Do you consider your primary residence to be an asset? Is the value of that home included in your net worth calculation?
I frequently see this topic debated on social media and it always surprises me to see how many people don’t view their home as an asset, and the reasons they give for why.
As a former accountant, I tend to view most personal finance questions from an academic perspective. From a purely academic perspective, the answer seems clear.
But since not everyone agrees with me on this matter, let’s go through the primary arguments and see if we can’t finally settle this debate.
I’ll start with my opinion…
Yes, your home is an asset and should be included in your net worth.
I believe that the part of your home that you own is an asset and you should include it in your net worth calculation.
Sure, there are a few (rare) circumstances where this isn’t the case, but for most homes in America, this should be the default response.
Today, I’ll share why I think you should factor your home’s value into your net worth by tackling some of the most commonly stated arguments people give for why it shouldn’t.
No one’s going to convince me that my primary residence isn’t an asset. But if we still disagree by the end of this post, that’s okay. Personal finance is personal and you are free to view your home however you choose.
Definition of an Asset
Before we get into the debate, let’s take a quick peak at the definition of an ‘asset.’
According to Investopedia, “An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.”
You should reflect assets as positive values on your personal balance sheet. Contrarily, you should report any debt on your personal balance sheet as a negative value.
Future benefits associated with assets typically involve generating cash flows, increasing sales, and/or reducing expenses.
When I read the definition of an asset, it’s pretty clear to me that my home is an asset and belongs in my net worth. The fact that we currently live in that home shouldn’t matter.
But first let’s clarify something…
I’m not trying to debate whether or not homeownership or renting is better in this post. Personally, I don’t believe there is one ‘right’ answer to that question.
While there is certainly a financial component to the decision of whether to rent or buy, your personal circumstances and preferences will help to determine the right answer for you.
Arguments people make for why your home shouldn’t be included in net worth
Let’s take a look at the most frequently stated reasons for excluding your primary residence from your net worth.
You don’t receive any cash inflows unless you sell it
One of the most frequent arguments I see is that owning a home costs a lot of money, but doesn’t provide any cash flows unless you sell it.
Do you know what other investment doesn’t provide you with cash flow until you sell it?
Every non-dividend paying stock in the stock market.
Technically there are practices, such as house-hacking or short term rentals, whereby homeowners actually can earn some cold hard cash while owning their primary residence. However, this is the exception, rather than the norm.
Either way, your home is an investment that can be sold on a market for cash at any time. The value of that investment deserves to be reflected in your personal balance sheet.
The process to sell takes longer and the housing market isn’t as liquid as the stock market, but a properly priced home will sell in a reasonable amount of time.
Whether the amount of money you receive is more or less than you paid for the home will depend on how good of a financial investment you made and the current housing market environment.
We’ll discuss how you should reflect the value of your home in your net worth calculation later on.
Your home is a money pit
I often see this argument combined with the one above. Owning a home does indeed require ongoing cash outflows.
In addition to a mortgage payment, you likely pay for property taxes, insurance, and maintenance costs. These costs may go up over time and can fluctuate unexpectedly.
However, the existence of these maintenance costs doesn’t mean your home isn’t an asset.
Additionally, your primary residence isn’t the only investment you have which requires ongoing costs.
When you invest in the stock market, you’ll owe annual or quarterly management fees on any mutual or index funds you own. You also likely pay fixed or variable maintenance fees to the broker you hold your accounts with.
Depending on your specific investment choices and account type, these investment fees can range from 0.1% – 2%+ per year. The dollar amount may be smaller than with homeownership, but the concept is the same.
Additionally, if you own rental real estate, you’d have similar ongoing maintenance fees as a homeowner. I haven’t yet met anyone who wouldn’t consider a rental property to be an asset.
You’ll incur high fees to sell your home
Most people making this argument are referring to realtor fees, which make up the majority of the total selling fees most people incur, and typically run between 5% and 6% of the home’s sales price.
If you were lucky enough to watch your home appreciate significantly while living there, you may also owe income taxes on a portion of the gains. Fortunately, thanks to the IRS’s current exemptions for sale of a home, most homeowners won’t have to pay these taxes when they sell.
Currently, the IRS allows homeowners to exclude capital gains of $500,000 (married filing jointly) or $250,000 (individuals) on the sale of a primary residence from income if they meet certain criteria.
We don’t expect to pay any capital gains taxes when we sell our home. The housing market is booming and we’re currently expecting to walk away with net profits of approximately $200,000 from our live-in-flip, which is well below the exemption. These tax savings will mostly offset any selling costs.
Yet again, houses aren’t the only investments that this argument applies to. You’ll have to pay something to liquidate almost any investment you own.
Unless you fall below the IRS’s income thresholds, you will owe income tax on any capital gains when selling stock from your investment portfolio. Additionally, many brokers and mutual funds charge separate sales fees (though you should try to avoid these when you can).
Remember the housing bubble of 2008?
Yes, I do!
I lost around 10% when I sold my first home in 2010. Fortunately the bubble wasn’t as bad in North Carolina as it was elsewhere, and I was able to ‘buy the dip’ and get my next home at a discount.
