We all want to be rich, right? Or "comfortable", at least?
Well, I don't know about getting rich, but I do like to keep an eye on my property. So, I'll stick to talking about real estate and how that influences your money planning.
So, how does your personal residence influence your financial profile?
During the extended period you will probably remain in possession of your own home, you may very well find that your house develops into a significant portion of your total financial worth. But the people who claim to know about this stuff say that net worth is what counts, so how do we find that?
Calculating net worth
You can calculate your net worth by deducting your liabilities from your assets.
Liabilities simply mean all your debts, or expenses. Common liabilities include things such as retail credit (store credit), credit cards, personal loans, overdrafts, car lease, and one or more mortgages.
Assets are any of the stuff you own, for which you can get money. So, your assets will probably include things like your bank accounts, pension funds, shares, bonds, unit trusts, your household content, your car, your golf clubs and/or your jewellery. (No, you cannot add a resale value for the kids!)
Now, after tallying a total for liabilities and assets, simply deduct liabilities from assets to reveal your net worth.
Buying a house means buying net worth
When you first purchase a property, the mortgage liability will be very close to the actual market value of the property. This is true, because you will be paying "market value" for the real estate, and because you are likely to use a home loan to pay for your real estate purchase.
The property value and the mortgage debt practically cancel each other out, for the purposes of calculating net worth. So, in the beginning of your ownership, your house will not have much influence (if any) on your net worth.
So, why do I say that buying a house means buying net worth?
Real estate gains value
Real estate is a funny thing, especially in today's financial circumstances: Property prices do not fluctuate wildly from day to day. In fact, history tells us that property prices gradually increase over time. Usually, only a horrible environmental disaster or a political calamity will cause house prices to drop out the bottom. And if that had to happen, there would be very few investments that do not lose value, anyway!
With hoards of international investors being able to disinvest from one side of the world, and transfer their funds to the other side of the globe, with the click of a button, most other asset classes have become more volatile in modern times. So, why did real estate not follow suit?
There is, as yet, no quick and easy way to dispose of real estate. Property has to be advertised and viewed, the terms of the sale has to be negotiated, and in South Africa, the transfer of ownership has to be registered in the deeds registry. This all takes time, so prices are stable over the short term.
The other thing to remember here is that we are talking about residential real estate. Everyone has to live somewhere, so there should always be a demand for residential property. The forces of supply and demand govern market value - even where real estate is concerned. So, unless people suddenly find a way to live somewhere other than on real estate, property values should be relatively stable in the long term, and even increase over time, shouldn't it?
Buying a house means forced savings
Statistics tell us that we South Africans are terrible at saving our money. But when you take the step of purchasing your own home, you will be making monthly repayments on the outstanding balance of the mortgage. Yes, essentially you will simply be paying back the money you borrowed from the bank. But you will be benefiting from any increase in the value of the property that may occur!
This increase in value means equity: the difference between market value and the mortgage debt. And if everything goes according to plan (as it has for a very long time), your equity should keep growing exponentially, as long as you don't take a second mortgage to go to the Bahamas, or refinance every now and then, to buy shoes.
Therefore, when you buy a house, you will benefit from the forced monthly savings plan that comes with it!
Money and equity
"So, I'll have equity? But how do I eat that?", some people are murmuring.
Well, the idea is that you won't...eat it!
Home equity should be seen as "holy money". It is not supposed to be spent on anything, other than improving your home, or buying more property. It just makes sense that you should use your equity to create more equity.
The equity will eventually turn into riches, but only if you can resist dipping into the honey jar too soon!
I think this is a good place to put a "to be continued..."
In the next instalment of Riches and Equity I will explain how equity becomes cash, for those few people who don't already know...
