This article investigates whether a home is a luxury item or a necessary item, and details the implications of either view on the California real estate market.
In an effort to define the purpose for owning a home, two camps of economic ideology have formed. The dividing concepts considered by historians and economists involve whether a house is a necessity or a luxury. Whichever camp you side with, they assert, will define how you view the health of the current real estate market and what is to come.
If housing is a luxury item, prices rise and fall along the line of personal income. The more wealth an individual acquires, the more they spend on the home they choose to live in.
Proponents of homes as luxuries also view homes as investments: assets held with ownership expectations that present a risk of loss. They believe that, while a place to live is a basic need, owning a home is above all else a status symbol reflecting the occupant’s wealth and elevating them to the level of social acceptance they desire. To those embracing this view, owning a home is a luxury by society’s standards since it is assumed they have the financial wherewithal to own it, and having money equates to having success.
But does that make the housing-as-luxury rationale true?
Those who think otherwise view a home as a family nest; its purpose is to create stability and provide shelter. If housing is then a necessary item, prices rise along with the rate of consumer inflation.
Here’s another way of approaching the quandary. If housing is a necessity, it meets enduring basic needs. If housing is a luxury, it meets both basic and hedonic needs (bigger and better amenities).
Either way, a house at its core meets a basic need and needs to be primarily classified as such. While owning a home may also equate to success and status for some, the history of real estate price fluctuations reflects their eventual return to the trend line set by consumer inflation. Pricing for the occupation and use of real estate is driven foremost by income (31% of income for mortgage payments) and the basic need of a population to live somewhere. [For more information regarding pricing, see the May 2010 first tuesday article, Buyer purchasing power.]
Houses, fundamentally, are just aggregations of labor and materials — the cost approach to valuation. As personal income for most in the labor force increases at the rate of consumer inflation plus a value for any skill appreciation contributing to their employer’s benefit, over time a smaller percentage of that inflating income is spent carrying a home.
The housing bubble had most convinced otherwise
While periods of economic plenty are enjoyed when the price of a home skyrockets to produce a sizeable profit, those times are only noted exceptions — boom times. Prices eventually return to the price equilibrium dictated by the path of inflation when the real estate market rediscovers evaluation fundamentals as it always does, much like the price of milk or any other staple good. Homebuyers who buy a home after the mid-point of a real estate boom and own it when the boom cycle turns to recession (as it inevitably does) end up losing.
However, several decades of public policy have encouraged a collective mindset treating a home as a perennial nest, but above all else as a status symbol — one which is upgraded whenever possible.
California real estate experienced the long-term formation of a pricing bubble that commenced during the stagflation years of the late 1970s. It grew with the boomer invasion of the 1980s and 1990s, and then eventually imploded in early 2006 — for lack of buyers to house a family and action taken by the Federal Reserve (the Fed) to fight inflation in August 2004.
That long-running bubble was left unabated to produce nearly two generations of homeowners and encroaching speculators, all convinced the value of a home would always climb steadily upward. With profit in mind, they planned to sell and be set for life when the time came to retire.
In reality, the Golden State’s housing market is merely part of the greater economy, and subject to the same recessionary symptoms.
The tide that became a tsunami
The homeownership-as-luxury idea was given impetus in the late 1970s, when the disruption of war a decade earlier created severe consumer inflation and, in the end, radical real estate asset-price fluctuation. People soon realized they made money just by owning a home.
The initial housing policy fueling the ideology that a home is a luxury was influenced by the fact people were more financially independent (and less costly to the government) at retirement if they owned a home. Thus, the decision to subsidize homeownership, and save the government even more money, was simple. The tax code was used to implement this policy.
To kick off the 30-year run to the top of the California millennium housing boom, an unnecessary and perverse housing tax credit was implemented in early 1975. It encouraged people to buy up the newly built homes held unsold by builders and real estate owned (REO) lenders, which then set off a home price inflation that wasn’t knocked down until 1983. A tax credit was also extended to vacation homes in 1976, encouraging ever more homeownership by individuals.
As unintended consequences, these government-sanctioned tax policies to supplement homeownership income artificially increased home values (not just homeownership rates) and re-sparked the pre-1930s idea that owning a home was an investment, not a savings account. [Internal Revenue Code §280A et seq.]
The encouragement to treat a home like an investment was thwarted for a time amidst separate oil and energy crises in 1980-1981. Rising inflation drove the Fed to make money more difficult to come by in an attempt to stabilize the dollar’s purchasing power. Mortgage rates reached 11% in late 1979 (ultimately peaking around 14%), leaving home prices going into the 1980s to be driven by images of a recession, and back to trending with the rate of consumer inflation.