In this post, we’re answering a controversial question: is your house an asset or a liability?
If you’ve ever read the popular book Rich Dad Poor Dad by Robert Kiyosaki, you’ll know that Robert is a firm believer in houses being a liability.
But is he right?
Before we start, full disclosure – I’m a homeowner myself.
But I have rented in the past, and in this post I’ll do my best to lay out both sides of the argument to make it a fair fight.
To begin our answer, let’s first set out what we mean by an asset and a liability.
What Is An Asset?
According to The Balance, an asset is a resource owned by an individual with the expectation that it will provide economic benefit.
A good example of this would be an income-generating asset, like owning a property which you rent out.
Every month, you receive money from your tenants in the form of rent. The economic benefit you are receiving is the monthly income from your tenants.
Another type of asset could be a growth asset, which appreciates in value over time.
A good example of this would be a vintage wine which increases in value the longer you hold onto it.1Note that a rental property would also constitute a growth asset if the value of the property increases over time. We’ll come onto this later.
The wine doesn’t pay you any income, but you can sell it after a couple of years for more than you bought it for, which makes you a tidy profit. It’s a resource that you own which will give you an economic benefit when it’s sold, so we classify it as an asset.
What Is A Liability?
A liability is something that an individual owes.
A good example of this would be a bill, like your mobile phone contract. You owe your mobile telephone company an amount each month for the duration of the term. Having your contract entitles you to the phone, but it also costs you money.
You can think of a liability as the opposite of an asset. If you hold an asset with the expectation of an economic benefit, then the expectation of holding a liability is an economic detriment.
Either the liability costs you money to keep, like a bill, or the resource will have depreciated in value by the time you come to sell it, like buying a brand new car. In other words, a liability loses you money.
Treating Your House As A Growth Asset
Perhaps you’re the type of person who will take on a lodger or a tenant in your home. Or maybe you’ll allocate some garden space to growing strawberries so you can sell jams to Mrs Smith at the county fair.
However, for the vast majority of people, a house will be nothing but a house. By this, I mean that it won’t be generating you any income whilst you own it.
This means that the only way you’ll be able to make money on your house is by treating it as a growth asset. That is, you’ll be expecting it to appreciate in value the longer you hold on to it.
Over the long run, treating a house as a growth asset is a pretty safe bet. We know that houses tend to increase in value over time, at least in line with inflation and often by more.
Just take a look at the graph below to see how the average UK house price has changed since 2008.
If you’re living in the same house for at least 10 or 15 years, you’re very likely to ride out any short term fluctuations in the housing market and make yourself a gain after you sell, minus any ancillary expenses like estate agent fees and legal costs.
Of course, if you intend to own your house for a shorter time period than this, then you’re putting yourself at the mercy of the market. The chances that you’ll make a profit when you sell in the short term decrease significantly when compared to a longer term outlook.
For example, if you’d bought your house at the top of the UK market in 2007, it would have lost 17% of its value on average a year later in 2008. This highlights the risk you take if you only plan to own your house for a short number of years.
There are other factors which can contribute to whether your house grows in value over time too.
For example, if you renovate your home or extend it to increase more liveable space, there’s a good chance that your house will increase in value more than what it cost you to make the improvements in the first place.
This is all fact specific, but the important thing to recognise is that the value of your house is not static.
It will go up and down over time, but the general trend is a slow upward increase in the long run, which can be accelerated by making valuable improvements to your property.
What Is The Economic Detriment Of Owning A House?
Looking at your house as a growth asset is only one half of the equation. Once you own your house, you also have lots of other costs, like utilities, maintenance, tax and insurance.
Clearly, these are economic drawbacks. Paying these costs does not provide you with any direct financial return,2The indirect financial return would be that having electricity and heating your home allows you to survive so you can go out and earn money. and they are costs that you would not otherwise incur if you hadn’t bought your house.
In addition, unless you’re a cash buyer, one of your biggest expenses will be your mortgage.
Assuming you have a repayment mortgage (as opposed to interest only), your monthly payments will pay off both the loan amount (the ‘principal’) and the interest that accrues on the loan.
Unfortunately, much like the other costs of running your home, the money that goes towards paying off the interest is effectively ‘dead money’.
You’re obligated to pay off the interest (otherwise the lender would not agree to lend to you) and it doesn’t increase your equity in the property. It therefore doesn’t provide you with any direct economic advantage.
What Is The Advantage Of Having A Mortgage?
