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Debunking the Buying a House is a Bad Idea Myth

by Leon Yang on May 3, 2014 · 12 comments

  
Is buying a house a bad investment idea?

Recently I came across this article spouting some reasons why buying a house is not a good long term investment. Let’s just say I strongly disagree his argument and in this article I will thoroughly dissect his reasons as to why he is wrong.

He bases his arguments through Shiller, the guy who won a Nobel Peace Prize Award last year along with another economist who argued completely against Shiller (go figures, right?). Granted, it was nice of him to create a index for pricing homes, but if we have learned anything in the last twenty years, it is that economists are always wrong. So basing a real estate investment thesis on an arm chair professor? I don’t think so. Let’s move on to the next part.

Shiller argued that housing is not a good provider of capital gains, but rather a good provider of housing services. Hm, I’d like to tell that to the IRS. I’m pretty sure a house back in 1950s does not cost the same amount as today. Despite Shiller charting home prices going back to 1890s to show that home values did not change much AFTER adjusting for inflation, home values do go up. What he forgot to mention is also that home prices seem to do surprisingly well during eras of inflation too.

Related: Stocks vs. Real Estate: Which is Better?

Stocks Vs. Real Estate?

From this point on the author compared stocks as a better investment, as if the dozens of stock market crashes in the past 100 years do not indicate that the stock market is an extremely volatile investment. While you can say if you just invest in the index you may outperform home as an investment, but let’s delve a little deeper to see the benefits of owning a home.

What the author forgets in his thesis, despite the fact that he quoted Shiller is saying that owning a home is a good provider of housing services, is that inflation does cause the cost of housing services to go up. What you paid for rent in the 1890s is totally different from what you paid for rent in today’s world. As I chronicled in my recent trip to Argentina, I wonder how an Argentinean feels when he or she has to sign rental agreements that stipulates the 2nd year of rent has to go up 30%. Or I wonder how does even a San Franciscan feels about rent when he or she chose not to buy a house in the 1990s? Living expenses do go up. Rents go up.

But not if you owned a fixed rate mortgage. If you owned a fixed rate mortgage, your payment is always going to be the same. In an inflationary environment, you are getting a huge discount on your debt service. Even in 2014, I wondered what payments were like in 1984. Let’s just put a wild figure and say your monthly mortgage was maybe about $600. The cost of gas in 1984 is $1.21. That means in 1984 you needed 495 gallons of gas to pay your monthly mortgage. If your payment today is still $600, but gas is $3.68, it means you only need 163 gallons of gas to pay your monthly mortgage. You needed way less gas to pay to live in your house. Meanwhile, I think rent probably went up along with the price of gas. And that is the power of owning debt in a state of inflation. So all I am saying is that I bet you are going to feel pretty smart by 2044 when you locked up a 30 year mortgage rate now.

Related: Real Estate vs Stocks: Which is Better? (You Might Be Surprised…)

Conclusion

So I think in this instance the author and Shiller both missed a huge point. Although housing prices may stay stable throughout the times once the prices are inflation adjusted, the cost of living in a house got totally taken out of the argument for their convenience sake. Millions of Americans have hedged against rising living costs by owning a home. You can’t do that with stocks.

Stocks go up. But so does your rent. Your principal and interest payment on your house? It is going to be same (don’t lock up anything adjustable, go with fixed!).

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{ 12 comments… read them below or add one }

Kyle Hipp May 3, 2014 at 6:01 am

Leon, I think you and Shiller are speaking of two different things. You are talking about the benefits of financing whereas shiller is comparing housing and stocks as investments. I vet qhat you are saying however I think there is a missing link between the financing ability of and investment and the actual merits of the investment regardless.

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Eric May 3, 2014 at 6:09 am

I agree, buying RE is a great investment. I would rather own, than rent.

But if I was in my 20s, I would probably rent. I would be renting within walking distance of work, no matter where I worked. I would also move across the country following the highest paid work. How do you factor in the time, and money spend on transportation?

Owning also has another advantage though. If I want a 200 lb dog, like the renters I just rejected, I can.

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Bobby May 3, 2014 at 6:12 am

I’ve come to the belief that the writers on the Motley Fool site are just shills for who ever pays them the most money to write an “article” which basically becomes a subtle advertisement….

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Doug Merriott May 3, 2014 at 6:16 am

Great article Leon.

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Cliff May 3, 2014 at 7:05 am

I think you missed a key piece that was only glossed over in the article. Even in your critique, you never take into the account the huge negative carry of owning a home. You only focused on the top line number of the price. When you take out the costs of repairs, insurance, and taxes it is a big drag on your numbers and those numbers have been growing with inflation, sometimes more than inflation. When people purchase homes, they don’t purchase the home as an investor would. An investor takes in to account all these costs to determine that there is a positive return there. A homeowner picks a place to live.

