Your home might be less of an asset than you're led to believe

Posted by Conor MacEvilly on Thursday, June 15, 2017 at 4:30 AM By Conor MacEvilly / June 15, 2017 Comment

Debt is one person's liability, but another person's asset - Paul Krugman.

Is my home an asset or a liability? The US real estate market is currently booming and Seattle real estate is top of the heap. At the time of writing this, Seattle home prices are up close to 13% year-over-year and a whopping 47% above the previous highs of 2007.

If you own a home, you might be gleefully looking at those newspaper headlines detailing the latest market surges, dwindling inventories and desperate buyers fighting it out trying to buy a home while driving prices upward. While sipping your morning coffee, you'll be silently pondering "I wonder how much my home is worth now?'

Yes indeed, times are great and homeownership is a great investment!

Or is it?

No, this is not an article about whether we are in the midst of another real estate bubble, but rather a look at how the biggest purchase of your life can be an asset or a liability, or neither. Also, even if you walk away with $200,000 in your checking account after the sale of your home, was your home really an asset / good investment in the strict sense of the word?

A home can be a potential asset or quickly spiral into a financial albatross around your neck. Alternatively, your "investment" can just sit there and do nothing. Some things, like sudden economic changes, are out of your control, but others like taking too much equity out of your home to buy a speedboat are within the realm of human stupidity.

Historically, home prices have gone up in value but it's not a smooth, linear upward trend. Here's the Case-Shiller US home price index, adjusted for inflation, starting way back in 1890. Note that the index measures the changes in the sale price of single family homes that have sold previously (excludes new construction and condos). The index is normalized to have a value of 100 in 1890.

Case Shiller US home price index adjusted for inflation

As you can see, there were numerous upward and downward trends and times where the market was essentially flat. The boom years after the second world war, the irrational exuberance of the early 2000's followed by The Bubble and now we are on an another upward surge again.

Whether your home becomes an asset or a liability might just depend on when you bought the home, how long you keep the home but also on unexpected life events or self-sabotaging yourself by abusing the equity you have in your home. Also, some buyers would be better off not buying at a particular time of their lives and just waiting a while.

Your home as a (potential) asset:

Some would argue that in reality, your home is only an asset once you sell it and cash out. So, based on that scenario, how much actual PROFIT did that investment generate for you?

Say you bought a home for $400,000 with a $50,000 downpayment.

Now, 10 years later it's worth $550,000.

Sweet, a cool $150,000 profit! Right?

Not really.

Your envious renter friends will automatically do the above simple math of subtracting the purchase price from the sale price and declare, "Wow, you guys lucked out!"

Homes are not like a gold bar that you buy and bury in the garden, wait 10 years for the gold market to go up, dig it up and then flog it for pure profit (minus certain taxes). Owning a home has lots of associated expenses:

Monthly mortgage payments (principal and interest) and potentially, mortgage insurance
Property taxes and hazard insurance
HOA dues and unexpected special assessments
Maintenance costs and major repair bills
Upgrades and remodels
The costs associated with both buying and in particular, selling the home
Need to allow for inflation
Yes, there are tax deductable benefits that offset some costs

Say you get a big fat $200,000 deposit into your checking account two days after closing on the sale of your home. How much of that $200,000 is actual pure profit? You must take into account all of the expenditures while you owned the home. And don't forget that $50,000 of that $200,000 is the downpayment you made when buying the home.

So now, you're down to $150,000..... minus all those expenses and over 10 years, and that's a lot of expenses.

Now the question becomes: what return did you get on your initial $50,000 downpayment over that 10 year period? Was it a good investment (an asset) or a bad one ( a liability)?

Would you have been better off by investing that $50,000 elsewhere over that same 10 year period? If you're a professional property investor and had tenants in the home covering all of your expenses and generated a positive monthly cash flow, then that's a lot different that living in your own home.

A home is first and foremost a H-O-M-E. You're not a property investor, you're a HOME-OWNER.

So why am I popping the homeownership/investment party bubble (for Is your an investment or just a home? want of a better word)? Because homeowners should stop viewing their home as an investment and stop believing all the hype out there about homes always being a great investment. It should be a home first and foremost and if it generates some profit for you, all the better. And if you're honest with yourself and you do the math, sometimes that investment doesn't generate much, if any profit.

If you own actual investment properties with tenants, then that's totally different. But here we're talking about YOUR HOME. The place you live, the roof over your head, where you raise your kids, have good times, bad time and some amazing times, being part of a community. Your home fills psychological and emotional needs.

While your "investment" might not always generate buckets of actual profits for you, it sure beats renting where you have absolutely nothing to show for that 10 years of rental payments. Even if you break even when you sell your home, you still get your downpayment and all your expenses back and can go buy another home.

To quote Robert Shiller, he of the Case-Shiller index above (and winner of the Nobel Prize for economics): "If you look at the history of the housing market, it hasn't been a good provider of capital gains. It is a provider of housing services".

Your home as a liability:

I always tell home buyers not to buy a home unless they intend to keep it for at least 5 years. Why? Because nobody has a real estate crystal ball and nobody knows what will happen in the next 5 years. Will you have enough equity in the home in order to at least break even if you need to sell?

