Do you ever get the feeling that you must be right about something just on the strength of how ludicrous people sound when they argue against you? Take this, in defense of housing-as-an-investment:
Say you live in a neighborhood that you believe is going to clean up, crime will go down, housing stock will improve, and rent is going to go from $500 a month now to $1,000 in three years and then grow at 8% a year perpetually…
And say that you’re right, and say that no one else is as perspicacious as you are, which means that houses in that neighborhood are still cheap. Then yay, you’ve just found a gold mine!
Except, beware confirmation bias. “Housing markets are extremely local; block by block even. It's much easier to spot a trend that others haven't, and have local knowledge that others don't, when the relevant market is your neighborhood,” continues Adam Ozimek.
I’ve got many friends who bought houses in London or NYC, saw both rents and property prices saw, and ended up making mark-to-market profits often exceeding their total lifetime earnings. That’s a good sign of a bubble, but at the time it seems like a sign of farsighted and insightful investment prowess. The point is that either property prices in general go up, or else they go down. Real estate is pretty much never a good investment in a down market, no matter how granular and detailed your local knowledge is. Meanwhile, in an up market, it doesn’t matter much either. Yes, that gentrifying neighborhood is going up in value. But so’s the old-money neighborhood a mile away, and so’s everything else in a 20-mile radius.
Remember that it’s sometimes not a good idea to buy a house even if your total monthly payments are lower than what you would be paying in rent on the same place. If prices fall, rents can fall too: just ask any landlord in New York City. And while the renters next door are happily renegotiating their lease so they pay $300 a month less than they were paying last year, you’re stuck with the same fixed mortgage for the next 30 years. If only you’d held off buying, your monthlies would be lower while renting, and you could buy now, if you were so inclined, at a lower price. Price the option: if you’re renting, you always have the option to buy. If you already own, you don’t.
Ozimek has other arguments, too, including the novel one that house investments are inherently leveraged while other investments aren’t. Well, yes, exactly. What that means is that a house can make you bankrupt in the way that other investments can’t: you can lose more money than you invested. And then there’s the bit about the “covariance with the rest of your portfolio”. OK, I’ll grant you that one: if the value of your home (not your downpayment) is somewhere in the region of 5% to 10% of your net worth, then congratulations, you’re very rich, and you can go ahead and buy what you like. For 99% of us, buying a home means putting our overall portfolio massively overweight real estate. And the only real way to justify that is precisely because a home is not an investment.
Ozimek finishes his argument with this rather bizarre rhetorical flourish:
A housing investment is more like buying a small business than it is like a security investment. In fact, it is buying a small business; the business is being your own landlord. Being a landlord is more likely to be a profitable venture if you have reliable renters who you can trust. As a landlord, you're the best renter you could ever want, which makes being your own landlord less risky than being someone elses landlord. This is because being your own landlord solves the principal agent problem inherent in the rental relationship; the owner/renter interests are exactly aligned.
Huh? Living in your own home is like renting that home to yourself? Well, you are making rent-like payments to someone else — they’re called mortgage interest payments, and they’re going to the bank. Only in this case, if you find yourself in a situation where you can’t continue to make those payments, you can’t just move somewhere cheaper: instead you’re liable to end up losing all your money and your credit rating.
In any case, as a landlord, the best renter you could ever want is a renter who reliably pays more than your mortgage, and whose rent payments go up every year — maybe even by 8%! But there’s a problem here: even if the rental value of your property does go up a lot, you don’t reap the benefit of that unless and until you sell the house or move out and rent it to a second-best renter while looking for somewhere else to live yourself.
When unemployment is high, there’s a premium on mobility and the ability to go where the jobs are. Houses, by contrast, tend to tie people to one spot. And what happens if your neighborhood goes in the opposite direction to the one you’d hoped for, with crime increasing and all those overextended boutiques and coffee shops moving out? Try asking anybody who owns a home in Detroit whether houses are a good investment.
In my experience, most people who buy a home do so primarily for psychological reasons. They’re not bad reasons, necessarily, they just don’t make a lot of financial sense. People who insist that their home is an investment tend to be people who would have bought anyway, but who are just casting around for good-sounding reasons to justify their actions. They should just be happy that they have what they want.
Hi Felix, do you have any thoughts on good sources of information for people who are considering buying a house? It may not be a good investment, but there is still a difference between a poor investment and a disastrous investment.
@JonHocut –
A. The an excellent indicator of a good deal is if you can get a 30 year fixed mortgage (with 20% down) that is cheaper than the equivalent rent you would pay for comparables.
B. Another excellent indicator of a good deal is if the ratio of (price)/(1 year of rent on comparables) is in the range of 12 or less.
One more factor: The same house may or may not be a good deal depending on the buyer. Specifically, what kind of interest rate can the buyer can get? What may be a good buy for someone facing 5% fixed interest may not be such a good buy for someone looking at 7.5%.
The other factor is to avoid buying more house than you need. A 5 BR for a family of six? Sure, if you can afford it! A 5 BR for a family of 2? Waste of resources and money!
Felix –
Homeownership is a terrific pseudoinvestment. The best pseudoinvestment most people will ever make. If done properly, it will chain people into a forced-savings regimen that will leave them much better off financially than they would otherwise be. It will also chain them into the kind of routine existence that is good for their financial health.
There is a reason homeownership is the foundation for much of the wealth in this country.
Ha!
More renter self-confirmation claptrap!
Mmm, I kind of agree with the sentiment – houses are not a easy route to riches, which is what people in Britain believe(d) – but I can’t quite agree. When you buy a house, a bit like buying a washing machine, you are paying now for a stream of consumption later. Which is an investment. Contrast with watching a movie.
The problem with that simplistic argument is of course most people can’t afford to buy a house, so borrow against it. But that isn’t necessarily wrong, again look at how people (traditionally) bought washing machines.
This sounds a bit irrelevant, but it comes to my main point which is houses are great pension assets. Shelter is about the only aspect of consumption you can reliably be sure you will want when retired, and furthermore can stockpile in advance. It’s like tin baked beans, but much nicer. Thus insofar as you know 20% of your income in retirement will go on housing services, to save reliably for that now is a good thing.
[As I said otherwise I agree with you. I'm not sure about this 'option to buy' though if you are renting. Doesn't an option have a fixed strike price?]
It’s “soar” not “saw” just FYI. Although right now they are more likely to “saw” in half, IMHO.
Felix is right that it is a highly levered bet that you are making and hence the chance of bankruptcy is considerably more than zero. However, you can significantly mitigate that risk by building in a substantial “rainy day fund” in case you are made redundant for example, 24 months of mortgage payments should be enough…
However, to claim you are a 30 year bear on property is a strange call. Also, don’t forget the convenience and tax efficiency of saving by paying off the capital in your mortgage. Most morons taking this option don’t even realise they are saving and actually compare principal+interest payments with renting in their affordability calculations giving even further margin for safety.
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