The house you live in is a bad investment

I have long argued that the property you buy to live in is not a great investment.

This was sent to me this week by a reader who saw it in “The Daily Reckoning”, an excellent newsletter that reports on the economic follies of governments, companies and indeed the public at large.

“I have always rigorously disputed the idea that rising home values equal wealth creation. Even the owners of the houses, in reality, gain very little from the rise in prices.
Everyone may feel richer. But they are no richer in housing comfort or anything else. If anyone would later exchange his residence for a place of the same quality, he would have to pay exactly the same high price for which he sold”.

The argument is well made, and in fact I have received several emails on the same topic in the last few weeks.

The point is, if the value of your property goes up, you are no better off other than a paper profit. Since all other property has gone up equally – then you gain nothing.

You could of course take out some of that equity in the form of a bigger mortgage but then you would simply have a bigger loan and higher repayments. You can’t sell the property because where would you live?

This, dear reader, is all true.

I know that you were expecting me to wholeheartedly disagree but how can I disagree with something that is so obviously right.

“But if that is true, then why are we all investing in property as a way of making our economic future that little bit brighter?” I hear you say.

It all comes down to the fact that the investment potential of a property you live in is no where near as good an investment as a property that you Buy-To-Let. Let me explain.

The only way that you can achieve the full capital gain from your property is by selling it and putting the money in your pocket. Pay any fees and any tax due, deduct the amount you paid in the first place, and what is left is pure profit.

And that’s all OK. But you can’t do that if you live in the place can you?

You could, of course, cash in your capital gain and buy a smaller place but who wants to do that? And what is the point of making a shed load of money if you then have to move into a smaller place than you had before?

I certainly don’t want to.

But if you own Buy-To-Let properties then you don’t have these problems. If the BTL has gone up in value by say £100,000 since you bought it you have three choices:

  1. Sell up and take the profit. (You may want to nominate it as your primary residence and live in it for a short while in order to minimise the capital gains tax).
  2. Take out a bigger mortgage. You couldn’t do this on a property you live in because YOU have to pay back the loan. On a BTL you have a tenant and if the property has gone up in value then chances are the rent has gone up as well. If the rent covers the new loan you just put all the capital gain in your back pocket and guess what? No capital gains tax because you didn’t sell it.
  3. Alternatively – do nothing. Since the rent will have gone up you should now have an excess of income over expenditure. You don’t get a lump sum but what you do get is a monthly income and you don’t have to work to get it. This is square one on the ladder to financial freedom. What would you rather have, a lump sum now or a regular income ….. forever. Your choice.

I hope it is obvious from the above choices that selling up and taking the profit essentially takes you out of the game. You buy a car, or maybe a boat, some nice clothes and a wide-screen television. Three years later your money’s gone and you are back where you started. Leaving the money in means you achieve more capital gains, more monthly income and you have more choices. You have to be in to win.

Eventually you will probably reach a point where you do want to sell one of your properties in order to pay off all the mortgages on the rest of the portfolio. I don’t think there is anything wrong with that once your property empire has reached a size that you are comfortable with and your monthly income frees you from the usual nine to five routine.

I do understand that many new readers will at this point be saying they cannot envisage giving up their day jobs. The usual rationale I hear around my dinner table is along the following lines:

  1. I like my job because it challenges me – I would miss that.
  2. I couldn’t imagine not getting out and seeing people every day, I would go mad.
  3. I don’t just work for the money you know, I do actually like my job, in fact I like it a lot.

When you have made enough money to have a choice about whether you leave your job or not your views will change. Believe me – there are plenty of challenges in life, plenty of “getting out” to be done, and lots of things to like in the world without getting a telling off for being ten minutes late in the morning or sitting in the rush hour on the M25 every night.

When you DON’T have that choice I understand that you have to buy into these reasons for sticking at it or you would never get your weary bum out of bed every morning.

When you’ve got an alternative income stream that doesn’t require you to work five days a week you will have a different view. If you want to test this theory just ask yourself the following question. If your boss said you could work four days instead of five, but get the same money, what would you do?

See what I mean?

I now want to go back to my original point explain why the property you buy just to live in is not a great investment.

  • You tend to buy property that YOU like (and why not – it’s your money and you are going to live in it). But you do not take into account what percentage of other people would like it. You don’t mind the fact that you are miles from the nearest bus or train station or that it has a massive garden that needs maintaining – in fact that is a big plus as far as you are concerned.
  • You buy through an estate agent and you pay the highest possible price. I know this because if someone else is willing to pay MORE than you then they will get the house and not you. That is how the system works. Chances are, the house you bought on Friday could not be sold on the following Monday for the same price.
  • YOU finance the deal, by which I mean you will pay the mortgage which will be secured on the basis of your salary. The total cost of purchase including all interest will be borne by you (none of it is tax deductible).

The risks are high, If you can’t meet the mortgage payments you lose the house – simple as that.
All in all, this is a high cost, high risk investment that you will have to finance and which is worth less to anyone else than the price you paid.

Now compare that “investment” with the so-called risky world of Buy-To-Let.

  • You buy property that MOST people like. It will be modern, close to transport links and shops. It will have low maintenance and therefore low bills. If you want to rent it or sell it it will appeal to a huge group of people.
  • You will negotiate a discount, or at least some kind of deal, so that you make money on day one. Making money on the way into a deal reduces risk and increases profits.
  • Someone else will finance the deal – your tenant. (Note: expenses and interest payments are now tax free)
  • Your risk is vastly reduced because now if the person who is financing the deal, namely your tenant, cannot pay the rent then you kick them out and put someone in who can.
  • And yet Buy-To-Let is always considered the “risky” investment and lenders have the cheek to charge you 1% more in interest to justify this risk. What a nonsense.

So how the hell did we all make so much money from property then?

The answer, of course, is that the capital gains have been so great that despite all of the above, the vast majority of people have still made more money from the house they live in than anything else. Nothing wrong with that at all, but when you read that lots of people don’t make money or have their homes repossessed (even when house prices are going up in double digits, now you can see why).

The house you live in does, more often than not, go up in value so to that extent it is an investment but that doesn’t mean it should be your ONLY property investment. Buy-To-Let has far more opportunity, far more flexibility and far less risk – and that is what makes it a better investment.

One is for living in – and one is a way of achieving financial freedom.

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