Economist Robert Shiller has declared that purchasing a home as an investment is no longer a sensible choice. This is a departure from Millennium Boom thinking when the public viewed homeownership as a fool-proof investment in the face of rapidly rising home prices. Today, the story has evolved.

The investment returns seen during the Boom were unprecedented, speculative and will not occur again for decades. Home prices escalated during the 2002-2005 boom at an average rate of 20% each year among low-tier homes. The normal rate of price increase over time? 3%! This rate is consistent with the average increase in income levels, matching the rate of consumer inflation.

This 3% average price increase diminishes further after factoring in a home’s monthly operating costs and paying interest throughout the life of an above-market mortgage.

For these and reasons of constant future interest rate increases, homebuyers need to return to viewing homes primarily as shelter rather than an investment vehicle.

Shiller suggests viewing a home purchase like a car purchase: make the purchase for its intended use rather than a financial investment.

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Shelter or investment?

Shiller’s message, if conveyed, is a much-needed wake up call to homebuyers. Most continue to expect a high return on investment (ROI) from a home purchase. Even in the aftermath of the Great Recession, when short-term expectations for price movement generally remain realistic, long-term expectations run irrationally high.

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What’s missing? Homebuyers need to understand that home prices are inextricably tied to the mean price trendline. This trendline represents the long-term value of a home to which prices always return and is dependent in large part on the rate of consumer inflation.

Despite real estate booms and busts, home prices inevitably return to their mean price point. Thus, when viewing a home as a long-term investment, rational homebuyers need to expect no more a price increase than is level with this trendline.

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Buyers can also take a cue from younger homebuyers—Generation Y. This demographic has largely put off homeownership for the time being, and are less likely than their Boomer parents to own at all in the future. Members of this generation are more inclined to rent, investing their earnings in more lucrative investments than storing wealth in a condo or other housing for their shelter.

Gen Y seems to intuitively understand the opportunity cost of purchasing a home. Sinking all your wealth (the few who have some) into your shelter makes zero sense in an era where the Dow Jones has fully recovered and housing prices have not. Buying rather than renting also comes at the expense of immobility, a precious asset during this period of persistent unemployment and constantly shifting job opportunities.

Agent advice

So is this bad news for agents? Not necessarily.

Instead of pushing a home purchase as a fool-proof investment option, consider the sensibilities of the next generation of homebuyers. Encourage homebuyers by focusing on the many savings to be had by becoming a homeowner.

To calculate the homeownership savings, first consider the expenditures the buyer would make over ten years of owning, including:

• mortgage payments plus interest;
• repairs and maintenance;
• property taxes;
• homeowners insurance; and
• utilities. [See first tuesday Form 306, Property Expense Report]

Then, include the buyer’s savings on:

• monthly rent (which, with today’s low rates, is consistently much higher than a new mortgage payment);
• the mortgage interest tax deduction (MID); and
• property tax deductions.

When homeownership pays off

When is homeownership the smart choice?

• If a buyer would otherwise leave their down payment savings in a bank account, which presently earns less than the rate of inflation; and
• if the savings to be had outweigh the benefits of renting.

The exception is for those who are willing to take slightly riskier approaches to investing. For instance, a renter will benefit from investing their down payment money elsewhere if they are willing to invest in more complex or risky assets beyond their control.

Help potential homebuyers through this daunting calculation by preparing an ownership expense analysis. This will demonstrate exactly how much money they can save each year by owning their shelter — a helpful exercise for both you and your client.

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