The housing market can be volatile. There is no guarantee that your home will appreciate in value, let alone exceed the amount of money you ultimately put into it.
But this is true of all investments.
Just take a look at the stock market which is down over 20% year-to-date as of the date of this post.
Stocks not only lose money, but they do so more frequently than houses, and have historically been much more volatile than real estate.
There is no reason to expect that the value of most homes will decline over the long term. Like buying and selling stock, timing is everything. Home ownership is another form of diversification.
You have to live somewhere
This is my favorite argument. Yes, we have to live somewhere. But we don’t have to live HERE.
There are millions of housing options in the USA… billions if you expand that globally. Each housing option has a different cost. It also has a different potential benefit.
We’ve chosen to invest money in our current primary residence. The value of our home is currently estimated at $1 million, which means that if we sold it today, we’d receive around $800,000 in cash. That’s after paying off our remaining mortgage balance and closing costs.
With that money, we could move back to North Carolina and buy a similar home for under $600,000. That would leave us an extra $200,000 to invest however we wanted.
Did that $200,000 magically appear? No! The value was there all along. We just had it temporarily invested in our primary residence.
Just because you have money tied up in your current home, doesn’t mean that money can’t be used for something else in the future.
A look at the argument from a different perspective…
A lot of people argue that your home shouldn’t be included in your net worth calculation for the reasons stated above.
But what about the future housing costs renters will face?
If homeowners shouldn’t include the value of their home in net worth, should renters be deducting future rent costs from theirs?
No one’s arguing that it doesn’t cost a lot of money to own a home. Yet, many of these costs are fixed or declining.
For example, we pay $1,334 every month for our mortgage, of which approximately $1,000 goes towards the principal. Our mortgage costs will never go up while we own this home. In fact, once we finish paying off our mortgage, these costs will go away completely.
We’ll still have to deal with property taxes, HOA dues and maintenance costs, but these are typically a much smaller percentage of the pie.
The same cannot be said for renters.
Renting gives you the freedom to invest less money upfront, relocate more easily, and avoid lumpy repair costs that can come with home ownership. There are certainly plenty of benefits to renting.
But, renters will likely see their rent increase every year… forever.
Additionally, while you may not pay for repairs and property tax costs directly, you’re effectively charged for these costs by your landlord through your rent.
In the Phoenix metro, rent has increased 20-30% over the past year. In contrast, our personal housing costs have actually decreased over the past couple of years, despite rapidly increasing home values.
By investing in our home, we’ve hedged against rising housing costs and it’s currently paying off. This reduction of future expenses is yet another attribute of an asset. Of course, the tides could always change before we are ready to sell.
Who is better off in this scenario?
For a final gut check, let’s take a look at the example below.
Who is financially better off?
With everything else held equal, it’s difficult to argue that the renter is financially better off than the homeowner in this scenario.
Yet, when you exclude home equity from the homeowner’s net worth, these individuals’ financial situations would look exactly the same. That’s just not reality.
The homeowner has an extra $400,000 in value that they could convert to investments or spend, if needed. There is a real difference in their financial positions that isn’t appropriately reflected if you exclude home equity.
Somehow this difference should be reflected.
How to reflect your home’s value in your net worth
This is where it helps to understand how a statement of net assets (a.k.a. net worth) works.
The value of your home should be reflected as an asset on your statement of net worth (positive value). Any outstanding mortgage debt you have should be reflected as a liability (negative value). You then subtract total liabilities from total assets to arrive at your net worth.
Having a mortgage against your home doesn’t change the fact that your home is an asset. It just reduces the net amount of the value you own.
For our statement of net worth, we record the net realizable value of our home as an asset. To get to this number, we reduce the lowest fair value estimate per Zillow, Redfin and Realtor by 7% for estimated selling fees and realtor commissions. You can reflect your home at it’s actual fair value, if you prefer, but we like this more conservative approach.
Our remaining mortgage balance is then reflected as a liability, which effectively reduces our our home’s value to the equity owned.
How we reflect our home in our statement of net worth:
|Estimated Fair Value of Home||$1,050,000|
|Less: Selling Costs & Realtor Commissions (7%)||$(74,000)|
|Net Realizable Value of Home (Asset)||$976,000|
|Mortgage Balance (Liability)||$(168,000)|
|Home Equity Reflected in Net Worth||$808,000|
Financial Independence Portfolio vs. Net Worth
Saying that your primary residence belongs in your net worth is not the same as saying that you should count it in your financial independence portfolio.
In most cases, it’s probably better to exclude your home’s value from your financial independence calculations.
This is because you do actually need somewhere to live. Your home’s value will not be available for you to withdraw under the 4% rule unless you sell or downsize.
The benefit of owning your home is instead reflected through lower expected housing costs once your mortgage is paid off.
It might make sense to consider home equity in your FIRE calculations if you have a substantial amount of equity and plan to downsize or move somewhere more affordable in retirement. In theory, you’d be able to convert a portion of your home equity into investments at that time.
This is our circumstance. While we haven’t made any adjustments for it, knowing that we’ll have excess home equity helps us feel more comfortable using a 4% withdrawal rate.
I’m including the value of my home as an asset in my net worth. Are you?
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