Imputed Rent from an Owner-Occupied Home

20 responses so far ↓

• 1 The Financial Blogger // Jun 4, 2007 at 8:05 pm

  Hi CC,
  However, if you have a 80% mortgage on the property ($202,400), your mortgage payment over 25 years at 5,25% (let’s be optimistic about interest rate for 25 years) is $1,206.14. Then, you add up property taxes for another $275 a month (we will keep $3300 a year even though it will increase over time). Finally, we add another $316.25 a month (1,5% of property value at 253K). Your total monthly payment is therefore $1,797.39. You are now “technically” losing $197.39 a month with the same property and save the time and hassles of maintenance.

  In 25 years, your house will be paid off and will probably worth much more than 253K. However, when you deduct your “loss” and calculate inflation, your expected return is not that great. However, it is always good to feel home !
  Cheers,
  FB.

• 2 Canadian Capitalist // Jun 4, 2007 at 10:20 pm

  FB: The $1,206 is the total mortgage payment including principal repayment. Why would you count the principal portion as an expense? If you include only the interest portion of the payment as an expense, your monthly expense in the first year is about $1,450 and decreasing every year thereafter.

• 3 FinancialJungle // Jun 4, 2007 at 10:53 pm

  Secondly, the market rent rises every year, thus widening the gab between the “invisible” monthly revenue and monthly expense.

• 4 FourPillars // Jun 4, 2007 at 11:55 pm

  Given that interest is one of the biggest costs of owning, I think you’d have to calculate all the interest amounts for each month (or years for simplicity), calculate the present value of those amounts, and then take the average of those present values to calculate an average interest cost.

  I don’t feel like doing that but I’ll make an estimate that the “average” interest payment over the 25 years is one half of the initial interest payment. In the case FB puts forth, that would probably be about $480. I think the inital payment has about 80% interest so $1206 * 80% *50% = $480. Putting that into FBs equation makes the ownership scenario look much better.

• 5 Riscario // Jun 5, 2007 at 12:47 am

  Home ownership seems better than renting because you get the appreciation in the value of the house. How can you take advantage of that appreciation, though?

  If you “downsize” your house at retirement, you can turn the gain into cash. I wonder how many people do that though. Emotionally, it would be tough to sell a house that, over the years, has become a home.

• 6 brad // Jun 5, 2007 at 4:18 am

  This seems a lot more complicated than simply including your equity in your home in your net worth statement. As you build up equity, your net worth increases.

  Another cost of home ownership that renters avoid is the additional insurance costs. When you’re a renter, you insure only your belongings. When you buy a house, you have to ensure the entire property as well as your belongings. Plus many people either take out mortgage life insurance or augment their existing life insurance to cover the cost of the mortgage in case one person dies. And if you’re talking “invisible” income you also have to talk about “invisible” expenses such as all the time you spend dealing with maintenance and repairs — not just the cost of the maintenance and repairs themselves, but your time in dealing with them. If your roof leaks and you’re a renter, you handle it with a 2-minute call to your landlord. As a homeowner you may spend many hours researching roofers, getting estimates, etc., and that should be factored into the equation if you assume that your time has value.

• 7 The Financial Blogger // Jun 5, 2007 at 6:41 am

  Hi CC,
  I was more looking at a cash flow perspective than paying out a debt. To make a complete calculation of this example, you would also have to take in consideration your time. I do spend a few hours every week on my property. Even thought I enjoy doing so, it doesn’t mean that it is free.

  My point was that you would pay $1,600 if you rent the property and more if you buy it. After 25 years, you will be left with nothing if you rent. However, if you buy the house, it will be free an clear. If you downsize your property at retirement as mentioned by Riscario, you will definitely make a good move. However, I don’t know how many people actually do it.

  FB.

• 8 Middle Class Millionaire // Jun 5, 2007 at 7:53 am

  I agree have to admit I agree with Financial blogger. Personally, I don’t include the value of my home while planning for retirement. I do this for the simple reason that I don’t plan on “downsizing” or moving to a cheaper town in retirement. Although, I understand the concept of your house producing an “invisible income” I would not put that invisible income on a personal cash flow statement and as a result wouldn’t include it in my retirement plans. I do however plan on having my mortgage paid before retirement so obviously I would remove mortgage payments from my cash flow at that time.

  I think it’s fine to include the value of your home in a networth statement but serves little value while planning for retirement (unless of course you plan on unlocking some the equity in your home by either downsizing or a reverse mortgage)

  Great post,

  Cheers,
  MCM
  http://middleclassmillionaire.blogspot.com/

• 9 Phil S // Jun 5, 2007 at 8:28 am

  I recall bantering about this a couple weeks ago. The key point that I tried to make at the time is that the “implied” yield from owning a place is actually tax-free because if you rented you’d have to pay for your rent with after-tax dollars.

  For a wage slave like me who is in the marginal tax bracket, that REALLY hurts if I were to try to pay for the equivalent rent using investment income.

  On the other hand, I can see how if you’re self-employed working from home and you can write off the rent from your income, then renting would probably make more sense on an after-tax basis than owning. The same goes for automobiles and every other business expense if you were self-employed.

  So, it’s definitely not a “one-size-fits-all” solution. I just mean to say that you have to look at stuff like this on an after-tax basis. For wage slaves in high tax brackets, a home can be thought of as a fairly good tax shelter.

• 10 Canadian Capitalist // Jun 5, 2007 at 10:28 am

  4P: Good point about how interest should be expensed.

