A Personal Residence is NOT an Asset!

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With the economy perceived to be improving, and interest rates still historically low, people everywhere have gotten caught up in real estate fever. I’m no different, and have been doing my best to acquire as many properties as possible! Currently, I’m working on closing my third property within the last year. Clearly, everyone wants a piece of the American Dream, right?

The Message

So, what differentiates me from the masses of other homebuyers? What am I doing that’s so “unique” and “special”? Well, whereas most folks are flocking to secure their own personal residence (the giant house with the white picket fence), my version of the American Dream marches to a different beat — that of freedom.

If you’ve ever read Rich Dad, Poor Dad by Robert Kiyosaki, one of the major points he brings up is that a home is NOT an asset. The book has become mainstream, and I was even forced to read it in High School (kudos to my Economics teacher, Mr. Castro), but apparently the message has still gotten lost in translation.

So, let’s repeat this key point once again:

“A Personal Residence is NOT an Asset!”

The sooner this message gets across, the wealthier you will become!

The Lie

Mainstream media, and even the president are constantly urging American citizens to invest in real estate. They say your biggest asset is your personal residence. This could not be further from the truth. If we go back to the basic definition of what assets and liabilities are, it’s this:

“Assets are things that put money in your pocket.”

“Liabilities are things that take money out of your pocket.”

So, then, how can a personal residence possibly be considered an asset? Owning a personal residence will not make you richer. Every month, you have to pay for: mortgage, property taxes, insurance, repairs/maintenance, etc.

What about the tax breaks for home owners? Yes, it’s true that interest payments are tax deductible. But how could that possibly be considered a wise investment? Would you pay your credit card company interest every month, just so you could reclaim a portion of it come tax season? No, you would never do that. You would use your hard earned capital to invest in real assets like stocks to put money into your pocket, instead.

But hold on. What about appreciation? That’s the ace up the sleeve that all homeowners hold, right? If you’re counting on appreciation to make you rich, you are playing a fool’s game. We only have to look back as far as 2007-2009 to see what can happen to folks who speculate on appreciation to make them rich. If the market corrects and the homeowner/investor can’t afford to make the mortgage payments, the end results won’t be pretty. That’s when the market will get flooded with short-sales and foreclosures. Whether you are a homeowner or investor, playing the appreciation game is akin to playing with fire.

The Numbers Don’t Lie

If you still aren’t convinced, let’s run some numbers to prove why investing in a personal residence is a losing proposition. This is especially true if you live in an expensive part of the country.

Everyday, I see co-workers excited about buying their first home residence. After closing, they truly feel like they’ve made it, and arrived in this world. They’ve FINALLY achieved the American Dream. I don’t say this aloud, but inside I’m thinking to myself, “congratulations! You’ve just signed yourself up to work for the MAN for another 30-40 years.”

The numbers don’t lie. Here in the Bay Area, a typical single family starter home looks like this:

San Jose_Property

Again, the price tag might shock you, but this really is the going rate for a starter home in the Bay Area. At $600,000, you really aren’t purchasing too much. It’s a single family home that was built in 1970, in a B neighborhood. The interior is in decent condition, but don’t expect anything remotely resembling turnkey.

So, let’s run the numbers as see for ourselves:

San_Jose_Numbers

For a 25% downpayment, this requires you to have $149,750 in funds. Further, by “investing” in this home, don’t forget you are now also responsible for $376.25/month in property taxes. And don’t forget the insurance either. When you rent a house, you get accustomed to making a single payment to your landlord that covers everything (plus his profits). 😉 Most new homeowners make the mistake of assuming that the mortgage is their only bill. The total monthly bill ACTUALLY turns out to be $2812.64.

For the above calculations, I’ve left out vacancy and property management since these items won’t apply for a personal residence. For a single family home, you would most likely have to pay for landscaping and utilities, even if you rented, so these numbers really just wash out. They are set to $0 to keep things simple. Maintenance, which used to be handled by the landlord, would be another new expense for the new homeowner. Again, let’s keep things simple and set this to $0.

Rent Instead

Now, suppose you ran the math and realized what a lousy “investment” this personal residence really was. At this point, you’d want to look onto Craigslist or Zillow and determine what the market rates for rent are in your area.

For this property, here is what Zillow found:

Zillow_San_Jose

Rent is estimated to be $2421/month, which sounds about right for this area in San Jose. So, the difference between renting and buying comes out to be:

Buying: $2812.64
Renting: $2421.00

Difference: -$391.64

In this example, which applies to most of the Bay Area (and many parts of the country), by electing to purchase a primary residence, you will be throwing away about $400/month!