Although your mortgage is a liability, there can be an economic benefit to having one.
Depending on your interest rate, most of your monthly mortgage payment will go towards paying off the principal of the loan amount that you borrowed to purchase your house.
The more of the principal you pay off, the more equity you gain in your house.
Assuming you don’t make any overpayments, a 25 year mortgage will have you paying off the principal in 25 years, at which point you own 100% of the equity in your home.
In this sense, we can think of a monthly mortgage payment as an enforced method of saving. If you make a monthly repayment of £1,200 and £400 of that pays off the interest, then each month you’ll gain £800 worth of equity in your house.
The more equity you have in your house, the more options you have to release that equity or leverage it against other assets.
For example, you could use it to secure a loan for your new business, or to purchase another property which you rent out to generate income.
In short, whilst a mortgage is a liability, it can also double up as an enforced method of saving. If you didn’t own your house, would you really tuck that £800 away every month, or would you be tempted to spend it instead?
The answer to this question will very much depend on what type of person you are, but for some, a mortgage is actually an efficient method of saving money and investing it in a physical asset.
The Opportunity Cost Of Home Ownership
People who argue that a house is a liability often point to the opportunity cost of home ownership.
In investing, opportunity cost is defined as the opportunities you forgo by having your money invested somewhere else. In the context of owning a home, by having your money invested in the house, you lose the opportunity to invest it elsewhere.
This is a valid point. If we assume that the stock market gives an average annualised return of 7.5% after inflation, then your house would need to increase in value by 7.5% each year after expenses to provide a greater return.
On a purely mathematical basis, if your focus was to maximise your returns, you would likely do better by investing in the stock market than by owning a house.
However, what this point fails to take into account is the alternative to owning a home. It assumes that if you didn’t own your home, you would have no other costs. And, as we will see below, this is simply not the case.
The Alternative To Buying A House
Assuming that you cannot live with your parents or friends for free, the alternative to buying a house for most people is renting.
Renting has its advantages. The biggest is that you aren’t responsible for maintaining and repairing your property. If your oven breaks or your boiler is on the blink, then your landlord will be the one that foots the bill.
You also don’t need to worry about insuring the property. If the building burns down or falls over, your landlord will be the one who has to worry about rebuilding it.
Another economic benefit to renting a property is that you aren’t tied down in one place. If you need to up sticks and leave, all you need to do is provide the requisite notice to your landlord.
It’s much easier than selling a property and will allow you to chase opportunities in other locations, like being promoted to a different office or starting a new job in another city.
You also don’t have to worry yourself about short term fluctuations in the housing market, because you don’t own the property you’re renting. You don’t have any downside because you don’t have any skin in the game.
What Are The Disadvantages Of Renting?
The biggest disadvantage to renting is that the rent you pay is ‘dead money’. Much like paying off the interest on your mortgage, rent payments don’t give you any direct economic benefit.
Once the money is gone, it’s gone, and you won’t build up equity in the property because you don’t own it. In fact, your rent payments will go towards building someone else’s equity in the property, i.e. the landlord.
This is one of flaws with the ‘opportunity cost’ argument. Even if you didn’t own your house, the majority of people would have to rent instead.
By spending money on rent, you still encounter the opportunity cost of where your rent could be invested instead (e.g. the stock market).
What’s more, even though your rent may be cheaper than your mortgage repayments, paying your rent does not build you any equity in the property.
So not only do you lose the opportunity to invest your rent money elsewhere, you also lose the opportunity to build equity in your home.
In addition, the majority of tenancy agreements will specify that you are responsible for paying the utilities and any ongoing taxes (e.g. council tax). As such, these costs are almost unavoidable regardless of whether you own a house or not.
Conclusion: Is Your House An Asset Or A Liability?
So what does all of this mean for you? Well, whether your house is an asset or a liability will depend on a number of factors.
However, generally speaking, the longer you own your house for, the greater the chances of it being an asset. This is particularly true if you make valuable renovations or improvements to your home.
In contrast, if you only intend to own your home for a short period, your house is more likely to be a liability. You are less likely to ride out any bumps in the market and any marginal increase in value will be offset by the ancillary fees associated with selling your property.
The alternative to home ownership for most people is renting. Paying rent money is most definitely a liability, but it may still be cheaper than short term home ownership and more financially beneficial for people who will move locations.
Do you think differently? Let me know in the comments or by messaging me on Twitter @OfficialLOAM.