The recently enacted 21st Century ROAD to Housing Act echoes the belief that homeownership is an important part of the American Dream, an idea that goes back to the 1950s. One foundation of this belief is the perception that homeownership promotes wealth accumulation for individual homeowners. We need to re-think this perception in the modern era.
Relative to renting, owning a home confers many benefits—status, control rights, access to properties that are not available on the rental market—but ending up with more money in your bank account isn't generally one of them. And it is a big responsibility. Control rights come with control obligations.
The first fallacy is that a house is a good financial investment. For example, my aunt bought her house in the Berkeley Hills for $276K in 1993. It is currently worth $1.8M, based on recent sale prices of comparable homes on our street. Sounds like a pretty good return over 33 years—5.8% per year. What would that $276K have grown to over that same 33 years from 1993 to 2026 if the money had been invested in the S&P 500? $8.4M. That is, 10.9% per year.
Of course, who is to say what these returns will be over the next 33 years? But at least in the stock market you get diversification. When you buy a home, you put a lot of eggs in one basket, especially if your house represents a significant fraction of your wealth. As for the expected future growth rate in house prices, one could argue that in the long run, house prices should merely appreciate at the rate of inflation.
But what about in the short run? In the U.S., younger, poorer people, who have yet to buy homes, are clamoring for policies that would make housing more affordable. The ROAD Act makes strides in this direction, by encouraging local governments to relax zoning restrictions and other barriers to increasing housing supply. Older, richer people, who own most of the existing housing stock, are countering those efforts to reduce house prices with equal vigor. The fight is far from over, but if the ROAD Act and other policies to make housing more affordable gain traction, future house prices could grow more slowly than inflation.
By contrast, stocks and bonds are priced to deliver a positive expected inflation-adjusted return. For example, 30-year Treasury Inflation Protected Securities (TIPS) are currently priced to guarantee a 30-year 2.9% return over and above inflation. For retail investors who are willing to bear risk over that 30-year period, as they would if they bought a home, the Vanguard Total Stock Market ETF offers the entire US stock market in a single package for only 3 basis points per year in fees. In theory, the expected future after-inflation return on the stock market should be even higher than 2.9%, to compensate investors for the extra risk. The realized after-inflation return on the US stock market over the last 150 years has been 7% (9.5% including inflation).
The second fallacy is that owning a home is forced savings. In fact, it is forced spending. Paying the upfront cost is just the beginning. Then there are property taxes, insurance premiums, utility bills, and maintenance costs, or else condo or co-op fees. Added to this are mortgage interest costs, if the upfront cost is financed with a mortgage, or else the opportunity cost of the foregone returns from not investing that upfront cost in financial markets. Lots of homeowners finance these ongoing carrying costs by taking out second mortgages or home equity lines of credit, in which case, they aren't building equity.
Let’s stop making our kids feel like failures if they don’t buy a home they can’t afford and don’t have the time or expertise to manage. Let them rent housing services, while they pour their savings into the financial markets through retirement accounts that shield returns from capital gains taxes. At the same time, they’ll be better able to focus on their careers and their own children while they leave the hassle of managing a property to others. By skipping expensive financial services, such as mortgages, and earning attractive returns through direct stock and bond market participation, our kids can make enough money to leave their own kids with generational wealth. That’s the real American Dream.
