Many homeowners consider their primary residence to be an asset. I define an asset as something of value that puts money in my pocket. My definition of a liability is something of value that takes money out of my pocket. So, is the home you live in really an asset?
Based on my definition, an asset would include an appreciating stock, interest bearing savings account, mutual fund, an asset producing a dividend or revenue stream, or a rental property producing a positive cash flow. These types of assets generate revenue and put money in your pocket.
Your primary residence does not produce an income stream or put money in your pocket. It takes money out of your pocket, and is therefore a liability. Most owners pay a mortgage. Even if home is paid for, owners must pay for hazard insurance, property taxes and maintenance expenses. These expenses take money out of your pocket, and homeowners can only write off the interest and property taxes on their primary residence.
In Austin, homes appreciate at best at the rate of inflation. With the current recession, we are seeing most home values drop slightly. Many homeowners purchase homes because they think values will increase. In a good market, we will see values increase. However, no home increases in value more than the cost of living in the home. Most owners are not going to retire early, send their kids to college, or get rich by purchasing an expensive home.
If you purchase the right property, an investment rental property can be a great asset. Interest rates are in the mid four percent range for non-owner occupied property (October 2010). These are record low interest rates. I started purchasing rental property over ten years ago, and the interest rates were in the mid eight percent range in 2000. Even during the Austin high tech bust and easy financing days, rates for rental properties were in the mid six percent range. Home values have dropped, and foreclosures are near record highs. This is the best opportunity I have seen in my career to purchase a positive cash flow rental property.
Unlike a primary residence, investors can write off insurance, repairs, management fees, and even depreciate improvements made to the home. The IRS gives landlords more deductions than homeowners. And, the mortgage is paid by a tenant. So, a rental property meets the definition of an asset because it puts money in your pocket and is paid by someone else. With today’s low interest rates, most properties priced below $130,000 will produce double digit return. However, you must put 25% down to get the best rate and have six months cash liquid reserves.
An investment property can produce a huge return from multiple buckets. Most assets only produce a dividend or may appreciate in value. Rental property is the only asset that can generate an instant return on your investment when you buy below market. Additionally, rental property can generate positive cash flow, appreciate in value, and reduce your principle each time your tenant pays your mortgage. An investment property is the only long term appreciating asset that can be depreciated. The IRS allows you to depreciate the improvement of a rental property over 27.5 years. See my depreciation article for more details on calculating depreciation.
Just because your primary residence does not meet my definition of an asset does not mean it is not a good long term investment. We have to live somewhere. Homes in good neighborhoods with good school districts are very desirable and will increase in value over time. And, it is hard to put a value on the quality of life a home brings a family. And if you live in the home long enough, you may eventually pay off the mortgage.
In summary, purchasing the home you live in can be a good long term investment. I just do not consider it an income producing asset. But you have to pay to live somewhere. I recommend homeowners purchase a primary residence in the best neighborhood that meets their needs. Purchasing the smaller home in a good neighborhood will be a better long term investments than purchasing the largest home in the same subdivision. The pool of buyers shrinks as the price of the home increases. In a declining market, larger priced homes can depreciate much more than lower priced homes. And, the best mortgage to have is one paid by someone else.
If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.