Other Cons

Yes, I realize the interest portion of the mortgage payments can be partially reclaimed during tax time. And I realize you can depreciate the home for 27.5 years, which is why I elected to throw away the maintenance costs. Still, overcoming $400/month difference is no small task.

But that’s not even the worst part about owning. Here are some other cons:

-Fixed mortgage payments. Try missing one mortgage payment, or property tax bill… you’ll see who REALLY owns the house.

-Exit strategy is dependent on state of economy. In a downmarket, you’ll have difficultly selling for “fair” value.

-Opportunity cost. In this example, that’s $400/month in investments you’re missing out on.

-Lack of mobility. You tie yourself down to a particular area.

And the worst part of all…

You’re probably signing yourself up to work another 30 years!!!

The Alternative Play

I often get asked, “How come you don’t own your own personal residence, yet invest in rental property?” The simple answer, going back to our discussion about assets and liabilities, is because my rental properties pay me! When I own a rental, I don’t care about property taxes, or mortgages, or insurance, etc. because my tenants pay for all of that. As an investor, I’m only interested in the bottom line, which is positive cash flow.

So, how would I attack the personal residence conundrum? I wouldn’t. I’d keep on renting. Actually, what I would do is re-define what the “American Dream” really is, and put that downpayment to better use! For myself, the American Dream is freedom. I desire to be free and not have to work for anybody. Owning rental properties will help me achieve this vision, as you’ll soon see.

This is what I would do with that very same $149,750 downpayment:

-Invest in two 2-flats in Chicago ($45,000 each)
-Invest in two single family homes in Indianapolis ($25,500 each)

Total Investment: $141,000

Which would help generate the following revenue:

-Chicago #1: $650.49
-Chicago #2: $650.49

-Indianapolis #1: $443.97
-Indianapolis #2: $443.97

Total Monthly Revenue: $2188.92

Please see this post for more details on investing in out-of-state properties (and for more details on the numbers).

What a HUGE Difference ONE Decision Makes!

Going back to our personal residence example, the Bewcastle property would have cost us $2812.64/month to live in, had we chosen to “invest” in home ownership. By electing to NOT buy, and rent instead, we could pick up that very same property (or one just like it) for $2421/month. By opting not to buy, we instead invested our downpayment into purchasing 4 rental properties. Our rentals now bring in $2188.92/month. Our cost to live in (but not own) Bewcastle has now been reduced to only $211.08/month.

Let that soak in for a minute. Now, instead of making regular monthly payments in the amount of $2812.64 for 30 LONG years, we only need to pay $211.08/month to live in the EXACT SAME HOUSE. Better, we own 4 rental properties that will one day be fully paid off. When that happens, the income stream will become overflowing!

Also, what this does is it frees up our future capital. And that’s really the most important point. Each month, we have an additional $2601.56 (we went from paying $2812.64/month in rent to $211.08/month) we can use to invest in assets, or on anything else we desire!

Rent Free

By accomplishing the above, we’d be able to basically live rent free forever after. We could even eliminate that $211.08 spread by finding another rental that was slightly cheaper. Or, If the local market’s rents increased, we would simply raise rents on our rental properties to offset any differences. It sure is nice to be in a position of power!

So, there you have it. You could follow conventional wisdom, be like everyone else, and be tied down to a mortgage payment for the rest of your life. Or you could continue renting, knowing that this is by far the better financial bet, and invest your capital more wisely elsewhere.

This is exactly what I’m doing. I’m building up my capital each month to buy more rental properties. As the rental paychecks come in, I simply let them snowball and work towards building up for the next downpayment. Lather, rinse and repeat.

In closing, here is a motto I’ve heard and believe to be most true: “Live where you want. Invest where it makes sense.”

The choice is up to you!

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JC @ Passive-Income-Pursuit
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That sure does sound great. I’m curious how this would have fared during worse times for rent prices. Say situations when rents are falling. Although I would imagine that can be largely negated by your location choice. I’m not sure I could get the wife on board with this but it’s definitely something to consider. I could probably convince her to let us pick up a rental property or two after we get settled in and as long as they’re cash flow positive then that would effectively lower our mortgage payment on the primary residence. Looks like you’ve got a great plan in place!

