Guest Post: Housing is not a good investment
This is a guest post by Josh Snodgrass.
Housing is not a good investment, and it never was.
Our country has a special reverence for home ownership as a route to comfort and prosperity – and so provides subsidies and tax breaks. But, actually, housing is not nearly as good an investment as people think and it wasn’t so good historically, either. The big gains people earned from housing in the past were mostly the result of leverage, forced savings and inflation.
Many, white, middle-class American families have a story that goes something like this: They bought a home with a $10,000 down payment. While they raised their children there, the house grew in value to $250,000 which provided the funds to send their kids to college with something left over for their retirement.
This idyllic story led us to mythologize housing but it is just that, a myth. While the facts are true, the growth is a mis-perception. While things turned out well, the house was not that great an investment. Here is the full story.
The $10,000 down payment was only one-fifth of the total cost of a $50,000 home. So, instead of a 25-fold increase in value that they perceive, the price increased “only” 400%. Even 400% doesn’t seem bad, but considering that it took decades to earn, it wasn’t that great. Most financial investments we hold for decades grow to a multiple of their cost. The reason houses seem special is that they are the only asset we hold that long. Actually, the gain on houses typically just barely holds its own against inflation.
The key to turning a mediocre gain into a big one was the mortgage that they took out. If you only put up a fraction of the money but get all of the gain, you can multiply the returns earned. Wall Street loves this game and calls it leverage. But, it has a downside.If prices drop, you lose bigtime – as millions of families losing their houses to foreclosure these days are learning to their sorrow.
The mortgage was key to the myth in two other ways. In addition to the $10,000 the family put up when they bought the house, they may have paid a total of $100,000 on their mortgage, but since this was in relatively small monthly payments, it tends to be ignored when people do mental accounting on the investment.
The need to make monthly payments effectively required the family to save regularly – something we have trouble doing if we aren’t forced to do so. Saving regularly is a good thing. So the saving they had to do to pay the mortgage, more than the house, was what resulted in their having money for the kid’s college and retirement.
So, is this a good strategy after all? Not really. Buying a house on leverage is a risky investment. Home prices do go down, more often than we realize. And, with leverage, a 20% drop in price can wipe out all of the family savings.
In addition, home prices have been propped up by tax subsidies, low interest rates and the mythology. We cannot be sure their prices will even keep up with inflation in the future.