Your home as a retirement asset (2)

The second post in this series explains why your home should be included in your calculation of net worth. The case can best be illustrated with an example. Consider the following two people:

Person A: this person has no assets and no liabilities. Net worth is zero.

Person B: this person has no assets and no liabilities other than owning outright the family home.

In all other relevant respects the two people are identical.

Those who argue that the home should not be included as part of your net worth would conclude that the net worth of Person A is the same as Person B - which is absurd. (Those who argue that the home is a liability would reach an even more absurd conclusion.) The home has value and that value can be realised. Another way of looking at the question is to consider what you are trying to measure. If you are trying to determine your overall financial position, then your home is clearly part of that calculation and must be included in order to obtain a valid determination of your position. If you are trying to evaluate some sub-set of your assets (e.g. retirement accounts) then it may be valid to exclude your home but in doing so you are not determining your overall net worth - only the value of the chosen sub-set of assets.

A few other miscellaneous points on this issue:

1. wealth surveys often look at "investable assets" or similar concepts and exclude the home from their calculations. The reasons for this approach is often that the surveys are done by institutions who want to sell financial products and services to high net worth individuals (HNWIs). From the institutions' perspective, the home is largely irrelevant as it will seldom (if ever) be available as an investment and is therefore not relevant to the purpose of the survey. Put differently, what these surveys measure is not net worth but a particular sub-set of the assets that comprise the HNWIs net worth;

2. if you want to borrow money, the lenders will look at your net worth and will take the value of your home into consideration in deciding whether or not to grant a loan and, also, in deciding the terms of the loan. Even the fact that you own rather than rent is a positive factor in some lenders' evaluation of your risk profile. From the lender's perspective the home clearly is one of your assets and is highly relevant to the bank's assessment of your credit worthiness;

3. statistically home owners are wealthier than non-owners - much wealthier. The reasons for this are debatable but the correlation is a strong one. One of the reasons may be that owning a home requires a degree of financial discipline both to accumulate a deposit and to pay off the mortgage (many sub-prime lenders and borrowers would have done well to think about this).
For those who lack the financial discipline to save regularly, the requirements of servicing a mortgage is a form of forced saving.

As a final note: while I maintain that the home is an asset and is part of your net worth determination, I have not got into the issue of whether or not it is a good or a bad investment. That is another issue and a much harder one to evaluate.

Next up: the role of the home in retirement planning.

The home as a retirement asset (1)

There have been several articles written about whether or not your home is an asset or a liability. As an example: Lazy Man and Money has a good article on the subject (the comments also make a good read). As follow on questions, even some of those who advocate that it is an asset claim that it should not be taken into consideration in determining net worth or when planning for retirement.

My view is that not only is your home an asset but it also should be taken into account in net worth calculations and for the purposes of retirement planning. I will address each of these three points in separate posts.

Your home is an asset

Your home is an asset. Unless it is being used as a dumping ground for toxic waste, it has value and that value can be realised. Realisation can be achieved through one of three means:

1. sale (including a partial sale of land if it is situated on a section large enough to sub-divide);

2. as security for the raising for finance (and for most of us a loan secured against an owner occupied home will be the cheapest finance available);

3. generating rental income (either by renting out spare rooms or by moving out and then treating it as an investment property).

Your home is not a liability

The arguments for claiming that your home is a liability are typically based on the liability associated with a mortgage or negative cash flows (mortgage payments, rates etc) or claims that a home is a bad investment. Taking each of these points in turn:

A. the fact that most people will borrow money and secure the debt against the home does not turn the asset (your home) into a liability. The asset (home) and liability (debt) are two separate things. If the claim was valid, it would also follow that any asset which is purchased using debt finance is a liability, which simply cannot be true. Consider an investment property or the purchase of shares on margin as examples;

B, the fact that your home generates negative cash flow does not make it a liability. Many assets produce negative cash flows either during the early stages of their economic lives or until such time as they are realised. As examples, consider a property development, an oil and gas lease, a forestry plantation and a wine collection;

C. the fact that it may be a bad investment (a very debatable point) does not turn an asset into a liability. Almost all investments have the potential to produce either undesirably low or negative returns. If this happens it just means that the asset is a poor one for investment purposes. It does not make the asset a liability. Consider a share that depreciates in value or a negatively geared investment property as examples.

In summary, I see no basis for claiming that a home is a liability. Next up: whether your home should be included in your calculation of net worth.

An unsolicited offer (2)

I have done some further thinking regarding the unsolicited offer and looked at a few other properties in the same area (Mid Levels). The conclusions are as follows:

1. the yield on purchase price is attractive (it is higher than the cost of funds);

2. the yield on the offer price is still attractive (at or just slightly below the cost of funds);

3. properties in that area which show better yields are few and far between and usually have major problems with them (e.g. very old buildings or low floors right next to a noisy road). Finding a replacement value proposition in the same price range will not be easy. Most likely we would end up buying something more expensive (which in the longer term we may want to do anyway);

4. the location (close to the escalator) means that it should always be easy to rent;

5. we have no need of cash at the moment;

6. the price offered is right on the bank valuation. Looking at recent sales I think the property is worth more than this. However, the recent comparative sales are for very low floors and there are only two of them meaning that it is hard to be too confident about the market value;

7. my previous thoughts on the difficulty in adding value to the property remain. In the longer term we may wish to sell and reinvest in a better quality property in the same area, but as we are currently looking for another investment property anyway, there is no need to sell this flat now.

I have concluded that the offer is not attractive. I have nominated a price which is slightly above my assessment of the current value. If someone wants to pay the nominated price, that is fine with me. If not, I will keep the property.