Flipping houses. Booming real estate markets. Bidding wars. There seems to be nothing that gets the average person to care about financial matters more than the topic of residential real estate. Is it the surplus of home improvement television shows? Is it the convenient websites that show all the local real estate activity, including the current value of your own home? Is it the crazy rise in home values in many markets, especially on the West Coast? Regardless of the reason, we would like to address a related topic that we see quite often: a household’s net worth being positively distorted based on their primary home’s value. What’s the problem with this? Isn’t this a good thing? Usually, yes. But “house-rich, cash-poor” is a well-known phrase for a reason. Let’s dig deeper.
First, let’s illustrate the problem:
Household A
Outstanding mortgage balance: $100,000
Current home value: $1,100,000
Current retirement savings: $75,000
Current emergency cash savings: $2,000
This household is wealthy. They are, in fact, millionaires. They also barely have enough cash available to pay their cell phone bill. Almost all of their wealth comes from one asset: their primary residence. Don’t get us wrong. Your home can be a good asset to have.
Booming real estate markets have created this problem. Modest earners bought modest houses decades ago, and, ever since, the value of these houses have gone through the roof. Unfortunately, this led some households to assume their overall financial picture was in extremely good shape, solely because their home value made them wealthy.
But looking closer, our sample household reveals that their wealth is basically entirely comprised of their home’s value. They do not have an adequate emergency fund, they might not be saving into their retirement plan at work, and their cash flow might be negative. “But our house is worth so much!” they will reply. True. But their house is a very illiquid asset, meaning it cannot be easily sold to receive cash for its value. The process of selling a house is not an easy one, not to mention that they currently live in this house. In other words, tapping into their home’s value is not a real solution for cash-flow problems, and it certainly should not excuse them for not properly saving for retirement.
But what about home equity lines of credit (HELOCs), cash-out refinancing, or reverse mortgages? Yes, technically these are ways to tap into the equity in your home but are often used irresponsibly and rarely address fundamental flaws in a household’s financial plan.
Bottom line: Houses are great assets but can often distort a household’s financial situation. The value of your home will be part of your overall plan, and we are here to help incorporate this element into the comprehensive financial plan you will require going forward.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.