Is Your Home an Investment?
A few years ago, a 30-ish man moved into a house across the street from us. Shortly after, we saw a large bin placed in the driveway and, based on the debris going in, it soon began to look like a good section of the house was being gutted. Within a couple of years, the house had been sold and our neighbour was gone. The process is called house flipping and if you’ve watched HGTV or the DIY Network, you’ve probably seen it in action, although the idea of moving into the house that you are flipping does strike me as a bit more of a challenge.
In Canada, living in the house you renovate has the added benefit of making the sale tax-free as you can qualify for the principal residence exemption. The CRA has, however, cracked down on that practice in recent years. It is now obligatory to report the sale of your principal residence. Furthermore, the authorities have identified individual renovators as a specific category of property flippers who should be reporting the profits they make as business income or as a capital gain.
While most of us are not in the business of house flipping, I suspect many of us view our homes as the largest single item in our investment portfolio. But is your home an investment?
What is a Home?
My wife and I have lived in more than 10 places spread across Japan, the United States, and Canada. With all those moves I have come to think of home as less an address than the relationship I have with my wife. Nevertheless, the usual definition of a home is the physical address where you live. That applies to a place you rent no less than one you own. For the purposes of this blog post, however, we will think of a home as a place in which you have an ownership stake, even if there is a mortgagee in the picture and you, the mortgagor, still owe more than you own.
What is an Investment?
Investopedia defines an investment as, “an asset or item acquired with the goal of generating income or appreciation.” You invest when you put something you have, like time, money, or effort into that asset or item, which you then hope will generate income for you and/or it will allow you to sell it for a greater amount than you paid. If you pay for some kind of professional, technical, or vocational training, you hope to generate income from the time, money, and effort that you put into the training. If you buy a delivery van, you hope to make money in delivery services for an amount sufficiently greater than your expenses and the value of your time. Does that apply to the home in which you live?
What the Real Estate Industry, Government, and Society Tell You
Given the amount of money we put into our homes, it may seem reasonable to consider the piece of real estate we buy to live in as an investment. That perspective is also reinforced by the residential real estate industry, successive governments, and society at large.
Real estate brokers and representatives make their money by providing the service of arranging for the sale and purchase of our homes. There are other services provided as well, such as appraisals and property management, but we’ll focus on purchase/sale agreements for now. I am not writing this to cast aspersions on realtors. My dad sold real estate for years and I have friends and acquaintances who sell real estate now. It is quite legitimate to seek out someone with expertise and experience in the field. Not everything should necessarily be done on a DIY basis.
Nevertheless, if you hire a real estate sales rep, you know that they make their commission only if they are able to close a sale. They will therefore encourage you in your thinking that this is more than a big expense – it’s an investment!
Government has for years supported and encouraged home ownership. Home ownership is seen as socially positive. Homeowners tend to maintain their properties better than tenants, which makes the neighbourhood more attractive and creates value. It is a kind of virtuous circle that improves society. The Canadian Mortgage and Housing Corporation has been a fixture since shortly after World War 2. In the 1950s, the Bank Act was amended to allow Canada’s chartered banks to lend money for mortgages. In 1971, the Tax Act was amended to allow something that we now take for granted, the exemption of principal residences from capital gains tax. In 1992 the Home Buyers Plan was established allowing first-time home buyers to withdraw up to $25,000 from their RRSPs without paying tax. In 2019, that limit was raised to $35,000.
No doubt you’ve heard encouragement from your parents and from society at large to buy a house. From your parents you may have gotten the impression that buying a home is an indication of adulthood. Not just a “home,” either. It needs to be a detached single-family dwelling. It’s a sign that you are settling down, starting a family, etc.
From your financially savvy friends and family, you may also have heard something like, “Why pay your landlord’s mortgage?” It has immediate appeal and probably generates at least a little righteous indignation: my landlord is taking advantage of me, making money off the sweat of my brow (or my cramping fingers on the keyboard).
How Your Home is an Investment
One of the important calculations most people should make is to determine your net worth, which is basically adding up all that you owe and subtracting that sum from all that you own. You hope to see that, over time, this calculation is going up. If you own a home, the value of that property is likely to have a significant impact on your net worth, not only from the appreciation of its value in the market, but also from your regular payments against the mortgage.
