There has been a lot of discussion if homes are an investment or a liability. There are generally three points of views:

• Homes are one of the best investments that one can make

• Homes are not an investment unless they generate income via rentals

• Home bubble may pop thus may not be such a great investment

All points have validity. A home can be a good investment with a few caveats which I explained in “Before Buying Your New Home” . The typical buy versus rent break-even point is approximately 2-4 years depending on your specific situations and location. Thus, if you plan to say in a home for a while, it can be a good investment. However, there is a limit to a home being a good investment. Some buy a bigger home than they can afford thinking the bigger the investment the better. Others do not call a home an asset because it does not produce income. So what is a home, an asset or a liability? It is actually a little bit of both.

If you did not own a home, you would need to pay rent. By owning a home you eliminate this expense (especially when mortgage is paid-off). You actually have an asset generating income to offset the expense. So, I consider a basic house an asset because there is an income being produced even though it is produced by eliminating a basic living expense.

Yet there is an additional cost in a home when you buy a bigger home than what you would have done if you rented instead. It is easy to decide between a $1,000 rental that you need and $2,000 rental that you may want because you can see the difference in cost. Thus, you can decide easily if the additional $1,000 is worth the cost and if you can fit into the budget. Yet, in buying a home, you have a tendency to pick the bigger home because it is perceived as an investment. Yet, if you would not pay the higher rent (e.g., the $2,000 rent), the bigger house is not an investment. The bigger home is now more of a liability because the bigger house will not produce a return on your investment.

What is the cost of a home? Factoring in no mortgage (for simplicity), the cost of owning a home

• 5 – 8% Post-tax return of investing in other assets (e.g. stock) instead of home*

• 1 – 2% Property taxes

• 0 – 1% Insurance

• 1 – 3% Maintenance

• 0 – 2% Selling Costs (amortized over length of ownership)

———

• 7 – 16% Total

* For the money you have invested in the home, otherwise this is the cost of mortgage interest for the amount borrowed via a mortgage.

What is the return on a home?

• 5 – 6% Appreciation (long-term)

There are some tax consequences that make a home a better investment (e.g., deductibility of mortgage interest and property taxes). Yet, it is hard to overcome the 2% – 10% difference in costs of a home versus return on home. This difference can be overcome by factoring in the savings of not paying the rental cost instead of owning a home. Yet, if you would not pay the higher rental cost of a bigger home, then the additional cost of a bigger home is a liability because the house value typically will not appreciate fast enough to overcome the cost of owning a home. Thus, the base home is an asset that can give you a better return than renting if you own it long enough. The bigger home that you would not have rented due to cost is a liability because the cost of home ownership is much greater than the appreciation of a home.

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This entry was posted on Tuesday, August 1st, 2006 at 9:26 am and is filed under House. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.