Sunday, August 3, 2014

Buying a Home is an Expense not an Asset

What a bold statement to make.

Recently, I have been thinking a lot again about finally leaving the nest and to move out to get a place of my own. It is actually the biggest goal that I am working towards in my life now - secure enough finances to allow me to purchase a house and move out.

I must thank SG Young Investor for doing the dirty ground work in an earlier post while I just double-checked the numbers. He does solid mathematics. Investment Moats also wrote a property piece comparing 4 and 5 room flats, while AK resurfaced a previous blog entry about furnishing his apartment. I also just finished reading a thick book titled Investing in REITs, which I will slowly write my review about soon.

And because of all this property talk, I remembered a previous post I wrote about The Flipside of Homeownership which is based on an article on Zerohedge titled "The Fallacy of Homeownership". Here are the points talked about in the article:

1) A house is just about the most undiversified investment you make

"You will own exactly one asset class (residential property), in which you only own one investment in that one asset class, which is one property located in one neighbourhood in one country. Investments rarely get as specific as that."

2) Homeowning requires the use of leverage, which can be dangerous
3) Residential property is just another asset class - and ALL asset classes go up and down.
4) Homes are illiquid with liabilities
5) Land is never free - you're either owning it, renting it or freeloading on it. Renters pay a premium for only being committed in the short-term, that's the only difference.

So, what is the definition of an asset?

I think the Investopedia definition of "something that can generate cash flow" is a good place to work from. The home that you live in isn't an asset, because it doesn't generate cash flows for you. That second investment property that you buy is an asset because you collect rent on it, but not your home.

Why is it an expense? Renting is an expense, agreed? Well, when you transform from renter to homeowner, you are instead just using the money that you previously used for rent to pay off your mortgage.

Sure, after 30 years you finally own your home which is technically an asset, but what can you do with it to generate cashflows for you? You still live in it! Whether you are renting a place, paying off the mortgage or completely owning the place, your home is your home. You can't rent it out as long as you still are staying in it.

I am not talking about buying a 5 room flat and renting out all the empty rooms. In that sense, your "home" is only just the rooms that you occupy, and the other empty rooms are your "second investment property". You paid additional money for this space that you do not need, in order to rent to out. You invested in the other rooms.

From this train of thought, even if your "home" appreciated in value or dropped to zero, it does not matter to you, since you live there. As far as you are concerned, this "asset" is not for sale.

Let's say the entire property market jumped up in value. Are you any richer? I think the answer is no. One home still buys one home. Unless you sell your home at the top of the property cycle, rent out a place and then repurchase again at the bottom of the property cycle, I don't think you can become richer using your home. You need at least 2 asset classes to cycle between one and the other to become relatively richer.

So what does this mean to me?

I think my main takeaway from property now is that my home should be only as big as I would ever require of it, and not anything bigger. That means for me, I would be fully contented living in a 1-bedroom apartment.

If I lived in a 2-bedroom apartment, I would effectively be owning a 1-bedroom apartment as my home, and I have an "second investment room", which I will have to manage and rent out myself. If the room is empty, you have to rent it out. If it isn't empty and you use it, then it is part of your home. It's either one or other, that's all.

Since I am single, a 1-bedroom apartment is perfect for me. Instead of getting a bigger place which I (most likely) will not use in the future, I might as well save on the extra capital outlay and purchase the right size of home for myself.

All that extra capital that I save from not getting a bigger place, I can deploy in the market. I think even if I decided to invest with that sum in a few good REITs, it would earn much more than if I try to rent out a room by myself. And of course, I will still get my own privacy in my own home. Perfect!

Any thoughts on this issue? I'm just 24, I would love to hear any inputs from those with property investments and home purchasing experience!

3 comments:

  1. Replies
    1. Uncle CW8888, THANK YOU!!

      Thank you for writing those articles and for linking them to me. I really like 2 of them:

      Home for Living and not profit taking (6)
      Will You Try To Pay Off Your Housing Loan ASAP If You Have One? (4)

      Yes, the word that I was looking for is "Utility Value". A home has utility value, so a good home is not something that will give you the highest return on investment, but it is something that you can utilize and enjoy.

      MH

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  2. That's true. You shouldn't have to spend beyond your means, especially for fairly illusory stuff like you said, such as the need for a big house. Then again, mortgage shouldn't have to be too much of a problem either. Big or small, and whatever your financial situation, there are ways to resolve such problems at both financial and legal fronts. All the best to you!

    Stanley Erickson@ The Bankruptcy Legal Services

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