Posted by Tim Stobbs on July 11, 2012
On my net worth posts I’ve been asked a few times how comfortable am I having so much of my net worth currently tied to my house. I have always answered that I’m completely comfortable with it, but I thought perhaps a more detailed look on why could be useful.
Owning your house is not actually required for a retirement plan. There is an assumption by a lot of people that you have to own one, but depending on your interests it could be a better fit to buy a RV or boat instead. In my particular case, I do like to spend a fair bit of time at home so it would make sense to owe a home as a hedge on inflation for rental costs.
Actually as a hedge on rental cost my house is an excellent investment, I crossed checked rentals of similar houses and they currently list for $2200 to $2500 a month. If I take the low value and deduct property taxes and insurance (since renters don’t pay those), based on I paid $190,000 for the place that means I’m getting a 11% return by not paying rent. Yikes, that’s good money.
Oh, but wait it gets better. I also bought more house than I needed, but it allows my wife to run her daycare business. So on top of that her business transfer some cash back to the house, if you include that extra income that equals a 15% return on my initial investment. It’s nice when you can convert part of your equity into something that provides a cash flow.
Given how much we like that idea, my wife and I were discussing that when we downsize houses we might actually buy a little bigger than we need again but with the idea of creating a rental suite in the house. Yes that introduces all sorts of issues, but it provides a nice cash flow out of otherwise not very useful equity.
Yet after all that gushing about what’s good about my house as an investment, what are the downsides? Ah, that is a long list, but a few of the obvious ones are:
- Illiquid – Good luck cashing out your house in a hurry. It can take months or even years in a slow market. Selling and moving also trigger a lot of extra costs as well.
- No Diversification – I’m stuck with a lot of money in one investment in one very local market. If that market drops fast I could lose equity in seconds. It gets worse if you don’t have much equity, as you could end up owing more than the house is worth.
- Upkeep – Houses don’t look after themselves and keeping the up is costly. I’ve currently put in a new furnace, some flooring, paint and some bathroom renos in my place, but I also know I still need to invest more in new shingles on the roof soon and some windows.
So how do you make sure you house is an investment rather than a money pit? Forget what the banks tell you about affordability since they often rely on low interest rates to give a huge number. The only metric you need is your income to the house mortgage ratio. I personally suggest keeping this number under 3 if at all possible. So if you earned $80,000/year as a family, don’t get a mortgage beyond $240,000. Low right? Yep, but that ensure your house in really an investment, yes you can go higher, but the odds of your house turning into a money pit start to increase.
So in the end, your house can be an investment or a money pit. It’s really about your choice on how much you put into it and your mortgage amount that drives the issue. So how are you doing? If your house an investment or a money pit?