Note that this section of the website is not particularly active; I hope to publish about one personal finance article per month.

Sunday, April 13, 2014

Your House Is A Liability, Not An Asset

Although your home is an investment, it is very different from financial assets. Housing is an investment that loses money every year, up until the house is sold. It is better classified as a liability rather than an asset.

More House, More Expenses

Generally speaking, the larger the value of the house, the larger the cost of owning it. And this is not even counting the cost of financing the purchase.

There are four main factors that lead to housing costs increasing with the value of the home:
  1. Property taxes are proportional to the value of the home throughout most of North America. (As an aside, there are differences in how property taxes are handled between Canada and the United States. American municipalities typically keep the property tax rate fixed, so that the tax take rises and falls with the housing cycle. Conversely, Canadian municipalities decide what level of tax they want to extract, and then adjust the tax rate to hit the revenue target.)
  2. Heating and cooling costs are typically increase as the home size gets larger. (This may be less of an issue in more temperate parts of the world.)
  3. The bigger the house, the more stuff you can (and probably will) squeeze into it. Stuff costs money.
  4. Maintenance costs will rise based on home size. This is an important factor to keep in mind for aging wood-framed houses, which is the standard Canadian home construction method.

A larger home also entails more work around the home, which is an increased drain on what may be the most precious resource for working households – their time. Less free time entails monetary costs to compensate (eating out, paying for home maintenance services, the “need” for expensive vacations to reduce stress levels, and less time for part-time work).

If your financial plan is to live your life in a home you own, a more expensive home will generate increased negative cash flows throughout your life. This meets the definition of increasing a liability, not holding a larger asset. Plus, you have to sell other assets that generate income, and/or borrow, for the privilege of owning a cash drain. The only time the increased value of a home will increase the cash flows that you receive is when you sell the thing – but even then, your transaction costs will probably also increase (particularly in Canada).

If you do die a homeowner, your estate will be larger if you have a more valuable home. But that is based on the assumption that you had enough financial assets to cover your spending when you were alive (in order to leave an estate).

I have not forgotten that “you need to live somewhere”. Owning a home eliminates the need for paying rent, and home ownership was historically relatively cost effective, as long you did not need the flexibility of being able relocate. (As many have discovered in the United States in this cycle, being locked into a home can cost you potential jobs.) But when doing the rent versus buy decision, the real comparison is not necessarily for renting the same sized residence as you want to buy; the comparison is for a sensibly priced rental unit, which may be much smaller. If you are renting, you should not be accumulating piles of material goods, as you will have to move your possessions repeatedly. You only need to rent a large house if you have already locked yourself into the treadmill of accumulating a lot of stuff that you need to pay to keep somewhere.

In summary, your residence is not really a portfolio asset; it is a lifestyle decision like deciding which automobile to drive (or not). Housing expenses have to be held under control within a budget, allowing you to accumulate assets that actually pay you to hold them.

Investment Properties

I am not writing here about owning properties as a form of investment. If you buy a housing unit in order to rent it out, you have to evaluate it like a business. Renting out properties is more straightforward than a lot of other businesses, which is why it is attractive to a lot of people. That said, you need to keep in mind market conditions and your overall financial position before taking the plunge into being a landlord.

NOTE: This is a reworked excerpt of my article Housing And Portfolio Allocation that appeared on my main site.

(c) Brian Romanchuk 2014