Primary residence – to include or not to include it in your net worth calculation

Do you include your primary residence in your net worth calculations? I do but I admit I have doubts whether to include it or not.

 

Reasons for including:

  • It is indeed an asset that you have. In case of financial stress, you can always sell it and move somewhere cheaper or where you pay a small amount of rent. You can also rent it fully or partially.
  • The fact that you own your primary residence means that you do not have to pay rent, i.e., you are indeed saving this money on rent you would have to pay if you did not own it.

 

Reasons for not including:

  • It might artificially inflate your net worth. If you have a house which is worth 1 million EUR which is the only asset in your portfolio and debt of 200k EUR, that situation is totally different from someone who has a 100k EUR home, 900k EUR in assets that yield 7% a year and 200k EUR in debt. The second person can be considered nearly financial independent, whereas the first one is very far from it.
  • According to Robert Kiyosaki your house is not an asset and I agree with his arguments. Our primary residence does not yield us money and generally takes money away from us, in taxes, maintenance, etc. in addition to the fact that we generally buy more expensive goods for our primary residence.

I have decided to include it because I believe argument #2 is very strong, i.e., the fact that we own a property means we will not have to pay rent elsewhere, however I admit my net worth will be highly inflated by my primary residence, which I value at 380.000 EUR, in particular as I pay down the debt.

It almost seems as I giving in to lifestyle inflation and this is positively reflected on my net worth. My net worth is being benefited by the fact that I am kind of falling in the trap of lifestyle inflation, which should not happen. Nevertheless, I would indeed pay at least 1k per month if I did not own it and lived in a house slightly worse off that the one I bought. What are your thoughts?

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Your house is not an asset

It is crucial to end up with this non-sense idea that your house (primary residence) is an asset, probably the only one you will ever own and therefore all your savings shall go into that one asset. Work, ask for a mortgage, pay your house and then retire.

 

 

If a house is taking money out of your pocket (insurance, taxes, miscellaneous, etc.) then it is not an asset. Not only you are actually spending money but also you have to consider the opportunity costs of having our money invested into that house, which you wrongly perceive as an investment, whereas you could have invested the same amount of money in another house or investment that could actually yield at least 5%. In a hypothetical example of a 100k house with an average of 2000 per year on expenses, you are actually spending, per year, 7000 = 2000 + 5 000 (5% of 100k). You have to consider the money you actually spend plus the opportunity cost of not using the 100k in another more profitable investment. Here I have assumed that the other profitable investment would yield an average annual return of 5%, which is very conservative if we consider real estate investment.

In addition, there are also two (hidden) costs which I consider very relevant when you buy the house you live in:

1 – You loose flexibility. Either you assume it or not, it is more difficult to move into another city or country if you know you bought the house you are “supposed” to be living in, not only because you are emotionally attached to it and you probably end up more expensive things for your house, in particular furniture, but also because it is really not that simple to rent a house, get a property manager, etc. from one day to another.

2 – You end up of not making the most rational decisions when you invest in a house with the purpose of living in it. You take into account variables that are important to you and not to the market, like being near your family. Or you are willing to accept living in a area which is not as recognized by the market, like the fact that it is near a highway or a factory, because you prefer to pay a bit less. However, those decisions can make this house a very difficult one to sell or rent to a third party and therefore would not yield any cash flow, in case you decide to rent/sell. In sum, it is a very bad investment.

According to Frank Gallinelli there are 2 rules of real estate investing that we should follow: do not hold any sentimental attachment to any of the properties you invest in and if you think it will be difficult to sell/rent, then it is not worth buying.

 

Another sentence I loved in his book What Every Real Estate Investor Needs to Know About Cash Flow… And 36 Other Key Financial Measures which highly reflects my approach on real estate investing is the following:

You are not buying a properly, you are exchanging a fixed price for an income stream.