When asked what your biggest financial asset is, what would you say?
If you're a homeowner, the answer may seem easy—your house! While owning a home comes with several long-term advantages, is it really the most beneficial asset in your portfolio, or is it a bit more trouble than it's worth?
Let's take a look!
Your Home Is An Advantage, But Is It An Asset?
Society paints homeownership as a hallmark of the American Dream, and though building equity can be financially helpful, your home likely isn't the money-maker you think it is.
Think about why you buy a home—more space, a good school district, putting down roots, etc. Your primary motivation for buying a house isn't really to make a whole lot of money, even though it's one of the most expensive items you'll purchase.
It's not like buying stocks, bonds, or other investments that don’t actually provide you with any immediate use. You buy a home to live in. The “investment” aspect is a side effect, not the primary purpose.
Assets Provide a Return
When you invest in an asset, it usually generates regular income or provides capital gains over time. For example, when you invest in stocks, they may appreciate in value, pay dividends, or both. Bonds provide an interest payment and pay you back a lump sum at maturity.
Does your house generate regular income?
If you scoffed, that's okay. No, in general, your house doesn't produce regular income; instead, it takes that income away. There are property taxes to pay, repairs to keep up, and the occasional update. (You don’t still have wallpaper in your bathroom, do you?)
Of course, that’s not always the case. An excellent example of an exception is if you rent a room in your house.
Perhaps you have the occasional AirBnB or VRBO guest, or maybe you rent out your whole house when you’re gone. Even still, those elements alone may not push you into profitability; you need to consider your labor. You could always be spending your time on something else, like a side hustle, passion project, time with family, relaxing and restoring, etc.
Building Equity Takes Time (and A Lot Of It)
Yes, a house can be a solid long-term investment. Ideally, you'll sell it for more than you bought it, and after closing costs, you may end up with a profit you can put toward your next house.
But building equity in a home doesn't happen overnight. It often takes several years (5+) to earn enough equity to cover what you put into it.
That’s primarily because of the way that homes are financed. A portion of your payment each month goes toward interest, and the rest goes to paying down the loan balance.
At first, you're paying more in interest than on the principal, so the balance doesn’t fall very quickly. Your house isn't as much of an asset unless you've been paying your mortgage for a while because the debt to value is so high.
The reality is that at the beginning, you don’t really own much of it; the bank does.
Homeownership Is Usually Low Risk and Low Return
Historically, property has been a great long-term investment. In the right area, it's also relatively low-risk. But there is always a tradeoff between risk and return.
Real estate produces much lower returns than people think. Compared to the stock market, the average annualized rate of return for property was 3.7%, and stocks were 9.5%.
A significant thing to consider when evaluating homeownership as an investment is leverage. Most people do not pay cash for their homes but rather finance them. The most typical arrangement is to put 20% down and borrow the rest. That means the actual cost of your investment isn’t the home's purchase price but the cash you put down.For a simple example, let’s say you buy a house for $1MM (assuming you can still find a home at this price in the Bay Area):
Purchase price: $1,000,000
Down payment: $200,000 (@ 20%)
Mortgage balance: $800,000
If the home appreciates by 3.7% as discussed above, the value is now $1,037,000. A $37,000 return on your $200,000 investment = 18.5%. This is the power of leverage. You earn the appreciation on 100% of the home even though you only technically own 20% at the start. The downside to leverage is if the house declines in value by 20%, your entire equity is wiped out and you still owe the bank the $800k that you borrowed.
You can do the same with stocks (it’s called buying on margin), but it’s much riskier and not advised.
Your House Is Expensive
Sure, you have the monthly principal and interest payment, but think about all the other ongoing expenses. In addition to the property taxes and updates that we already mentioned, don’t forget that stuff breaks or wears out. Your roof may get damaged, and appliances could go out. Then there are electrical and plumbing problems that often require licensed professionals.
And that’s just the big stuff. There’s also routine maintenance like lawn work and cleaning. Even if you handle the labor yourself, you still need equipment and supplies.
The simple fact is that your house can cost you a lot of money to own and maintain.
Owning A Home Is Right For Some People, But It Isn't Always An Asset
There's no one clear answer, but while your home can be a great value-add to your life, it's likely not the "biggest" asset you own—your ability to earn a high income (i.e. your human capital) and the money you have set aside in purely investment assets are.
If you are trying to decide if homeownership is right for you, how much you should spend, or how to finance your purchase, give us a call. We help people in the Bay Area navigate the particular nuances of the local housing dynamics every day, and we are ready to help you too.