This article critiques the popularly held notion that homeownership is a lucrative investment.
A tale of two dollars
It should come as no surprise in the current economic climate to hear that a professor of economics does not consider a home purchase to be a lucrative investment. But the assertion that purchasing a single family residence (SFR) has never been a sound investment could come as a shock to a nation that has always believed in the myriad virtues of homeownership — not the least of which has been the idea that if all else fails a profit may be turned by selling their home.
Robert Bridges, a professor of economics at the University of Southern California, points out that between 1980 and 2010, the value of a mid-tier SFR in California increased by an average of 3.6% per year, from $99,550 to $296,820, not much greater than the rate of consumer inflation. Thus, even those mid-tier California homes that were sold during the most recent market peak in 2007 show a moderate average annual price growth of 6.61%.
A comparison of the appreciation between a dollar invested in California housing versus the same dollar invested in the Dow Jones Industrial Index (the Dow) is quite revealing in terms of the viability of the relative investments. Given the average annual price growth of mid-tier California housing, one dollar invested in the California housing market would have grown to a peak value of $5.63 in 2007 and to $2.98 in 2010. The same dollar invested in the Dow, which to some extent ran in tandem with the vicissitudes of the California housing market, would have been worth $14.41 in 2007 and $11.49 in 2010.
Relative rates of return on dollar to dollar investments is one thing, but what of the popular perception that paying-off a home mortgage provides long-term financial security for those who own California real estate outright? While a home can function fine as a long-term piggy bank, it is one of the most notoriously illiquid assets one can own, a risk acutely evidenced by today’s real estate market. [For more information on homeownership as an integral aspect of the American dream, see the July 2011 first tuesday article, Like myths, this old dream will never die.]
Do you consider homeownership a lucrative investment? Total Voters: 67
Do you consider homeownership a lucrative investment?
Total Voters: 67
The illiquidity syndrome
In order for a homeowner’s 100% equity interest in a piece of California real estate to make a difference in their spending power or practical wealth, they would have to take out an equity line of credit or reverse mortgage (or sell their home leaving them to rent their shelter). The problem is, equity lines of credit are expensive and for every dollar pulled from equity the home owner could end up losing twenty cents, which exponentially diminishes the return on the homeowner’s dollar.
Without the phenomenon of an unsustainable real estate market boom, purchasing a home is tantamount to investing your money in a piggy bank. [For a snapshot of the cyclical nature of the California real estate market, see the July 2011 first tuesday article, California tiered home pricing.]
Betting on a real estate market boom is never sound fiscal reasoning. As the old adage goes, what booms must go bust, so it is not enough to simply hope your home value will sky rocket, but one must be prepared to capitalize on the boom moment if you consider your home an investment.
This means selling at the right time and replacing your housing once your asset has been liquidated. However, purchasing a replacement home when prices are inflated would be not be an investment at all, since you simply change properties and gain nothing through the exchange.
Matching rhetoric to reality
The notion that homeownership is an income-producing endeavor is at odds with the reality of such an “investment.” When rising prices rapidly replicate like a virus on steroids, this runs counter to the other fundamental attraction of homeownership — its stability. The only time — allow us to repeat for appropriate emphasis — the only time homeownership produces dividends beyond the rate of inflation is during a boom cycle, which of course is the variable in the homeownership equation that renders it unstable.
When the California real estate market reaches equilibrium, as it seems it will approaching 2012, home values will only rise at or near the rate of consumer inflation for several years, well into 2016. Again, this renders homeownership outside the confines of booms and busts as a net-zero investment – no real gains after accounting for inflation’s damage to the dollar’s purchasing power.
It is time to do away with the tired old rhetoric espoused by housing ideologues (interpret: builder and broker trade unions) that purchasing a home is a good investment and call it what it is: shelter. [For more information about the luxury vs. necessity debate, see the October 2010 first tuesday article, Is homeownership a luxury or a necessity?]