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Sharon Tzib May 3, 2014 at 8:34 am

I’m really tired of the stock vs. real estate debate, and clearly Motley Fool has a vested interest in swaying people to the former, so I take these articles with a grain of salt, especially when they start quoting stats from 1890!!

And Cliff, I totally agree with you – most homeowners grossly underestimate the costs of ownership when they buy, especially if it is their first time, and there are many more costs than just the mortgage, such as the utilities you’re now responsible for paying (vs. when you rent), purchasing appliances and furniture, contracts with vendors like gardeners and pool service, HOA, PMI possibly, pest control, snow removal, tools, yada yada – the list goes on.

Also, most people don’t buy just one house and stay forever. The average person buys and sells about 4-5 times in their adult lifetime, which can get very expensive, and since your mortgage won’t “carry forward,” you are spending a lot of money on securing new loan costs, realtor commissions, transferring of utilities, moving costs, etc.

Not saying don’t buy your own home, but the longer you can stay in it, the better you can hedge for inflation and the more equity buildup you theoretically should have, a point I think you’re trying to make Leon. Thanks!

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Chuck H May 3, 2014 at 9:21 am

Rents dont crash. My stockfolio (just made that word up) was brutalized in the tech bubble AND the housing bubble. Over that time my rents have only gone UP!! My rents rescued rescued my stockfolio because i had to pile more money in to take advantage of dollar cost averaging. It has rebounded and i made a hefty sum. I just pull it out and buy more real estate!

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Joe S May 3, 2014 at 12:23 pm

Leon, you are comparing a mortgage to rent, you should also add in commissions for both buying and selling the house, repairs and maintenance, and property tax. When you figure these in with liquidity of paper investments then just maybe Real Estate doesn’t quite become the supreme investing option. Just some thoughts.

Regards,

Joe

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Giovanni May 3, 2014 at 12:39 pm

Just to be clear Shiller won the Nobel prize for Economics, not the peace prize.

I agree with @Cliff and @Sharon that the full cost of homeownership is often grossly understated. Even Zillow who should know better completely understates the cost of maintenance and repairs- but they’re shilling for houses the same way Motley Fool is shilling for stocks.

At the end of 2012 I wrote a piece on the true cost of owning a home and built an interactive spreadsheet to generate the chart in the piece. The conclusion was that based on the long term returns and the real cost of ownership owning a home is a great way to secure cheap housing but as an investment it was barely a breakeven. See the whole piece and the chart here: http://ashworthpartners.com/the-buy-vs-rent-meme-that-just-wont-die-and-my-challenge-to-zillow-rentals-realestate-multifamily/

That’s not say that there aren’t opportunities from time to time where you can buy houses at pennies on the dollar that work well, for instance REOs after a housing bubble collapses, but that will be a crowded trade going forward now that institutions are in the game. Plus with Wall St. involved in securitizing mortgages, buying distressed houses in bulk, and securitizing those as well, individual investors are competing against people who get paid millions of dollars to be just a little better than you. Their cost of capital is lower too so they can pay prices that are hard to match.

Right now hedge funds and private equity firms are buying giant pools of distressed mortgages directly from Fannie, Freddie and the large banks before any of it hits the market, keeping the good stuff and dumping the junk. The way things are trending houses will become another asset class trading like a stock with all the volatility that can produce. If all that wasn’t enough, think about who owns Congress and the White House these days.

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Syl May 4, 2014 at 3:48 pm

“Even in 2014, I wondered what payments were like in 1984.”

I was paying 18% on my fixed rate mortgage in 1984. Regardless of the actual payment amount, holding onto that mortgage would have been a mistake.

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Brian Levredge May 5, 2014 at 10:02 am

Actually, stocks can work quite similarly to real estate in regards to the subject of this particular discussion. Locking in on a great dividend paying stock at a low price is very much the same thing as buying a good rental on a 30 year am, fixed rate loan. In both situations your entry price is fixed for the term of the investment. Both assets return ever higher income to the investor over the long haul as well. Dividends more often than not beat inflation as well. Take Buffet’s investment in Coke back in the 80’s as an example. The dividend return alone annually now is almost equal to his original investment. That’s pretty sweet.

I love real estate much more than stocks, but trying to compare stocks as an asset class to owner occupied real estate is not accurate at all imo. As others have noted, when you factor in the true cost of ownership, it’s not really an “asset” at all. You pretty much have to wait for appreciation to bail you out, which many people do not have the luxury of doing.

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Josh May 8, 2014 at 2:14 pm

Jason Hartman calls this “inflation induced debt destruction”
I agree completely.

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