Much debate has taken place over the years as to whether or not your personal residence is an asset or a liability. For the record I’m of the opinion that it’s an asset, but not in the traditional way that we in the non finance world have come to understand it.
According to investopedia, http://www.investopedia.com/terms/a/asset.asp an assest is a resource that one owns or controls with the expectation that it will provide a future benefit.
Conversely, a liability is a debt that arises during the course of business and are settled over time through the transfer of economic benefits including money, goods or services, http://www.investopedia.com/terms/l/liability.asp.
Technically your home is an asset and the mortgage if there is one is a liability. Even in the case where the mortgage liability exceeds the value of your home (underwater), the house in and of itself is still an asset. The problem is pretty simple, for most of us, we’ve made income producing and asset synonymous, but an asset such as your personal residence may never generate an income for you. In the majority of cases your primary residence will NOT, I repeat, will NOT produce an income for you while you live in it or when you sell it. There are however some situations where your personal residence when bought and sold accordingly can generate a profit for you, but for most of us that’s not the case.
By day, I’m a software engineer and by night I’m a real estate agent and a wannabe investor and so I tend to want to try to turn everything into an income producing investment. That coupled with my passion for Real Estate had me convinced that my personal residence was an income producing venture. We’ll this all changed when my wife sat me down and had the heart to heart with me that in most cases we will not be making additional money from the inevitable sale of our primary residence. I should have simply taken her word for it, but my stubbornness kicked in and I had to run the numbers for myself to see. I’m hear to tell you that in the end it will be a wash. I won’t bore you with detailed scenarios, but the two primary issues are functional (curable) obsolescence and the correlation between actual home improvements and resell market value.
As you live in a place it gets old and it get’s old quick (functional curable obsolescence) and to keep up with the Jones we make the necessary upgrades along the way to keep things as fresh and current as possible. The problem is that 5K in upgrades doesn’t equate to 5k in additional market value. Even if we don’t do upgrades per se, we spend money simply maintaining and repairing the house as things break and need to be maintained. Certain upgrades can be added to what is called your basis and provides some tax benefit when you do sell, but the cost of repairs on your personal residence goes out the window. None the less we feel pretty good about ourselves because with the historical appreciation rate of 4% on real estate and the fact that we are paying off the property, we convince ourselves that we’ll make money when we sell.
Fast forwarding to when the property is paid off, you sit down to do the math to see how much profit you’ll make from the sale and realize that the cost of homeownership has negated most if any profit you would have received. Yes, you will get a lump sum back because you’ve paid the property off, but don’t confuse that money with profit, it simply represents a return of your investment. The age old question then becomes what would that money have looked like had you invested it in some other investment vehicle without the cost of maintenance and a conservative return of say between 6-8%?
OK, you may be thinking that I’m not an advocate of home ownership, but that’s not the case at all. Although I now realize that my personal residence is not an incoming producing asset, it provides two critical components that significantly help your bottom line over time.
1. Paid for shelter while you have a mortgage, and
2. Free shelter (exception of taxes) once the mortgage has been paid.
The second component is arguably the most important of the two. If you are able to pay off your mortgage in your prime while you still have considerable earning power, you now have disposable income to invest and or to use in other good ways. If you are not able to pay off your mortgage in your prime and make that final payment during retirement age, now your fixed income will be protected and not dwindle away as a result of a mortgage payment, and the funds can be used for freely going to see the grandchildren.
So the real benefit of homeownership is not in the income that it will produce but in the income that it will eventually preserve once you’ve paid for the property in addition to the shelter it will provide for you and your family along the way.
Paid for shelter in the future is a tremendous economic benefit, and therefore your personal residence is an asset and not a liability.