, both for their and family’s needs.

Nonetheless, what does it take for an asset to be an actual investment? remember that investing has a specified purpose that is related to money. Investing as per Wikipedia means; “It is the act of committing money or capital to an endeavour, with the expectation of obtaining an additional income or profit”. With that definition in mind, our home where we live in could actually pass as an investment because its price appreciates overtime, which could give us larger profits in the long haul, ONLY if we sell it.

The real question here is, did you buy the home primarily for investment purposes? if it’s a yes, then it’s expected that eventually you will be selling your home to get that appreciated capital and use it for other reasons. Probably you could use that capital to buy a cheaper home, or rent. Then you’ll be utilizing the proceeds of your sold home for your retirement.

In short, you bought your home to live in at the moment, but with the end goal to sell it at a higher price in the future, and use that gained capital for your retirement fund, or your other financial goals. Or, probably a home where you plan to pass it down you family lineage as a generational asset heirloom.

That’s how it can be an investment for the long-term. But wait there’s more, because without understanding all of its costs, the numbers, then we could not specifically say if the home you live in is a good investment.

A Home that we Live in as an Investment. . . (The Technicalities)

Most people think that they just buy a home based on the selling price they are willing to pay, then that’s it. Unfortunately, there’s is a lot more to it than that.

Buying a home is one of the largest financial decisions individuals make in their lives, it will also be one of the expensive, if not the most expensive purchase they will ever make in their lifetime.

Currently, home prices are very costly most especially in metropolitan areas. It is in average 4-5 times the average GROSS INCOME of individuals in most developed countries worldwide, that’s an insanely high multiple compared to the average GROSS income. This is the reason why majority of the people will take on a mortgage in order to finance the cost of buying a home.

Additionally, mortgage loans will always have a corresponding interest payment for the borrower, which will further increase the total amount that they’re supposed to be paying for the home. For instance, if a home is worth £200,000, that amount could increase to £300,000 when the total interests paid are factored in (The amount varies depending on the current mortgage interest rate). There is no other way around it, not unless we can save a large sum of money to purchase a home without taking on debt, which is not possible for most individuals.

We expect that our home will give us a larger return on our money in the future, but people forget that there will be costs such as, one off and also recurrent costs (yearly payments). To know if we have good returns on our investment, we need to factor in these costs and compare it to the our home’s yearly price appreciation, or its Compounded Annual Growth Rate (CAGR).

One-off Home Payment Costs

Note: These costs may vary depending in the country you live in. There might be lesser costs for some, or additional costs for others.

1.) Stamp Duty – This is the tax we have to pay if we buy a residential property or a piece of land. Not all countries have stamp duty.

2.) Home deposit – Most people get a mortgage, but that doesn’t mean that the bank will loan us 100% of the amount of the property we want to purchase. In most cases, banks require a down payment of at least 5% of the total home price, then they will loan us the remaining amount.

3.) Conveyance fees – these are the costs that is related to transferring the legal ownership of a property from one party to another. This is done by legal firms.

4.) Closing costs – These are costs related to the mortgage. Included here are the application fees, valuation fees, credit check, underwriting, broker fees and more.

5.) Home insurance initial payment – for property protection.

6.) Furniture Removal & Transfer costs – Some people would want to bring some of their furniture, appliances and things from their previous home to their new home. This will be an arduous task most especially if you have a lot of things that needs to be transferred and if there is no one to help you in doing such task. This is where hiring furniture mover services come into the picture, a business that helps with transfers.

7.) Cost of buying new furniture – With a new home, comes new stuff that we need to buy.

Recurring Home Payment Costs

1.) Home insurance – This will cover the costs of any damage to our homes.

2.) Maintenance costs – A home wears and tears overtime, and with that comes the need for maintenance.

3.) Renovation costs – The more we want to make our home into our liking, the more we will spend money on it. Included here are also the changes done in the interior design of the house. Just imagine the amount of money spent by people who keeps on changing the interior design of their home every 3-5 years.

4.) Mortgage interest payments – We need to pay what we owe.

Documenting & Computing Home Ownership Capital Returns

For us to see if we’re having a positive return on our investment, we need to record a lot of things and make projections as well. This will require a lot of patience because this is a long-term process.

1.) Always record all of the expenses you’ve incurred on both the one off payments, the recurring costs, maintenance costs and anything that is related to your home.

2.) Total all of the costs incurred relating to your home in a time frame of monthly, yearly and decades until the time you fully pay your mortgage loan.

3.) Know how much goes to your mortgage loan and the one that goes to your home equity.

4.) Document and record how much you pay for the interest on your mortgage

5.) Do these steps until you fully pay your mortgage loan.

6.) Once you fully cleared the mortgage debt in your name, look for how much your house is currently worth in the property market. You could check the home prices in your area and the houses that is the same as yours. This is for the purpose of knowing the estimated monetary worth of your home.

7.) Now, add all the house expenses you’ve incurred through the years and decades. Then add that result to your home’s initial price (This was the original price during the time you bought it a few years or decades ago). For example; (Total home expenses through the years) £20,000 + (initial home price from the time you bought it) £250,000 = £270,000.

8.) Then get the current market price of your home in the market and do the Compounded Annual Growth Rate Computation with the “Step 7” result.

9.) Compare the Compounded Annual Growth Rate (CAGR) result of your home to other asset’s CAGR within the same time period. The same time period meaning, the number of years from the moment you bought your home until you fully paid your mortgage loan.

10.) Unfortunately, there are additional costs that needs to be take into account as well. The costs when we sell our home, and the capital gains tax.

