BiggerPockets

http://www.nytimes.com/2010/08/23/business/economy/23decline.html?hp

It seems like they might be jumping the gun a bit. Yesterday they had an article that small time investors are leaving the stock market. But people will have to put their money somewhere.

i see the opposite of this everyday, people are dying to own a home, they understand that rent sucks and owning is good.

For people who don't save a lot owning a home is mandatory for the long term stability of our whole system. retiree's renting will be the death of usa if it happens in huge numbers, these people will just vote themselves even more money we dont have.... people want to and and need to own.

I believe "housing as a means to wealth" is patent BS. Forced savings, yes. Wealth, no.

Note that I do not mean real estate (or stocks or any other sort of) investing. I do mean "owning a home". I especially mean that total BS of "starter homes", "move up homes" and "trophy homes". "Property ladder" and similar gibberish.

All these ideas are promoted by people who have a vested interest in real estate transactions. NAR, NAHB, agents, developers, builders, and contractors. And, yes, real estate investors. They're actually not unlike stock brokerages. Transactions generate income. There's an old saying for stock brokers: "The firm made money. The broker made money. Well, two out of three isn't bad."

Yes, lots of people managed to buy a house at the right time (roughtly pre-2000). A few managed to sell at the height of the bubble and pocketed big bucks. Other people had a huge paper net worth. Some just watched it rise and fall. Others "spent their house" with cash out refis and HELOCs. They may have felt rich, but they were just riding the bubble. Some of those who "sold early" are now crying in their beer that they need relief from their upside down loans. And there are plenty of people who went into the situation with good intentions and just bought at the top of the market and are now caught in a squeeze. If those people stick it out and continue paying on their big loans they may never see even a sliver of retirement, let alone wealth.

Most of the "wealth" associated with a primary residence comes from a) a long time horizon, and 2) ignoring most of the costs. Bill Bronchick is fond of saying "don't you wish you could buy your parents house for what they paid?" Sure, is of course the answer. But I'd pretty much like to buy any asset that currently has value for the price it was selling for 50 years ago. The real value to real estate is that people typically own it for a long time (at least they did pre "property ladder") and if they don't make the payments they get the boot. But if they do make the payments and stay put for 30 years they now own a significant asset. Even if they've never saved a dime, and the house only appreciates at 3% per year, the $100K house they buy today is worth $240K. If that's all you have, that's quite significant. Looks like a $140K profit.

OTOH, even at today's low rates, a good borrower might be paying 4% on a 90% LTV loan. They put in $10K (really, more like $13K with costs) and make payments if $430 a month for a total of $155K. Plus the $13K in at the start. Oops, profit is only $72K. Further, they're paying taxes and insurance, at the very least. Figuring that at, say, $100 a month (PITI=$530). Over the 30 years that's another $36K. Profit's down to $36K. But try to sell that $240K house in the best of times and you'll pay $19K in commissions and costs. You're left with the princely profit of $17K.

The first house I bought was in 1987 and we were paying 9% on a 15 year owner financed note. We thought we had a great deal. (And, yes, the Mrs has reminded me more than once that house would have been paid for seven years ago.) The total of the payments for that 15 year note would be $163K. At 30 years, its $261K, leaving you in the hole even without the additional costs. For what its worth we paid all of $55K for that house (2400 sq.ft., but such a screwy floor plan counting bedrooms was an exercise in futility.) According to zillow (FWIW) its currently worth $148K. If that's true, that's roughly 4.5% appreciation over the last 23 years. Actually, I know it was worth only $65K in 1995 since that's what we sold it for. So, that's more like 6% since then, but almost nothing during the time we owned it. We did even worse for the house we bought in Bakersfield in 1995 then sold for a loss in 1999.

But wait there's more. Or less, as the case may be. If that house has been unmaintained and un-updated for 30 years, is it still worth $240K? If you walked into a house that hadn't been updated or maintained since 1980, what would you think? 30 year old HVAC. 30 year old roof. 30 year old kitchen, baths and plumbing. $17K is just over $500 a year. I'm thinking that, and more, gets spent on maintenance.

The real value to owning a home, IMHO, is that if you just stay put for the 30 years, or roll the value from one home to another and pay all the exorbitant transaction costs out of pocket, you have a place to live. If you're retired and living on a fixed income, even a $530 a month payment might be significant. The maintenance doesn't go away, either. OTOH, if you own your house free and clear you at least have a roof over your head.

A primary residence is an expensive doo-dad. Having expensive doo-dads is wonderful, assuming you can afford them. Having a "free" roof over your head when you income is limited is beyond wonderful. Expensive doodads, including residences, being a path to wealth is a myth.

let's say you decide not to buy because it sounds like a poor investment. That doesn't automatically free up your $700 to place in stocks or other investments! You still need a place to live and will end up spending that money to rent a place

Great point, nathan. When evaluating the return on investment of buying a home vs. renting, it is important to note that in many cases, a large portion of your payment would have been spent on rent anyways.

jeff

I agree with a lot of what Jon wrote above. Your primary residence is a nice-to-have and there is a ton of pride in ownership associated with owning. The home you live in is ultimately a money suck though and it isn't a GOOD investment UNLESS there is extraordinary appreciation during the course of owning it. All of the "investment" aspect is marketing propaganda promulgated by the interest groups he cited to keep THEIR cash flow machine working, not the other way around.

