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Is Being House-Rich Necessarily a Good Thing?

Posted by admin on July 26, 2007 in Real Estate

One of my personal finance hobbies is to read the financial profiles columns in financial publications. We have all read them before. Someone writes into the columnist asking for help on their personal finances and an expert helps chart a plan to reach their financial goals. The one feature I have found interesting in some of these profiles is that the persons being profiled are house-rich but otherwise barely getting by in other aspects of their financial life (modest savings, little in retirement contribution relative to their age, large debt loads). They have devoted substantially all of their assets to their home/their loan to value on their mortgage is very high (90% plus)/their home has greatly appreciated in price but they have few other assets outside their home; I do not count people with real estate investments in this category (nor in this post). This seems to be more prevalent with people in booming real estate locations like Vancouver or parts of Northern California.

I am often puzzled by being house-rich and otherwise asset poor. Principal residences are not liquid assets; even in the best case scenario, it would take 3-6 weeks to sell a home and, unlike other investments, you have to find other shelter; it is not like a stock, where you can sell it and simply sit on the cash; you have to replace your home and, generally speaking, most people with young families do not down-size homes. If you don’t downsize, you tend to be a worse-off position selling your home.

I understand the mentality behind being house-rich and nothing else. It is shelter after all and one should be comfortable in their own place. Houses are also tangible assets- you can touch, taste (!) and feel a home whereas some people consider stock as “not real” assets. Thus, there is a comfort factor in owning a home.

Having said that, good investing requires mitigating against risk. For example, the conventional stock investing rule is to hold bonds which generally work in an opposite cycle as stock (as one goes up, the other goes down). Where is the risk mitigation if you are house rich? I would hypothesize that investing in vehicles which pay out cash (dividend yielding stocks, income trusts, bonds, high interest accounts) would be a prudent down-side risk for those who are house-rich. Instead of buying the $2500 stainless steel fridge, put the money away. Houses are cash flow negative assets (remember I am only addressing principal residences); thus, you need cash flow positive assets to balance this off.

I suspect some will surmise that the logical solution to being house-rich and nothing else is to leverage their home and use the proceeds to invest in stocks, mutual funds etc. I would generally say that this solution does not address the issue of mitigating risk. If a person is house-rich and nothing else, are they in this situation because they have avoided stock investing? Or are they in this situation because they have bought a house they could not afford? If so, do you now take this inexperienced stock investor and/or highly mortgaged individual and ask them to invest substantial amounts of money in the market hoping that they can return more than the interest rate charged on the leveraged money? All finance is contextual and I have argued before that leveraging is only appropriate in certain situations. I would also add that in every profile I have read with people in this situation, all of the experts zero in on debt repayment/reduction and cost-control as solutions and not assuming more risk via leveraging. Leveraging does little to address risk control in this situation.

I would like to hear your thoughts on this issue.