When you buy a home you are committing (in writing and with a chunk of your own money) to regularly pay monthly mortgage payments including property taxes and insurance for as long as you own the home or until the mortgage is paid off.

If your maintain some equity on your home then it will / might remain a potential asset.

In the event that you have to sell your home but do not have any equity, then it has now become a liability.

If you currently have no equity in your home but don't need to sell and intend to live there for years to come, then who cares if you have no equity. The home will eventually go up in value over time and you will generate some equity. It's only a liability if HAVE TO sell and have no equity.

The day you buy a home, it's net worth immediately drops. What?!?

No, your new home hasn't actually dropped in value like a new car driven off the showroom floor, but the home's NET worth is now less by between 5 to 10%.

Why? Because it costs money to sell your home including agent fees, excise tax, escrow and title fees etc. Even if you tried to sell the home yourself as a FSBO, you would still have to pay excise tax and probably the buyer agent fees plus other costs. Also, the odds are heavily stacked against you if you go the FSBO route.

Very few buyers, except those with extreme buyer remorse or buyers with sudden, unexpected life changes would need to sell a home right after they have bought it. However, it does demonstrate the point that once you buy a home, the home has to go up in value for you to at least break even to offset the costs of selling the home.

If you have to sell your home a lot sooner than you anticipated and the home hasn't gone up in value to cover the costs of selling your home, or worse, has dropped in value, then you now own a liability. Plus if you don't have the option of renting the home, like some condo developments, then your options are extremely limited.

Bubbles of the non-champagne variety

Time are good right now and the real estate market is chugging upwards. In some markets, like Seattle, it's bordering on crazy and becoming a little irrational primarily because of a booming tech economy and lack of homes for sale.

A lot of people are wondering, are we in for another bubble? The last one was right around 10 years ago. Back then, lenders were throwing money at any Tom, Dick or Harry that could fog up a mirror when held to their mouth. There were predatory, subprime lending practices, home appraisals approved by a guy in a white shirt sitting at a computer terminal (Washington Mutual was good at that) and dodgy loans were buried in with good loans and sold as mortgage-backed securities. And then home prices went over the cliff and lots of people lost their homes, many of them who probably should never have qualified for loans in the first place. But hey, the banks got fat on it for a while, then had to be bailed out and nobody went to jail. Capitalism at it's finest! Nothing wrong with capitalism, just not when the white collar crime walks away scot free.

The arguments for that not happening again are that lending guidelines are must stricter now, buyers must have solid credit and make larger downpayments, more homes are being purchased with cash (about 23% in the Seattle area) and in the case of Seattle, we are becoming a mini SanFrancisico tech hub and we would be relatively immune to another bubble, if one did occur.

Do I personally know what's going to happen? I wish! Time will tell over the next 10 years. It will be interesting for sure. Everything goes in cycles and for real estate, it's usually every 7 years. The current one started in 2012..... stay tuned!

Squandering your home's equity and turning your asset into a liability.

Don't blow the equity in your home It's been a few years, but I'm just starting to see those "Hey, you've got lots of equity in your home, you should use it" mailers. Can equity-rich homeowners resist the temptation this time around?

When you have a chunk of equity in your home, it's tempting to think to yourself what you might be able to do with that lovely money. You could remodel that dated kitchen and bathrooms, you could convert the basement into living space or you could buy that speedboat you always wanted or buy a timeshare in your favorite vacation destination.

Two of these are decent choices and two of them are not particularly advisable. Plowing money back into your home on updates and remodels will increase the value of your home, however, they are unlikely to increase the value by the amount of equity your borrowed to do the updates. However, if you get to enjoy and appreciate those updates for a few years as opposed to just doing them to sell your home, then that's a definite plus.

The speedboat, facelift/liposuction, Hawaiian timeshares, toys-for-boys, mid-life crisis Corvettes are not the most prudent use of your hard earned equity. Even though yes, it's YOUR equity in YOUR home, or should I say, it WAS your equity, you have now just increased your monthly mortgage payments and have purchased stuff that will depreciate in value (you're going to need more facelifts). More importantly, you have reduced your protective cushion in that the event the market "takes a turn for the worse". You're turning your asset into a liability!

As the saying goes: those who cannot remember the past are condemned to repeat it.

Some ways are better than others at accessing the equity in your home like downsizing and potentially getting a reverse mortgage, although there are pros and cons to all of these.

Just because the mortgage is paid off doesn't mean you don't have any more bills.

If your mortgage is paid off, but you don't have the cash to cover your property taxes, insurance, maintenance costs, HOA dues, utility bills etc, then your home is a liability. You are house-rich but cash-poor. You could take some equity out of the home to pay those bills, but now you have a home equity line of credit that you need to pay each month, like a new mini mortgage.

However, one easy solution is to just sell the home and downsize (assuming you haven't downsized already). Or you could go with a reverse mortgage and get to stay in your home.

Closing thoughts: Your home can, and sometimes does, deliver a nice big net profit for you if you are fortunate enough to buy and sell a home at the right time. However, there is no guarantee that will be the case. You should first and foremost look upon your home as just that, a home, not as an investment strategy. The home you live in is not the same as a rental property owned by a savvy property investor who has tenants covering all the expenses and generating a monthly positive cash flow. Enjoy your home and if you walk away with a new profit when you sell, all the better!