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Stop Calling Your Home an Investment, it’s an ASSET!

| November 15, 2016
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Home Ownership

One of the most common conversations I have with clients is about their biggest “investment.” Nine times out of ten times, they are talking about their home. When I have this conversation with clients I normally try to help them look at their home as an asset rather than an investment. Generally, if you look at your home as an investment, you’ll find that it has underperformed as an investment.

When you look at the growth in value of a single-family home over a 20-year period, the average REAL rate of return tends to be about 1%. I’m sure many of you may be thinking why is this such a low return? Well, let’s use a real-world example that I covered with a client a couple of months ago.

When I met with my client, who we will call “Mr. Smith,” for their annual review, he always loved to tell me about how much money they have made off his home, and how it’s been re-appraised at $400k and he purchased 20 years ago for $75k. If you find yourself in this position, you should ask yourself “how much money have you made off your home?” In this instance, Mr. Smith had not made any money, because he had not sold his home, it has only increased in value.

The second questions you should ask yourself is, “how much income has my home generated me?” In the case of Mr. Smith, it had not generated any income, because Mr. Smith and his family had been living in it, not renting it out. This is at the exact point when I pointed out, that Mr. Smith’s home is an asset, not an investment. It’s an asset because for the past 20 years he had been paying a mortgage, not rent. They had been paying into an asset that they own, not an investment that is generating them an income, or would generate an income in its current state.

Mr. Smith was still stuck on the fact that the house was now worth 400k and they bought it for 75k, so it was a good investment. So, I started to run the numbers for Mr. Smith. When we added up the amount of interest they had paid on their mortgage, the money they had put into their home, the cost of home owner’s insurance, annual property tax, upkeep costs (landscaping ect.), and the commission they would have to pay to a realtor for selling the home. Mr. Smith would lose money if he sold his home at its appraised value (roughly about -$3,000).

As most people are when we go through this process, Mr. Smith was devastated that he would not make as much money as he thought. However, there is some light at the end of the tunnel.

Mr. Smith had a goal in mind, to generate more revenue, but he didn’t quite know how to go about it. He had this not so great investment he was sitting on, but it was a phenomenal asset. How could we get his home to start generating income for him? 1st we stopped looking at it as an investment and started viewing it as an asset. An asset that is valued at $400k, with only a $15k note on it. 2nd, we utilized the asset to get some cash through refinancing. We pulled out $250k from Mr. Smith’s home and used the $250k to purchase an income producing property. Mr. Smith bought a duplex.

So now, Mr. Smith owns two properties, and only has a mortgage on one. We are minimizing his risk by owning two properties, but only having a liability on one. To further his benefit, he is now renting out each unit of the duplex for $1,800 a month, for a total monthly income of $3,600. Mr. Smith’s total expenses which including his mortgage, property taxes and insurance on both properties is just over $2,000 a month. Mr. Smith is now generating an extra $1,600 a month AND he has increased his tax deductions and write-offs by owning another property.

Now when I speak to Mr. Smith, he loves telling me about this great asset he has and his new “investment” that is generating him an income.

This brings me to another point, why should you have a financial advisor. I believe this scenario can be a great example. Our clients do not pay us an hourly rate, they are charged a percentage of assets under management, and we do also receive commissions for some products that we use such as insurance.

Mr. Smith did not receive a bill for the hours upon hours I spent working with him, and I wasn’t given any type of commission for any of the purchases he made. Mr. Smith had a financial goal that he wanted to speak to me about, and we helped him with that goal.

If you aren’t having goal driven conversations with your financial advisor, then you should ask him or her why you aren’t. And if you would like to have a goal driven conversation with a financial advisor, then our team at Finance For Thought are always happy to do so.

Sources:

http://homeguides.sfgate.com/average-rate-return-real-estate-investments-72195.html

http://www.cnbc.com/id/100956880

https://www.jstor.org/stable/3145789?seq=1#page_scan_tab_contents

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