Is Your Home an Asset or a Liability?
As I pondered the unfairness of my own personal dilemmas, I found myself immersed in financial data and conducting trend analysis for a client in my newly established consulting practice (socialimpactmodels.com).)
It occurred to me that in today's market climate, the challenges of buying and selling real estate have become more intricate and uncertain than ever before. So here's my two cents, which may require a second cup of joe on this early Monday morning.
Your home, often seen as an asset, may actually be a liability. Let's delve into this notion. When you live in a house, it doesn't generate income for you. Instead, it incurs expenses such as mortgage payments, property taxes, maintenance costs, and insurance premiums, making it more of a liability than an asset.
Home Owners lend me your ears!
For those fortunate enough to own a house with equity and a low interest rate, complacency is not advisable. A fluctuating housing market, unpredictable economic conditions, or personal financial difficulties could swiftly transform your supposed "asset" into a significant burden.
Now, I don't mean to alarm you—only to enlighten you. Traditionally, an asset is something that puts money in your pocket, while a liability takes money out of your pocket. By this definition, is your home truly an asset? Ponder your financial position critically and consider diversifying your investment portfolio. Embrace the broader world of property investment, where assets work for you, generating passive income and providing financial stability. Homeowners, it's time to make informed decisions. It's time to turn your liabilities into assets.
Investment Returns: A Historical Perspective
Over the past decade, the value of the S&P 500 has consistently shown an upward trend, despite occasional fluctuations. This can be attributed to various factors, including robust population growth, an influx of remote workers, and increasing inflation rates.
However, it's important to acknowledge that rising inflation can significantly impact the actual returns on investments. For instance, while an investor may observe a 7% return on their S&P 500 investment, if inflation stands at 2%, the real return would only amount to 5%.
During the past 10 years, the S&P 500 has experienced steady appreciation, despite intermittent downturns. This phenomenon can be attributed to a combination of factors, such as robust population growth, an influx of remote workers, and an uptick in inflation rates.
Additionally, the housing market has witnessed growth during this period, primarily driven by low-interest rates, which have made borrowing more accessible and stimulated the overall economy. As a result, even the average individual can afford to invest in real estate.
It is crucial to note that rising inflation can significantly impact the net returns of S&P 500 and other stock market investments. As inflation rises, the cost of goods and services increases, eroding the purchasing power of currency. Consequently, even if the nominal value of an investment appears to increase, the real returns may diminish. For example, an investor may rejoice at a 7% return on their S&P 500 investment, but with inflation running at 2%, the actual return would only amount to 5%.
This phenomenon highlights the fact that apparent gains can be mitigated by concurrent increases in inflation. Therefore, for astute investors, considering the inflation rate when calculating potential returns is of utmost importance.
Big Mac Index:
For illustration, let's take the example of a big burger that cost $0.15 to $0.25 cents back in 1971. Today, the same burger would cost approximately $5.00, or thereabouts. If you're intrigued, you can delve deeper into this concept by exploring the Big Mac Index, a real tool used by economists to measure purchasing power parity (PPP) and the associated costs.
Case Study: A Comprehensive Analysis of a Property in Santa Barbara, CA
Financial Breakdown: Renting vs. Selling
You've inherited a property, you want to keep it, your brother wants to sell it. It's worth ~2million dollars. (I know lucky you).
To provide a clear understanding of the potential returns from renting out this property, we've broken down the projected annual income and costs as follows:
The annual rental income (if kept) is calculated at $9,000 per month, totaling $108,000 annually. The annual property tax, determined by the mill rate, comes to $25,200. Homeowners insurance is estimated at $760 per month, amounting to $9,120 a year. Therefore, the total annual costs amount to $34,320.
After subtracting these costs from the rental income, the net annual income is projected to be $73,680. This generates a Return on Investment (ROI) of 3.51%, considering only the rental income and not home asset appreciation.
Costs Associated with Selling
If you opt to sell the property, there are several significant costs to consider. Realtor commissions, typically the largest expense, usually account for about 5-6% of the sale price. Closing costs, which can include fees for escrow, title search, recording fees, etc., generally account for 1-3% of the sale price.
Property Comps and Market Analysis
Analyzing the local real estate market, the property is on the higher end of the confidence interval for homes in the zip code. Data from Zillow, Alien Realtor, and City Data suggest a selling price range with comps ranging from $1.1-$1.45 million.
Property in my opinion is herd mentality. You don't want to be the tiers if you're selling. If you're buying... well thats a different story.
Demographics & Trends
The average age in this area is 37.5, which has remained stable over the past five years. The influx of remote workers has heated up the housing market, making the back cottage ideal for young professionals who want to work from home, a second rental, or a live-in au pair.
Good school districts, a suitable average age demographic, and median income make the property ideal for rental and long-term investment as the median income and employment rates have ticked up while demographics have remained stable since COVID.
Understanding Tax & Utilities
The property tax (mill rate) of 1.07 equates to approximately $23-24k per year. The average homeowners insurance is estimated at around $760 per month. Factor in your monthly maintenance, repair, renters liability and 'do the math.' (better yet - let excel do it for you).
What would have financial returns been had you inherited this property in 2013. After all the number crunching, (in a bull market economy), if you invested in the S&P 500 (one of the wisest retail choices if you to choose to swim with the sharks), you would've netted about
(Home Value not selling)
If you had played the scenario forward, you would have gained a net of 1.25M. By keeping your home value alone at 2 million, you could have utilized home equity repeatedly to generate passive income.
When deciding between renting and selling a property, it's essential to consider the potential returns, the costs involved, and the broader socio-economic context. Whether you're an individual property owner or a seasoned investor, an informed decision will ultimately yield the best results.
Remember, real estate isn't just about bricks and mortar - it's about understanding trends, analyzing data, and making strategic decisions that can offer significant financial rewards. Whether you choose to rent, sell, invest, or become a local bee farmer; never a wrong decision as long as you are making an informed one.
The world is your oyster. Go get em!
Jessica McDonald Drieghe