In the world of personal finance and investment, the classification of real estate as either an asset or a liability has been a subject of much debate. While some argue that real estate is a solid asset that appreciates over time, others contend that it can become a liability, draining resources and tying down capital. Let us examining both its asset and liability characteristics.
Real Estate as an Asset
Real estate is traditionally viewed as an asset for several reasons:
1. Appreciation
Historically, real estate values have increased over time, making it a potentially lucrative long-term investment. This appreciation can result in significant equity growth for the property owner.
2. Rental Income
Investment properties can generate a steady stream of rental income, providing a passive revenue source that can exceed the cost of ownership, such as mortgages, taxes, and maintenance.
3. Leverage
Real estate allows for the use of leverage, where investors can control a large asset with a relatively small amount of money. This can amplify returns when property values rise.
4. Inflation Hedge
Real estate is often considered a hedge against inflation because, as the cost of living increases, so does the potential for higher rents and property values.
Real Estate as a Liability
Despite its asset qualities, real estate can also behave like a liability in certain circumstances:
1. Illiquidity
Real estate is not as liquid as other investments, such as stocks or bonds. Selling a property can take time, and there is no guarantee of selling at the desired price, especially in a down market.
2. High Costs
Owning real estate comes with significant costs, including mortgage payments, property taxes, insurance, maintenance, and repairs. These expenses can turn the property into a financial burden if the income generated does not cover them.
3. Market Fluctuations
Real estate markets can be volatile, and economic downturns can lead to property devaluation. This can result in negative equity, where the property is worth less than the mortgage debt.
4. Management Overhead
Investment properties require active management, which can be time-consuming and costly. Hiring a property management company can alleviate this but at an additional expense.
5. Opportunity Costs
The capital tied up in real estate could be invested elsewhere, potentially earning higher returns. The decision to invest in real estate should consider the opportunity costs of not investing in other assets.
The Costs of House Ownership
We shall discuss on the cost of property ownership after the property is purchased.
1. Ongoing Costs:
a. Monthly Mortgage Payments: For most homeowners, the mortgage is the largest monthly expense. The amount depends on the loan amount, interest rate, and loan tenure.
b. Property Tax: Property tax is levied by the local council and varies by location. It is typically calculated as a percentage of the property’s annual rental value.
c. Maintenance Fees: For condominiums and apartments, there are monthly maintenance fees that cover the upkeep of common areas, facilities, and sometimes utilities.
d. Insurance: Homeowners should consider obtaining home insurance to protect against damages or losses. The cost varies depending on the coverage and the property’s value.
e. Utilities: Electricity, water, and gas bills are ongoing expenses that vary based on usage.
f. Renovation and Repairs: Homeowners should budget for renovations and repairs, which can range from minor touch-ups to major overhauls.
Potential Hidden Fees:
a. Sinking Fund: Some residential properties require homeowners to contribute to a sinking fund for major repairs or replacements.
b. Special Levies: In some cases, additional levies may be imposed for specific projects or improvements within the residential area.
c. Early Settlement Fees: If you decide to pay off your mortgage early, some banks may charge a fee for the early settlement.
d. Resale Costs: If you decide to sell your property in the future, you will incur costs such as agent fees, advertising costs, and possibly additional stamp duties.
Real Estate for Different Purposes
When we purchase a real property, it is either for investment or own use. Thus, we shall look at the real estate from these two angles.
Investment Property
For investment property, the return comes in the form of rental income and/or capital appreciation. However, the capital gain is only realised if you sell the property. Thus, if you do not have a tenant for the property and you still have to pay for the monthly instalment and other expenses, it can be classified as a liability.
Even if you receive rental income, it is still a liability if the income is insufficient to pay for the expenses. Let’s talk about my own experience. I have a one-bedroom unit in Cyberjaya. The loan is still ongoing and there are other expenses like the monthly maintenance fee, annual quit rent and assessment tax. The rent is unable to cover all the expenses. Technically it is draining my cash flow. So, this unit is not an asset, but a liability to me. On the other hand, if the property is bringing you positive cash flow, it is an asset to you.
After the mortgage is repaid, the property will be yours. However, the other expenses still continue. If the property is able to generate positive cash flow for you, you can consider it as an asset. Otherwise, it will still be a liability.
How about the price appreciation? After all the years of paying mortgage dutifully, the price of your property should have increased from your purchase price. Nonetheless, we cannot just minus the purchase price from the selling price. You have to take into account your cash inflow and outflow from the property throughout the years, especially the interest from mortgage. I think unless the price of your property has doubled, there might not be much profit from the sale.
Own Residence
If you purchase the property for your own use, it is most probably a liability, instead of an asset. This is because you are paying for everything related to the property. Nevertheless, if you manage to get more income than expenses from your residence, for example renting out some rooms/space, it is an asset for you. I think only a minority of homeowners is able to achieve this feat.
Having said that, the feeling of owning your own house may overshadow all the drawbacks. If your life goal is to own a house, you should go ahead with it. After all, if you cannot achieve your goal, what is the use of all that money? Just make sure that it is really what you want and you have considered its financial impact.
Conclusion
The question of whether real estate is an asset or a liability does not have a one-size-fits-all answer. It depends on various factors, including the investor’s financial situation, and the purpose of the investment. For some, real estate can be a powerful wealth-building tool. For others, it can become a financial albatross, draining resources and limiting financial flexibility. A simple yardstick that I use in this article is whether the property is generating positive or negative cash flow.
You should conduct thorough due diligence, consider your risk tolerance and investment goals, and possibly consult with financial advisor before deciding to invest in real estate. By understanding the potential benefits and drawbacks, you can make informed decisions that align with your long-term financial objectives.
Last but not least, consider the opportunity cost of owning a property. If you do not own the property, what would you do with the extra cash? You could use it to invest in other asset classes such as stocks and bonds, which are more liquid and may give higher return. However, you could also spend it on purchases which would bring fleeting happiness, and leave you poorer. So, depending on your needs, choose carefully whether you should invest in real estate or not.
How can a financial planner help you?
I can help you to clarify your financial goals and objectives, and also identify your assets and liabilities accordingly. We would also run through the numbers to see if the real estate investment or home ownership is the best for you.
We will also develop a plan to reach your goals and objectives. This normally involves saving and investing. Furthermore, I will also help with your tax planning to reduce your tax liability. Depending on your situation, we may also work together in other areas of your finances, such as debt management and estate planning.
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Disclaimer: This post is for informational purpose only. You should use judgment and conduct due diligence before taking any action or implementing any plan suggested or recommended in this article.