This is one of the ways we could monitor our home’s return on investment. Take note, this is done mostly by people whose primary reason into buying a home is for investment, while living in it is only secondary, and for individuals who are adamant to prove that their homeownership is an investment. Then again, why do such things? why not just rent it out or flip properties because that’s where the real property investment gains happen. Also, I’ve never met someone who even does the computation that I showed you above, because most real estate investors rent or flip properties, and do not live in it.

Myth 12: Housing is a Good Long-Term Investment

The portion I’ll be showing you below is all taken from the book “A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan, by Ben Carlson”, Chapter 4: Market Myths and Market History, Myth 12: Housing is a Good Long-Term Investment.

From 1930 to 2013, according to the Case-Shiller Index, housing in the United States returned 3.8% per year, just over the 3.5% rate of inflation in that time. That means, net of inflation, housing barely broke even. And, these numbers don’t include the ancillary costs-taxes, maintenance, mortgage interest, insurance, closing costs, real estate broker fees, and so on. Add these costs and you’d be lucky to break even on average.

And when housing prices did really take off starting in the early 1990s following a mild recession, the Case-Shiller index was only up 3.2% per year through the end of 2013. Real estate investment trusts (REITs), commercial real estate securities that can be diversified by geography and different types of real estate – apartments, office complexes, shopping centres, and so on- were up more than 10% a year in that time frame.

You would think that because housing prices tend to go up most of the time that housing would be a worthwhile investment. Here’s Robert Shiller, who the Case-Shiller Index is named after, on why this isn’t the case:

Of course there will be those areas in big cities, waterfronts, and popular school districts that are outliers over time, if you bought in at the right time and in the right neighbourhood But a house is likely the biggest asset you will ever purchase that requires a significant amount of debt in a single property that’s tied to your local economy, where you also happen to live and work. It can be a huge risk to use only tour home to fund your retirement. Plus, there is the fact that you can’t spend your house, so to speak, unless you take equity out of it.

I’m not saying you shouldn’t purchase a home because it doesn’t have an above average return profile. ON the contrary, a home can provide psychic income-you get to choose your own neighbourhood, school district, and take pride in home ownership by putting down the roots in a place that you control. Think of housing as more of an asset that forces you to build equity over time than an investment that is likely to compound your savings. On average, your primary residence is not likely to be a huge money winner after netting out all costs and the potential risk involved with putting your entire net worth into a single, levered asset. You can accumulate wealth in your home, but it’s too risky to assume that it should be the only asset on your personal balance sheet.

To sum it up

When we look into buying a home for investment, one of the best ways will always be for rental purposes, period. Rental income is one of the 7 streams of income, while homeownership is not even included. We have to remember that homeownership is one of the common financial goals of individuals, but is not a part of any investment process. We have to know the difference.

Nevertheless, is homeownership really not considered an asset? in terms of price appreciation I would say it somehow is, but I would argue that it is a dead asset because that home doesn’t give you cash flow, in fact it bleeds out your pocket by taking money away from you. It’s just like what Robert Kiyosaki said regarding the difference of an asset and liability, an “Asset” puts money IN your pocket, while “Liabilities” takes money OUT of your pocket. Always remember this.

Needless to say, there are still people who adamantly insist that the home they live in is still a price appreciating asset. Probably because on the emphasis on the words “price appreciation”, but I always tell them first to do the computation that I’ve showed in this blog and do it overtime, before they could say with confidence that their home where they live in, is actually an investment and if it will yield good returns. Because, in an investment point of view, we wouldn’t know if it s a good investment or not, if the costs are not factored with its total returns.

It’s the same with businesses, a business owner could could argue and brag that they have generated a monumental amount of revenue in a given point in time. But, when the business’ costs are factored in such as, the costs of good sold/cost of revenue, operating expenses, interest payments for existing loans and taxes, maintenance capital expenditures and it showed that it exceeded its revenue, then basically the business lost money.

Furthermore, the complexity and the effort into doing this kind of computation takes patience, that’s why I would prefer a non-cash flow generating asset like art collections instead, than insisting a home I live in as an investment. First of all, art does appreciate overtime like the home we live in, but it doesn’t incur large amount of costs unlike a house. There are certainly other ways to make good returns on investments with less friction of costs than the perceived “homeownership as an investment” through its price appreciation.

All in all, our home can be a an investment but unlike other assets, it takes money away from our pocket via the accumulated costs, while it doesn’t even add any income to us at all. Secondly, most homes are mortgaged, meaning a substantial amount of our money goes for interest payments, and again, this is while we’re not even receiving any income from our home at all. As you can imagine, all are just expenses and no income flow. Can you just picture this in the long haul? doing this for 25-30 years, which is the average time for a person to fully pay his/her mortgage loan.

Additionally, it’s only due to our salary that our home that we live in, has still sustained and maintained its value. It’s just like what I shared to you in this blog regarding Robert Shiller’s statement, why housing would for most of the time not be a worthwhile investment.

This is the reason why I highly emphasize that, a home should always be primarily bought for its main purpose. To give safety, security, happiness, fulfilment and love for the family and never be looked into as an investment. Some people have this archaic belief that buying a home as soon as possible is the best option, because renting is just throwing money away, and owning a home appreciates overtime. That’s has been the belief for decades, that’s why most people just jump the gun and buy a home without reviewing everything like the area, their financial capability, their current employment, how likely will they settle in that home for a long time, the maintenance, costs and many more. When in fact renting and owning a home is beneficial depending on our individual circumstances. A home should be a BLESSING and not a CURSE.

Never mix its purpose, It’s either you buy a home for living purposes, or do the proper real estate investment method (rent or flip properties).

If you do the former, then you shouldn’t even be thinking of it as an investment, rather let it be a lovely home for yourself and your family where you could enjoy and live for the rest of your lives. Whereas, if you bought it with the latter reasoning, then rent it out or flip it, and make decisions based on investment philosophies and principles.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.