Though home prices across much of the nation have recovered their pre-crash levels, the volume of transactions is still less than half what it was at the peak of the boom, and still well below historical norms. The number of new home transaction is still hovering near historic lows. Analysts are starting to ask whether home ownership retains its traditional place as an element of the American Dream.
Should young people who have shied away from home investments be considering a purchase? It depends.
Measured in straightforward math, home ownership is a money-losing proposition. With the exception of the period from 2004-2007, all the fabulous stories you’ve heard about the money made from an “investment” in a home are pure garbage. People are as good at evaluating the merits of their homes as they are at judging their kids’ talent.
When people evaluate the performance of their home in investment terms, they subtract the sales price from the purchase price and pat themselves on the back. Occasionally they will incorporate the cost of the kitchen renovation, or a selected portion of that cost, but they will almost never account for all the cost of ownership. The ledger will magically fail to include the new water heater, lawn maintenance, the endless minor repairs, or the time devoted to upkeep. They will not incorporate the additional travel costs or time incurred because they had to live fifteen minutes farther from everything in order to find a place they could afford.
More importantly, they will fail to evaluate the opportunity cost of the investment or the cost of the lost alternatives. Across hundreds of years, real estate gains a fairly steady .5-2% above inflation. If prices move much higher or lower over a short term period you need to brace for a correction. By contrast, that same money placed in an equity investment can reliably earn two to three times as much. That lost opportunity will not make it into the ledger.
For those looking for “new buyers” entering the market to take prices back to boom levels, it’s time for a little sobriety. The only reason prices spiked in the last decade was because clever monkeys on Wall Street found a way to engineer a brief boom, using the mass securitization of the mortgage market to convert housing into high-octane Ponzi scheme. There is no mass of new buyers out there waiting to enter the market. The basic demographics of the country are heading in the opposite direction.
Population growth has largely stalled with the exception of new immigrants. Changes in the way the economy works means people who will earn enough to support home ownership start their careers and their families much later in life than before, meaning that their span of homeownership comes later and is often shorter than in the past. And growing inequality means that fewer and fewer young people today will ever be homeowners at any price.
The real estate boom is not coming back. Home price appreciation can be expected to stabilize back down around the low end of its historical norm
And the tax benefits of home ownership? That may be the cruelest hoax, especially for middle-earners. Even at the highest tax brackets, the savings are far less than you would expect. Very few Americans realize how little they spend in Federal income taxes or how much they spend comparatively in property taxes. In exchange for taking on a new property tax obligation, a middle earning taxpayer will get perhaps as much as a 6-10% discount on the interest they pay on their mortgage. With interest rates on new mortgages running in the 4% range, that’s not very helpful.
Home ownership is far more expensive than almost anyone realizes. As an investment it under-performs almost any available option, including treasury bonds. In a radically dynamic economy, it makes movement to pursue new job opportunities sometimes prohibitively expensive, tightening career options. Worst of all, it creates a fixed burden on young families that does not flex with changing financial conditions.
And for a lot of people buying a home is a pretty good idea. Here’s why.
The benefits are not entirely financial. A home should not be treated like an investment in the purest sense, though over time it will tend to have some stabilizing effects on a family’s finances. The main value obtained from home ownership has to do with the relative shape of the markets for single family homes as compared to rental properties and the social impact of ownership on families and communities.
First, there is some minor financial advantage to home ownership that helps offset some of the costs. The impact is not enough to convert ownership into an investment, but it does make it attractive overall when all the factors are calculated.
Home ownership based on a fixed-mortgage, the most common method in US markets, converts a home into a form of inflation hedge. If a homeowner follows the model pattern, purchasing a “starter” home around the time of marriage, then stepping up to “stretch” home at early career, they set in motion a process that could see their housing costs drop steeply below the cost of a lease or rental over time.
As inflation proceeds and their income (presumably) rises across the arc of a career, their mortgage cost remains flat while leasing costs rise with inflation. By about the ten year mark, their housing costs are perhaps a third of what they would be if they were still leasing. From about that point forward, they also begin to accumulate equity in the home which can be converted very cheaply into capital.
That rosy investment scenario requires a lot of uncertain variables to fall in a family’s favor. Divorce, for example, takes that promise of a long term benefit and converts it into a costly loss that often follows the family for many years. A job loss or transfer complicates the picture. And if income does not rise the effect is dimmed. That said, this is a plausible scenario that has brought meaningful financial advantages to a lot of families.
Perhaps the most persuasive reason for home ownership, the one that provides the decisive factor that trumps all else, is the way the housing market is bent toward ownership. The rental market in the US offers virtually no options to rent single family homes with the kind of predictable quality you would expect from a corporate product.
The rental market is volatile. The quality of landlords is highly variable and almost entirely unpredictable. That makes the prospect of a long-term lease very unsettling, but families at mid-career with young children face tremendous costs when forced to move. Decent rentals are hard to find and you often can’t identify whether you have a good or a lousy rental until you’ve moved in and experienced your first maintenance problem.
In short, the rental market for families is unstable, unpredictable, and far too dynamic for families to absorb. A rental may, in principle, provide some savings over ownership, but it is just as much of a gamble.
This could change. A very substantial portion of single family home purchases since the collapse have involved hedge funds. Many of those funds expected to “flip” the homes when market conditions improved, but the improvements they were expecting have not materialized. If a new market for corporate-quality, branded rentals emerges from the crash then this dynamic might change. If that happens, then the economics around home ownership might shift decisively in favor of renting.
Absent such a shift, home ownership is likely to remain an expensive, but necessary investment for young families.