The typical SFR purchase has capitalization rates south of 5% with loan constants north of 7% in normal times and thus have negative cash flow unless the LTV is south of around 60%. Rents don't follow values perfectly and thus this analysis is not ironclad either. There are also various functional obsolescence problems as Jon stated. What happens if every new home is equipped with solar panels in the future to power hybrid electric cars? Or what happens if some other whiz-bang technology replaces older homes and thus decreases their value considerably as compared with the new models?

In my opinion the primary sources of value in owning SFRs stem from:

1. Forced savings as Jon pointed out. The average American is spendthrift and owning a portfolio of properties forces one to save money

2. Net debtor as a result of borrowing is a large hedge against dollar deflation due to unsound fiscal policy in this country which I believe will inevitably lead to heightened inflation and low real borrowing costs because inflation tax stealing is easier than confiscation of income by the government

3. Amortization of loans, which goes with point 1 above as a path toward paper wealth. Note that paper wealth with self-amortizing loans isn't realized until rents follow inflation north or the loan is completely paid off

4. Appreciation by buying property where land is scarce and demand for product is high. One of the main reasons for heightened demand is access to good schools because of the way the government gerrymanders districts

5. Tax savings from paper losses due to depreciation expenses and dual use items. Note that the dual use item argument isn't good if one owns another business already

6. The heightened ability to take advantage of market inefficiencies due to gangster-high transaction costs that are impediments to sale of property during periods of owner distress

7. The ability to leverage heavily, which allows one to control more assets using real estate than most other asset classes. Prudent leverage is rarely used in the industry in my experience and is the source of a ton of "investor" distress and ability for true investors to find value centers

The rules change a lot when one moves to commercial property and I would argue that the value centers switch more toward cash yields and away from reliance on appreciation and other favorable aspects of owning.

Interesting discussion.

If you want to consider housing from a purely investment point of view, home ownership is certainly much different than other investments in large part due to the transaction costs, maintenance costs and information costs and taxes.

Buying a stock or bond or commodity as an investment entails a transaction cost at both the time of purchase and sale - usually small relative to the size of the transaction. A brokerage firm may impose small ongoing maintenance costs. As to the information costs, I can now look up the stock quote or price of gold or interest rate on my cell phone 24/7/365. This allows me to sell the stock almost instantaneously (and almost around the clock) anytime I feel that the value has reached a peak -- or I can buy more if I feel it will go higher from the current price. Of course there are tax implications at least with the sale of the investment.

No so with housing - large transaction costs at both ends. High maintenance costs regardless of the house's current value. Very high information costs to determine its value at any point in time as well as determining the value of any repairs now or in the future. And politicians love to tinker with tax incentives with many aspects of housing and many of these tax breaks also influence a homeowner's income level or may not be available at certain income levels.

Of course there are "psychic" returns to owning a house - the ability to be left alone, the ability to change your surroundings (paint, wallpaper, landscaping etc) without needing approval from the owner.

I have to raise the issue on the point of FORCED SAVINGS. What if that is NOT what a person wants? What if a person wants a more nomadic life - living in one area or city for only a few years and then moving to a different local? Athletes? Landscape painters? Writers? If that is someone's choice of lifestyle, does this FORCED SAVINGS aspect of homeownership curtail that person's choice especially given the high transaction costs?

One comment though on the improvements though. While improvements often don't make sense financially especially in the short run. The value from an improvement might add value over time. Best though for homeowners to consider anything spent as a sunk cost. If it is important to you as a family to have that nicer kitchen, that giant pool, or whatever, then do it, just don't expect to recover what you invested necessarily.

Bryan,

I think your point is spot on, if you are considering the US or other established markets. Where the "nomad" will find success and a greater opportunity to increase their wealth is in emerging markets that have a high demand for their skills and a relitively low cost of living. I would think in most cases, owning a home for a nomad, would be problematic. However, I can also see the case where the nomad owns a home somewhere in the world that is their base of operations.

To the point of the original post, I would agree with most, that your personal residence is not an investment. It can be a status of wealth, but it is much more than that for many when you associate the human interaction that occurs in a home. I think for most people, the arguent that, "it's a good investment" is mostly something that helps them convince themselves.

The thought process might be something like the following:

Two bedrooms upstairs for the kids...an extra den/office.. we could put your mom in their... nice living room...that's where the flat screen will go.. great garage... nice backyard for bbqs with family and friends... oh and its a good investment.

Might even be considered a rite of passage into some next step of adulthood.

More renters means more demand; when demand is high with respect to supply, prices hold firm or increase - so rental rates should not be reduced as a result. Unless the supply of available rental units increases drastically, of course.

The best means to build wealth is by achieving the highest long-term average after-tax return on investment. Your personal residence will normally not meet that requirement. Thus, as Jon Holdman points out, they are good primarily as a form of forced savings. (This is a valuable thing, though, considering how many people have difficulty with financial discipline.)

Kevin Yeats, your observation about the higher transaction costs of homes compared to stocks is valid. But your observation about information costs misses an important point. It is true that price information is freely available for stocks and somewhat harder to get for homes. But "value" information is very hard to obtain for stocks because most people are quite poor at valuing the worth of a company. As a result, you will often find many small-cap and mid-cap stocks grossly mispriced whereas finding such extreme mispricing is harder with homes. Even the least sophisticated person tends to have a general idea about the values in their neighborhood. And if they overpay, the appraiser is always there to rescue them!

Rich, Germany has historically had a lower home-ownership rate than the U.S. There are some structural reasons for this, including the greater availability of higher quality subsidized housing in Germany. I also think that cities with good public transportation tend to have less home-ownership. This is because such cities tend not to expand forever along freeways and have a higher population density, which makes them better-suited for apartments than houses.