Robert Kiyosaki was the first and has been the only financial pundit to suggest that your home is not an asset. As they so often do, Kiyosaki’s statements fly in the face of prevailing financial wisdom.
David Bach, author of Automatic Millionaire, not only says that your home is an asset, he asserts that home ownership is the first wrung on the ladder of wealth creation in America. He encourages everyone to buy a home as soon as possible to begin building their wealth.
CNN Money does their Millionaire in the Making profiles and I am shocked to find that in almost all cases 50-75% of the wealth of the families profiled is locked in their home. Given that people have to have a place to live, this is a problem.
In science, we have a term, “true, true and unrelated.” Does one thing cause another or do they simply occur together in time and space? Does home ownership produce wealth or are wealth and home ownership produced by sound wealth-producing financial habits?
The Economist, tracking real estate over the past decade, has concluded that the economics no longer support home ownership.
I bought my first home in 1991. The housing market in the North East had not recovered. The savings and loan collapse of the mid 1980’s depressed home prices and brought the condo market to a halt. Multiunit condominium properties were vacant. Many of the properties were very cool, but they continued to sit vacant because banks had strict owner occupancy ratios for condominiums. Mortgage money was tight. First-time home buyer programs were coming on the market and the minimum down was ten percent. I was raised to think that a home was an asset, an investment. My mortgage broker sat me down and said, “it is best that you think of your house as a roof over your head, not as an investment.” That was incredible advice. Prices dropped another 10% after I moved into my home. After 3 years of living in my home and 2 years of renting it out, I sold it for what I paid for it. After closing costs and realtor fees, I received a check for 447 dollars, significantly less than the $14,000 dollars that my family gave me for closing costs and the down payment. I always intended to pay them back with the proceeds from the sale. All told the housing market was depressed in the North East for over 10 years.
Even in an appreciating market, home ownership is no bargain. And a home is not an asset.
Most people will try to argue the point, so we will look at some numbers in just a moment.
Let’s tackle the issue of equity as a component of wealth first. Let’s say you buy a $100,000 home and put money down. Let’s say that down payment is 20%. In real terms at the time of closing you have 20% equity in your home. If you had $20,000 dollars in your bank account, you had $20,000 in wealth. If you move that money to your home in the form of a down payment, you may have $20,000 in wealth as long as the market at least stays flat. For this illustration, we will say that is the case. You have $20,000 wealth stored in your home. Now what can you do with that?
If you borrow against your home, you erode your equity and your wealth.
If you sell your home and get your $20,000 back, then what? You have to live somewhere and living somewhere costs money. The equity in your home is essentially dead. You cannot do anything with it. Sell your house and you reinvest that money into a new home, borrow against your equity and you lose it.
In short, the equity in your home, once in your home, will remain there. Useless to you in real terms, but that equity will do something that is quite dangerous. It will cause you to feel wealthy, wealthier in fact than you are and spend money, money that you, in reality don’t have.
It might be helpful if I defined an asset here. Kiyosaki calls an asset anything that retains or appreciates in value that pays you. For Kiyosaki a house does not fit that definition. I define an asset as anything that retains or appreciates in value that I can sell and dance around my house throwing the proceeds of the sale in the air and have a jolly good time. Can’t do that with a house because, once again, I need someplace to live.
Someone might say that they want to downsize. Sell their home, pick up something smaller and bank the rest of the profits.
The numbers don’t support it. One of the columnists for the WSJ wrote that he doubted that he had made much money on his home although it was valued at half a million dollars. He had lived in his home for 10 years and paid just under $300,000 dollars for it. When he factored in taxes, insurance and maintenance, he figured that he broke even. Broke even!
What that means is that he actually spent the $200,000 on his home in other ways and the sale of the home would just result in returning that money to him. Two hundred thousand dollars equity and wealth gone when you actually look at the numbers. So much for great profits! So much for down sizing.
The example on my home is just as concerning. My example is what happens when you refinance or draw equity out. For the amount of time that I have actually lived in my home I have made $82,800 dollars in payments. These payments went primarily to interest so let’s deduct the top tax rate. For tax rates lower than the maximum the numbers don’t look any better, in fact ,the top tax rate is the best-case scenario, so we’ll use that. Deduct $27,324 and get $55,476. Taxes and insurance paid amount to $20,460.
Now the total paid is $55,476 + $20,460 = $75,936. Maintenance, landscaping, updates, repairs total $29,779. Add the two, $75,936 + $29,779 and get $105,714. I refinanced the house in order to take money out and buy my first investment property. Add in the mortgage balance and the total owed, paid and put into the house is $188, 715.
Now this is a critical concept. Improvements on a home don’t necessarily increase the value of that home. Every neighborhood has a trading range. The trading range for an area is based on location, size of the homes in that area and amenities. Homes will trade at the high end or low end of a neighborhood based on those factors. Let’s say my home sold for $170, 000. Based on the difference between the mortgage and the sale price, the financial gurus would say that I have $87,000 dollars of wealth. Because you have seen the numbers you know better. In fact I lost $18,715 dollars. When I take into account the money I borrowed out to buy my first investment property, I broke even. I am assuming that I sell my home myself. Using a realtor would increase my losses by 6% of the sale price.
How can I call home ownership the greatest financial scam of the 20th century? I call it a scam when you buy something (a house) expecting it to lead to something (wealth) when that purchase can in no way produce that result. I call it a scam when the brokers who sell you the house know it won’t.
Sound financial habits will lead to wealth but home ownership in and of itself will not. Home ownership can in fact lead to poverty as people struggle to make payments and find that they are unable to maintain their homes. Sell and they risk owing more than the home is worth. Stay and their standard of living is reduced to pay for the house. Sounds like a winning formula for wealth to me.
While 20% of the homes in this most recent real estate bubble went to investors who were speculating in the markets, 80% of the homes went to people who believed that home ownership, not sound financial habits, were the first wrung on the ladder to wealth creation. They just believed what the gurus, the realtor, the mortgage broker and the banker told them. In a consumer society where everything is reduced to the lowest common denominator, they believed that a home could be purchased for little more than a moderately-priced flat screen TV and that down payments were a nuisance. They did not understand that as a worse case scenario, down payments are actually insurance against downside fluctuations in the housing market. Many people are finding that they don’t have wealth at all. What they have, instead, is a financial nightmare.
Perhaps moving forward into the 21st century, we will decide that sound financial habits and financial education are the first steps on the road to wealth. Maybe we will decide that wealth is created through work and due diligence and not by betting on the financial product of the day.