Our own home is in a fairly conventional 1970s-era neighbourhood in London, Ontario. We bought it toward the end of the year 2000 for $167,000. For years, the market in London seemed to lag other places, including the value of the home we once owned back in Chilliwack. However, a few years ago, values in the London real estate market started increasing significantly. Today, you would be hard-pressed to find a house for less than $500,000 in our neighbourhood. Of course, prices here pale in comparison to what you must pay for equivalent housing as you get closer to Toronto. In that sense, yes, our house has appreciated in value, has contributed to our net worth, and therefore functions as an investment.
There is another way in which a house can serve as an investment. When you get older, there may come a time when you can no longer look after yourself or your home. Selling your home and moving into an apartment complex that caters to seniors, or eventually into a long-term care facility, can be made affordable if you have a financial reservoir held in the value of your property.
How Your Home is Not an Investment
A home is not just an investment, though. First and foremost, it is shelter, something that we all need. Do we need to buy our own shelter? If we have the shelter we need through renting, do we need to invest in shelter by purchasing it? In truth, shelter is simply an expense, something you need regardless of its money-making prospects.
Consider as well, the regular maintenance costs associated with homeownership. If you have owned a home for a considerable period of time, you have probably spent money on a new roof, maybe a new furnace and air conditioning system, perhaps new siding, a new driveway, better insulation, trimming or taking down trees, a renovated kitchen and/or bathroom, new flooring, etc. There is property tax to consider, as well as property insurance. And then there’s that 25-year slow crawl to paying off your mortgage.
That doesn’t mean you shouldn’t buy a house. However, the reasons for making a purchase may be more psychological or emotional than financial.
We had children while we were moving around between Japan, Canada, and the US. In fact, we have children born to us in all three countries. Until we moved to London, we had never lived in one place for more than four years at a time. Although children are resilient, and the exposure to different communities was very valuable, we had begun to feel that stability of place was gaining in importance. When I ceased working as a pastor of a local congregation after about four years living here, it was not even a consideration that we leave London for a church-related job elsewhere.
Even though owning a home may not give you the big financial gains you want, you have the freedom to change your home to suit your needs and desires. Renting a home means you pretty well have to take it as is.
The average five-year mortgage rate hit 21.46% in 1981. You can imagine what that did to the housing market. Although the ride has been a bit bumpy, the path lower has been relentless, and with the impact of COVID-19, we are now down to residential mortgages of under 2%. These low rates have in turn made going into debt more affordable and driven up the cost of housing. There is no guarantee, however, that there won’t be another crash. Indeed, taking into account all of the bubbles and crashes, residential housing has increased over the years at approximately the rate of inflation. That suggests that your home is not necessarily the best asset to consider an investment.
How Much House Can You Afford to “Invest” In?
A longstanding rule of thumb is that adequate housing should be available for not greater than 30% of your before-tax household income. In the London, ON area, the average house price at the end of December 2020 was $555,324. If you bought this average house and managed to come up with a 20% down payment, your mortgage balance would begin at $444,259. A mortgage rate of 2% for the first five-year term and a 25-year amortization would result in a monthly mortgage payment of $1,881.22. Add in estimated annual property taxes of $3,998.33 ($333.19/month), property insurance of $888.52 ($74.04/month), an estimate of annual maintenance of 1% of the purchase price or $5,553.24 ($462.77/month) and you have monthly housing expenses of about $2,751.22.
If you divide that figure by 30%, then you need to have a monthly before-tax household income of $9,170.73 or $110,048.80 per year. The average household income, including government transfer payments, in Middlesex County and London is $91,863.
As noted, a house is less a financial investment than an emotional and lifestyle choice. Potential homeowners may reduce costs in other areas to make a home more affordable. It’s not for me to say whether that 30% figure should be held to hard and fast. These days it is often an impossible threshold to reach. It would certainly seem so in Toronto or Vancouver or other cities that have had booming markets.
I remember meeting a successful professional about 30 years ago who told me that she and her husband had chosen not to buy a house. At the time, it just seemed so unconventional that I did not know what to say. Now that I am older, I wish I could have that conversation again to find out what led to their decision. Even though we own a home, whether I would encourage others to buy is no longer so cut-and-dried for me.
Click here to contact me for an appointment.
In uncertain economic times, you may be interested in a half-hour no-cost, no-obligation financial planning conversation with me. It’s called FINPLAN30 and the range of topics is wide open. Click here to sign up for a free session.
Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.