  Brad: You are right about insurance; it should be added to the cost of ownership. I disagree about your other points though. How much life insurance (if any) a person should get doesn’t depend on whether he/she owns or rents. It does depend on how many dependents should be supported, for how long etc. I’ve also accounted for the time spent on maintenance by adding the same 1.5% a landlord would spend to maintain the property. We could quibble about the actual percentage but my point is there is an “invisible” income stream, not how much it is in % terms.

  FB: See my previous comment about accounting for time. The point I am trying to make is after the home is paid off, it provides a significant benefit and it is misleading to say that a home is just an expense.

  MCM: A paid-off home is a big first step to retirement because it dramatically reduces one of the biggest expenses for most people: housing. It also provides options (even if aren’t planning on them now) - the equity can be tapped, you can sell and rent a town home or apartment (I personally know someone who sold his house and rents because he is often traveling with his wife and doesn’t want to deal with the maintenance hassles of owning) or you can even move to another city.

  I am not for a minute suggesting putting the imputed income on any statements. It is silly and pointless and where would you stop? Should I put $200 in the income category because I cut my own lawn?

• 11 brad // Jun 5, 2007 at 11:26 am

  Hmm, maybe I’m a special case but I do think life insurance plays into the equation, at least for some families. My life insurance plan (provided by my employer) would pay out just twice my basic annual earnings. That’s not enough to let my spouse pay off the mortgage if I die; she’d lose the house. I earn five times more than she does, so I’m the one making all the mortgage payments; she wouldn’t be able to afford to keep making them without some additional insurance that covers the cost of the mortgage.

• 12 FourPillars // Jun 5, 2007 at 11:51 am

  Brad, I agree that life insurance can be a factor in ownership costs in some situations, but in your case, there would also be a life insurance cost if you were renting since it sounds like your spouse would have a hard time covering the rent (for an equivalent house) if you died. As in the case of the interest cost, the initial “mortgage” insurance would probably be more than the “rent” insurance but over time it would decrease as the mortgage is paid down.

• 13 brad // Jun 5, 2007 at 12:03 pm

  Four Pillars, right, I always forget about the “equivalent house” business. In our case we’re going from a 3-bedroom apartment for which we pay $550/month (which she could cover) to a 3-bedroom home for which our mortgage payments will be over $2,000/month (which there’s no way she could cover). And yes, after the mortgage is mostly paid down we will reduce our insurance coverage accordingly. But it is an extra expense during the first five years or so.

• 14 Canadian Capitalist // Jun 5, 2007 at 12:13 pm

  Brad: Fair enough. In your situation, you do need extra insurance if a home is purchased. My example is also somewhat artificial because people tend to own a bigger and nicer home than the one they were renting. But it’s the only way to make an apples-to-apples comparison.

• 15 FinancialJungle // Jun 5, 2007 at 1:17 pm

  I concur with CC. A paid-off home does improve your cash-flow by cutting down expenses. An “invisible” income isn’t so invisible when you can appreciate the rents saved.

  A home is really no different from a portfolio. Here’s a superficial example. Say it’s essential for you to retire with $3,000 income per month: $1,000 rent, $600 food, $300 utilities, and etc.

  You can “invest” in a house to cover the $1,000 housing cost; you can invest in stock AAA to cover the $600 food expense; you can invest in stock BBB to cover the $300 utility costs. So your portfolio is not that different from your home, except in a stock portfolio, you witness money flowing from the stocks to your bills.

  For all the reasons you want to remove the home from your retirement balance sheet, you can apply the same rationales to your portfolio. If stock AAA is covering my all dietary requirements, should I exclude it from my balance sheet?

• 16 GIV // Jun 5, 2007 at 3:54 pm

  I find it odd that people who don’t include their home would do so because it doesn’t produce any income. I mean, does that $50,000 you’ve got invested in RIM stock produce income, either?

  At the end of the day, the whole point of tabulating net worth is to track general progress. It’s not really some sort of race, I don’t think.

  As long as that’s the sentiment, I suppose you can include or omit anything you want.

• 17 ThickenMyWallet // Jun 5, 2007 at 4:29 pm

  As I implied on FJ’s post, net worth is a balance sheet calculation whereas real estate income is a statement of cash flow calculation. Anyone who takes something off a balance sheet because it has a negative impact on cash flow is mixing apples and oranges.

  As for the benefits of owing a home, I believe I read a study where the Federal Reserve reports that an average home owner is worth over 30 times more than an average renter. Imputed income or not, statisically speaking, you are better off owing than renting.

• 18 FourPillars // Jun 5, 2007 at 4:43 pm

  GIV - I can derive income from my $50k RIM stock retirement portfolio by selling it off bit by bit. You can’t do that with a house unless you have a huge property or are willing to downsize or can rent part of it out - ok I guess you can derive income from your house but not as easily as selling 100 shares of RIM.

  Personally I think the size of your mortgage is a lot more relevant for retirement planning than the value of the house. In my case I know I have to eliminate the mortgage completely before retirement so a lot of my planning involves figuring out how to pay it off most efficiently. The house value may become important later on if we decide to move but for now - it doesn’t mean a thing…

• 19 ML // Jun 5, 2007 at 10:20 pm

  When you have finally reached reitrement , the cost of maintaining a home is more important than its monetary value.
  However, if you live in an area where Market Value Assessment is a determinant of your municipal taxes , then the more your house is deemed to be worth, the more you will be privileged to pay for that honour.
  You do not want to be “house poor’ when you reach retirement.

• 20 FinancialJungle.com // Jun 6, 2007 at 12:03 am

  Technically speaking, you’re selling your home bit by bit each month by consuming the “invisible” income. If the home was tenanted, the rents would’ve been retained on the balance sheet. With RIMM, you may not receive income, but selling your shares is like selling your balance sheet. The end result is the same.

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