Homeownership Myth (Part II)

As I argue in the earlier posting, the Sunday Washington Post article raises a number of interesting points about the value of homeownership as an investment device.  I discuss many of these points in an article that will be published this Fall, and ultimately conclude that it is time to debunk some of the myths associated with homeownership. 

The Post article notes that one advantage stock purchases have over home purchases is the relatively low cost to acquire stock and the ease of completing a stock transaction.  A fair point, and one that is even more relevant for potential homeowners who have subprime credit and will generally have higher borrowing costs.  These costs are exacerbated for people who are steered into subprime loans even though their credit qualifies them for lower cost loans, a practice that recent studies suggest seems to be directed at minority homebuyers.

The Post article also discusses the oft-stated view of homeownership as a forced savings device.  At the same time, financial experts in the article argue that owning a home is preferable to investing in stocks because you can borrow more against your homes than you can against your stock holdings.  That homeowners can so easily borrow against their homes, however, means that this isn't as much of a forced savings device as it once was.  So, whatever the benefits of homeownership might be, as long as owners can so easily remove equity from their homes, it's hard to really say that owning a home forces people to save long-term.  And, the fact that so many homeowners are now "upside-down" on their homes (i.e., they owe more than the home is worth) illustrates the pitfalls of encouraging homeowners to treat their house as if it is the National Bank of Home.

Finally, the article extols the federal tax benefits homeownership provides.  Those benefits include the ability to deduct mortgage interest payments and property taxes and also the ability to sell a primary residence and keep certain amounts (up to $250,000, for a single person, and $500,000, for a married couple) tax-free.  Though these benefits collectively represent one of the largest wealth transfers in the Internal Revenue Code, the benefits disproportionately favor higher income taxpayers who are itemizers primarily because lower income taxpayers are more likely to take the standard deduction.  And, because minority homeowners are statistically more likely to have lower incomes than white homeowners, tax scholars (most notably Professor Dorothy Brown who will join the Emory Law School faculty this year) have found that these federal tax benefits disproportionately favor white homeowners.

What has been largely missing in the current debate about the housing crisis is a harsh, realistic look at why we encourage everybody to invest in a house (or, as it's usually stated to "own a home.")  Is it because it's really the best investment device?  Is it because it's the safest or easiest way for moderate income consumers to acquire wealth?  Is it because of the positive externalities purportedly created by homeownership (homeowners are more involved in their communities, homeownership leads to safer neighborhoods, schools are better in neighborhoods that have primarily owner-occupied housing, etc.)? Is it because so much of our economy depends on consumer spending?  Is it because home builders, mortgage lenders, and Home Depot need people to keep buying homes?

So, is investing in a home better than investing in stock?  Well, I guess the answer is still:  it depends. 

Comments

[Allan]

Interesting points.

But, assuming that you intend to live in a house for 30 years, what is the best way to do it?

1. You can buy the house. Generally the price will rise over time, so it is an investment. But, then again, you have to have shelter. So you really should deduct the cost of rent for a comprable property from the equation. And then add the costs of general repair and maintenance.

2. You can rent a house on a year to year basis. This is a pretty good deal, except that you might be forced to move (not good for the long-term plan) and rents rise. If rents rise with inflation, that $1,000 rent might end up being $3,000 or $4,000 thirty years later. Assuming that the $1,000 would cover a mortgage, you might end up paying 2x or 3x for housing than you would have, had you stayed.

3. Lease the house for 30 years. I have not heard of this happening in the modern era. But it was common (I think) in England in early centuries to lease for 99 years. However, the lease was for the land, not for permanent structures affixed to the land, i.e., a house.

Here is my bottom line: if you intend to stay in the same place for 25 or 30 years, the most economical option is almost always to buy the house (even in a bubble). Generally, housing prices will go up (not as much, perhaps, as stocks), you will save in rental expenses (as compared to renting a similar property), and you can't be forced out (generally speaking, I don't take eminent domain into account).

I propose that, with the savings over renting, the average home owner who stays in the house for 20+ years does much better than the average renter who invests some money in the stock market.

[Patches]

Allan you make a great case!

Even still the amount of amortized interest you pay on a 30 year fixed mortgage is going to be close to 3X the purchase price. Say you sell it 30 years later for more than 20,30,50 even 100% of the "purchase price" you are still paying or "investing" more than your eventual return or at the very least breaking even. Your other assertions though will make up some of that difference I assume. There are other expenses that you don’t get back. Insurance for instance, is something you may never realize a return on. Homeowners, wind-storm and flood (gulf coast anyway) are not investments that you are a guaranteed return.

Comfort, piece of mind, and sense of community is not something you can put a price tag on though and I believe a owning a home does provide those intangibles to most people. Whether those feelings are correct or can be obtained another way is not what I am asserting here today, but people do get them from homeownership.

I want it, not from an investment point of view but for my family. I want I grandkids to have someplace to go and visit grandpa and grandma.(not a rest home) It’s a gathering point! A place where families can come together and know its not going to be in some other city, state or country next year or the year after. To this day I get excited when I know I’m going to visit my grandmother (who is still kicking) and it’s in the same place I have always known. The memories; the feelings; “My family”! Homes for the most part are not thought of as investments by the people who buy them, it’s a side-bar rationalization.

[Chuchundra]

The Bloomberg Rent vs Buy Calculator is the best tool I've found for sussing out which is the best option for you. It takes into account everything from expected rents and inflation to the opportunity cost of your down payment. The bottom line is that, as long as you're not buying at unsustainable, bubble prices, buying a home generally makes sense as long as you're planning to live in it for 5+ years.

There are other factors to consider with purchasing as opposed to renting. For example, in many places rental housing stock is very different than housing stock available for purchase. There aren't many SFHs for rent in the area where I've been looking. Right now I'm renting a two bedroom, garden apartment. It's nice enough, but a bit cramped for me and the missus. We'll have no room at all once the baby comes in September.

[Experts on Credit]

It's easy for me to decide on stocks because I can't see myself being tied down to a home loan for a long period of time. If my situation were different, I think I'd choose a home purchase -- there are perks to this type of investment beyond the purely financial.

[Doug]

Allan: Your 30 year assumption (even your 20 year assumption) may apply to some folks -- but, in light of mobility, career changes, family disruptions, and so forth, it does not apply to others. Housing consumption, like everything else, has different market segments. The "30 year" segment is smaller than the entire market.

[ltk]

I'm surprised that no one has brought up the issue of leverage. Very few people would make a leveraged investment in the stock market. (And in any case, mere mortals are limited to 2x or less.) But for a house, effective leverage of 10x, or 20x, or infinity ("no money down"), was routine.

If you expect to live in the house for thirty years, and pay it off, then the leverage is probably a non-issue; essentially, your mortgage is a tool that locks in housing costs for the rest of your life, and the only uncertainty is what ends up left for your heirs. If you expect to sell five years later, then the house behaves like any other leveraged investment, and the homeowner can expect to make or lose a lot of money quickly.

The issue of available housing stock is also worth emphasizing. If I'm looking for a nice apartment downtown, then I can find rental and condo units that are reasonable substitutes for each other. But rental suburban houses tend to be slums.