A home is the single largest purchase most people make in their lives, often costing multiples of what they earn in a year. People who have owned their homes for many years often sell them for a higher price than they originally purchased, but is a home really an asset though?
Let’s start with a definition of what an asset is, in the context of a home. For the sake of clarification, let’s refer to our primary residence, or the place we call home that we own.
What is an Asset? What is a Liability?
In simple terms, an asset is something that you own, that is expected to earn you money in the future. The opposite of that would be a liability. Some common examples of assets would be stocks, bonds, rental properties and so on, that have increased in value from the time of purchase, and/or provide income on an on-going basis. These same examples if they lost money, would be considered liabilities.
So the key factor is whether what you bought earns you more money than you paid for it or not.
To simplify our discussion, let’s look at homes from two perspectives:
1) length & intention of ownership
2) cost avoidance
Length & Intention of Ownership
The length piece of this perspective can be broadly divided into two groups: mid-term and lifetime ownership. The intention is how the owner of the house views their home. Is it something to be bought and sold, working to trade up or make a profit? Or is it a home to lived in for a lifetime.
Let’s take a look at both of these groups.
Mid-Term Ownership
For the purpose of this discussion, let’s call mid-term ownership anything less than 10-15 years. It could be longer, but the main point with this group is that you are buying and selling homes multiple times throughout your lifetime. The intention when the home is purchased is not to live there forever, but to sell and move on when favorable/required timing arises. It is not so different from a trader who buys and sells stocks or bonds.
In this example, whether a home is an asset or a liability depends on the sales price of the home and all of the costs put into the home since its purchase.
For example, if a home cost $250,000, and over the course of ownership required repairs of $10,000, taxes cost $12,000, and homeowners insurance cost $8,000, then the total cost of ownership would be $280,000. If the purchase price less real estate agent’s fee and closing costs was $360,000, 10 years later, then the return on investment would be $80,000 making it an asset.
On the other hand, if the price of the home after fees only increased to $270,000, it would be a loss of $10,000, and hence a liability.
The level of risk will also come into play as to whether it is just speculation (hope of gain, but with risk of a significant loss), or a calculated risk (investment). For example, buying housing that is in short-supply with little room to increase the number of houses in a desirable area at a below market price (investment), or buying a home in a “hot” market above asking price because housing prices have been increasing rapidly for the past 5 years (speculation).
Let’s look at lifetime ownership now.
Lifetime Ownership
In this situation, the buyer intends to buy once and never move. This is their first and last home. In reality, they may need to move later on in life, but that is not their intention at the time of purchase, nor in their life plan.
For this group, it would not be appropriate to view their home as an asset because it is not something they will sell, and therefore they won’t make any money off of it.
Timing Matters
An important distinction for both holding periods is that the home is not an asset now, it only becomes an asset when it has been successfully sold for a profit in the future. Today, the house is almost always a liability (unless you’re short term vacation renting/sub-letting more than your expenses), because it is costing you money, not making it.
Cost Avoidance
This perspective is about the relative additional amount of money you’re able to save in relation to renting a comparable house/apartment. There are many hidden costs with renting, such as moving more frequently, reduced/lost housing deposits, and the cost of rent increasing over time (and faster than incomes).
The basic premise is that if your total cost of ownership < cost of rent, then the difference could be considered cost avoidance, or money saved. This is essentially the same thing as having an increased income (your net income or savings increases) and so could be considered an asset for that difference.
Quick Example:
Home Ownership Total Average Cost/Month = $1,400
– Mortgage & Interest Payment = $1,250
– Homeowners Insurance = $30/month
– Taxes = $100/month
– Repairs & Maintenance $20/month
Monthly Rental Expense = $1,600
The $200 difference in this example could be considered cost avoidance, and therefore, the home would have an “income producing” effect, making it an asset.
Summary
How long you own your home and how you plan to utilize it, whether as inventory to be bought and sold for a profit, or a lifetime residence has a large impact on whether your home can be considered an asset or a liability when it is sold in the future. In either case, for most people, your home today is a liability because it is costing you money every month.
If you are able to own your home for less cost than a comparable living, you can consider it cost savings, and thus an increase in savings and therefore an asset.
If you rent out your home for a short-term vacation rental or to room mates, the amount of income you receive in relation to your cost of ownership makes it either less of a liability if it is still a loss each month, or an asset if you’re making positive cash flow.
