Your house is not an asset

Is your house an asset?

People think that owning a house is an asset. As rich dad poor dad author Robert Kiyosaki pointed out in his book Rich Dad Poor Dad a house is a liability until it is fully paid for then it becomes an asset.  Some thinks that the only to save money is to park it in properties. My definition of an asset is when the house produces cash flow for you. Do note that in Singapore, even the resale public housing can cost up to $700,000 for 5 room flat in Clementi. You will get your flat fully paid off when you are old. Who wants to wait until they are old to have money?

A house is a highly leverage tool, with 20% of down payment, you can leverage up to 80% of the property price by loaning from the bank. This is good if the property price is on an upward trend. However, leverage is a double edge sword, if property price is on downward trend, there is a possibility of margin call by the bank if it drops more than your initial 20% down payment.

The house much like an university education is over hyped has been fed to you by parents. However, our parents bought their house when Singapore is developing and the house is cheap. It works for our parents but old ways of doing things are not viable in this generation. It is a middle class myth perpetuated by outdated thinking, politicians and mass media.

Is renting always a waste of money?

Why will you pay rent to the landlord when you can buy? You may argue that the money that you spend on the rental every month can be used to pay the deposit of your house. Firstly, people rent because they can be mobile and nimble. Mobility is a great thing in today's world. A lot of parents rent a place near their desired primary school for their children.

When you are renting, you are renting space that has no future value. When you buy, you are still renting, you are renting money. The money you rent are used to pay mortgage and a house which depreciates for you to live in. However, there is interest based on the principal you loan.

For simple illustration, there are two brothers Zhixiang the owner and Zhixiong the renter. Both have assets of $100,000 each, liabilities of $0 and net worth of $100,000 each at the start. Zhixiang bought a $500,000 house. He paid $100,000 as down payment. He took a loan of $400,000 and incur stamp duties, legal fees, insurance, fees etc for an amount of $30,000. Hence, his current situation is Assets of $500,000, Liabilities of $430,000, new Net Worth is $70,000. Zhixiong found an identical house next door which rent for $2000 per month. His assets and net worth is still the same as before. However, his Net Worth is higher than his brother Zhixiang. Now we look at Zhixiang the owner, say he took a 3% fixed rate mortgage for 30 years, total monthly payment will be $1,686 and the total interest paid will be $207,109. If we add other charges, the monthly fees will probably be close or slightly lesser than $2000. However, Zhixiang will need to continue to pay for the interest of more than $200,000 whereas Zhixiong can use the additional cash flow to invest in shares which gives cash dividend and appreciation over the long run.

The difference at the end of 20 years ultimately depends on whether Zhixiong can save the differences and also house owner needs to be mindful of the impact of transaction costs of buying and selling houses too often. Real world fluctuations can throw your projection out of the window. Hence, it will be wise to project modestly and not take on too much debt. It makes a lot of sense to buy a modest house to live in so that you will have money left over to invest as well.