JC @ Passive-Income-Pursuit
Guest

I was just thinking about this, but this could be a great way to invest 401k money after rolling it over after leaving work. I know you can invest in property with self-directed IRAs is a rollover IRA essentially the same thing? I’m assuming you can’t take distributions from a rollover IRA so you’d have to convert it to a Roth. I think I might have found a way to tap that money and turn it into cash flow whenever I do leave my job.

Martin
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That is exactly what it is a liability. You have to pay for upkeep, utilities, mortgage and everything around. The house won’t bring you any income, unless you sell it later with a huge profit, then maybe you can call it an investment.

People do not have this concept at all. And of course your approach is diametrically different.

Charles
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Charles

A house is somewhere to live, if renting is cheaper, why should you buy? The joys of ownership, it is more like bondage.

Executioner
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You may be painting with too broad a brush here. The specific example you include in this entry does not necessarily apply across the board. Real estate is highly variable from one location to another, and from one time period to another. Sometimes by running the numbers the purchase will come out ahead of renting, and sometimes the opposite is true. Also there are benefits to be gained by purchasing that you cannot get from renting (stability, more freedom to renovate and use the land, more predictable monthly payments over time, etc). Plus, once you pay off the mortgage on the primary residence, the monthly cash flow picture looks a LOT different. I can speak to this from experience. So personal residence question (rent vs own) should be considered on a case by case basis.

The ~$2400 rental payment in your example should cover the landlord’s taxes, insurance, mortgage payments, etc (unless the landlord is an idiot). Think of your own rental houses for comparison. Don’t you always charge enough in rent to cover those same expenses, plus leave a little extra for your own profit? So to me, you are paying these expenses on a personal residence regardless of whether you rent or own — the only difference is whether you are paying them directly or indirectly (by way of payments to a landlord).

I think of housing expense similar to how I would think of food expense or any other mandatory expense. In the case of food, you have to eat. You could buy food at restaurants (saving time and labor which can be directed elsewhere). You could buy food at the grocery store and prepare it (less expensive, but more time expensive). You could own land and grow and harvest your own food, then prepare it (possibly even less expensive, but much more labor intensive). Or you could grow food, sell it, and use the sale proceeds to spend on other food at restaurants or at grocery stores (swapping labor for cash). Depending on the specific case, certain people may find any of these options to be the most optimal way to allocate their cash and their time/labor. There is no way to say that any one of these methods is “superior” to the others. I view the personal residence decision with a similar lens.

Having said all of that, it sounds like you have a good system going for yourself. I think the key is that you ran the numbers first, made an informed decision, and understood the consequences (risks/benefits) of your decision. Nice work!

Leigh
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I’ve been watching too many people buy places that cost them more than they were spending in rent. It makes no sense to me. My monthly housing costs are less now than they were when renting by about $200/month and I have an extra 500 sqft. I realize though that it’s not an investment – it’s that I felt buying made more sense than renting for me personally. I refused to buy a place that I couldn’t pay off in under five years, not thirty. I don’t see my place as an asset, but as a prepaid housing thing. So if I end up being a crazy cat lady, I’ll never be making a mortgage payment again soon enough.

I’m curious to see how both of our routes to FI work out since they’re basically the complete opposite, other than high savings rates. Mine is to pay off the mortgage in the next 3 years while maxing out the 401(k) and Roth IRA and stockpile money in taxable index funds after that, which should result in FI in another 5 years after that or so. There are some other reasons that I want to keep working “that long”*, so I’m not that concerned about it.

*One of the many reasons is that I don’t plan to quit my job (at this time) until I have found a long-term partner, regardless of whether I’ve hit FI.

Refinerr
Guest

I love this article! It’s not the first time I’ve heard this argument but it never gets dull. I haven’t read RDPD but I happen to live it so I find the statement to be true in my experience. As you know SoCal/OC area has similar price points as the Bay Area. You have to add mello-roos and HOAs on top of that price point as condos & townhomes start at your stated price point above.

We also found 2 additional Fannie Mae/Freddie Mac “insurance” items fees were tacked onto the price tag of some homes – for what I don’t know but it wasn’t PMI. The total additional fees on top of the mortgage payment, home insurance and property tax was $600/month! This assumes your HOA fee doesn’t increase which it does! We’re renting for the price of less than the mortgage payment only for the same unit – savings of over $1,000-$1,500/month. This isn’t even talking about a single family home which easily start at $600k for the same bed/bath you stated above.

I’m very interested in your out of state investing so I’ll need to read up on those posts!

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