Blog | Personal Finance, Real Estate

Rich Dad Scam #6: Your House is an Asset

The difference between your home and investment real estate

It seems like every financial “expert” says, “Your house is your biggest asset.”

When I wrote “Rich Dad Poor Dad,” I said that your house is not an asset. Rather it is a liability. That was like spraying water on a hornets’ nest. The so-called experts lambasted me. At the time, the real estate market was skyrocketing. Everyone called me a contrarian who was out to sell books. Then, one of the worst housing crashes in US history happened, and they weren’t laughing anymore.

Recently, I’ve been writing a series of posts on what I’m calling Rich Dad Scams, lies that are fed to people by the rich to keep them poor and in the middle class. Today, I’m going to write on one of the biggest Rich Dad Scams of all, “Your house is an asset.”

Why a house is not an asset

Your financial planner, real estate agent, and accountant all call your house an asset.

In reality, an asset is only something that puts money in your pocket. So-called financial experts have lots of fancy accounting maneuvers to make things that aren’t assets look like assets, and they can be helpful for certain situations.

But in the real world where you need money in your pocket to survive, if you have a house, paid for or not, that you live in, then it really isn’t an asset. Instead of putting money in your pocket, it takes money out of your pocket in the form of a mortgage, utility payments, taxes, maintenance, and more. That is the simple definition of a liability.

This is doubly true if you don’t own your home yet. Then it’s the bank’s asset, and it is working for them. Each month you pay the bank interest on top of the equity you pay into the house in the form of your mortgage. If you look at an amortization table for your house, you can see plainly that the house is the bank’s asset because it makes them a huge return in the form of cash payments month after month. If you default, they keep the house and the money you’ve already paid them. It’s earning the bank a lot of money, but it’s not earning you anything.

But people make money off a house all the time, right?

Sure, you can make money from a house. There are lots of ways to do this, and I’ll describe how investors do it later. But often when people say you can make money off your house, they mean their personal residence. This is true. Some people do make money from their homes, and when they do, it can then become an asset.

The way most people make money is from selling a house after years of living in it. This is what you call realizing equity. The difference between what you bought your house at and what you can sell it for is appreciation. Often times pay a lot of equity down over many years. This coupled with a modest gain in appreciation can feel like a true windfall. But it is often a small return on the money you put into the house.

Worse yet, many people realized that appreciation is not guaranteed in the great recession. They lost everything as the price of their house dropped well below what they paid it for. Then the house was a real liability.

The reality is that while you live in your own home it cannot be an asset. If you’re lucky and you decide to sell, it can be, but that is truly a gamble. Until you decide to sell, your house takes money from you month after month, even if it’s paid off.

So, how can a house be an asset?

In business terms, assets are your pros and liabilities are your cons. You need assets to offset your liabilities. Most people spend their lives earning money at a job and spending it on liabilities, even ones they think are assets like houses.

This is easier to comprehend if you understand how your personal financial statement works. Read the post I just linked in the last sentence for a deeper understanding, but drawn from that post, here are two illustrations that make things simple.

This first chart shows the flow of cash from an asset into your income column. Again, what makes something an asset is that it puts money in your pocket each month.

This gets complicated by so-called experts because they’ll often list a liability in an asset column, like your home.

Here we see a $100,000 home is listed as an asset but there is no cash flowing into the income column. Additionally, there is a liability of the housing expenses and the $80,000 mortgage.

Now the minute you start to realize income from a house, it can then become an asset.

The caveat is that the income from the house needs to be higher than the expenses. It needs to have positive cash flow. This, of course, only happens with investment property. The renter pays you rent that covers your expenses, including your mortgage and your taxes. You make money each and every month while they also pay down your liability. It’s a wonderful thing.

Once you get away from the Rich Dad Scams, it’s easier to think in these terms, to think like an entrepreneur. Assets put money in your pocket. This is accomplished through four different categories, one of which is real estate.

When I say real estate, I don’t mean your personal residence, which is a liability. What I mean is what is described above, investment real estate, which is a great investment because it puts money in your pocket each month in the form of rent.

There are three other primary assets: business, paper, and commodities. If you are an entrepreneur or a business owner, your business is an asset. Paper assets are stocks, bonds, mutual funds, and so on. Finally, commodities include gold, and other resources like oil and gas, and so on.

My wife and I started out making our money in real estate, putting our money to work in properties that we could rent them out and see ongoing returns. After that, we diversified, so now we have some money in all of four of these asset areas.

Invest for cash flow, not appreciation

The Rich Dad Scam that your home is an asset was prevalent when I first wrote “Rich Dad Poor Dad.” That was in 1997, and everyone’s home values were climbing. It was easy to assume that your house was an asset because it was potentially making money for you in the long run through appreciation. People bought into the scam hook, line, and sinker, taking out home equity loans to buy cars, vacations, TV’s, and more.

During the Great Recession, those same people were so underwater that many of them defaulted and went into foreclosure. They gambled on appreciation, and it didn’t pay off. A lot of Americans got a fast, ugly financial education when the real estate market turned around. They realized very quickly that their homes were not assets.

Today, the housing market is again relatively healthy and a lot of people are starting forget the lessons from the Great Recession, so it’s more important than ever to re-education them on the fact that their house is not an asset, what an asset really is, and how to tell the difference between an asset and a liability.

The difference between my poor dad and my rich dad was a financial education. And that’s not a classroom and books education, that’s a nuts-and-bolts, street-smart education, a way of looking at money that is true and that works, not just what the rich want you to believe.

Rather than invest for appreciation, my rich dad taught me to invest for cash flow and to treat appreciation like icing on a cake. I encourage you to do the same.