A recent Vox article has renewed the old adage that ‘housing is a good investment.’ While the author makes some salient points, this statement in general can lead some people into a trap.
Is a House an Investment or Consumption Good?
The author admits home values don’t increase much more than inflation on average, but then he tries to explain how they are still a good investment because if you own a home you can live there rent-free, which is “like a de facto dividend.” Let’s stop right there for a second.
It is a little odd to consider residing in your home as ‘paying you a dividend’ simply because you don’t have to pay rent. If I buy a car with cash, I don’t really consider the car ‘paying me a dividend’ because I do not have to rent or lease one. Yet there is a grain of truth here to untangle.
First, we need to start with a proper definition of the word investment. An investment is an asset purchased with the expectation of creating wealth, either in the form of generating income or appreciating in value. Therefore, it is not purchased for the purpose of consuming it today.
Houses are very much a consumer good, because we use them for shelter and derive a consumption benefit from them. Furthermore, the actual housing structure degrades with time and wear-and-tear, much like a car. Roofs leak, furnaces need to be replaced, and appliances break.
However, there is some truth to housing being an investment because a house is not just the physical brick and mortar structure, but also the land and property rights, which usually do not depreciate and tend to keep up with inflation.
Let’s say you have $100,000 cash in the bank right now. You can choose between two investments: putting it in the stock market that will yield 5% total return per year, or buying a house and renting it out, which will also yield 5% per year after all expenses.
Both of these are investments, and both yield the same amount of return. If we assume the risks and everything else is identical, then you as an investor should be indifferent. Now let’s say you move yourself into the house you are renting out. You no longer get the income from the investment property, but you also don’t have to pay rent. So I agree with the author on one level that it is helpful to think of housing this way.
Housing Versus Other Investments
Therefore, if we keep it as an apples-to-apples comparison, then we are really just talking about the differences in risk and return characteristics between housing and the stock market — and here is where I disagree the most with the author.
He notes that renting his current home would cost about 5% of its value per year, while the stock market is yielding only 2.2% in average dividends. However, he also admits total return includes both dividends and capital appreciation, and stocks tend to go up in value much more than houses.
I’m also not sure I agree with his inflation-adjusted return on housing as 4%, as Shiller’s data to which he links shows housing only keeps up with inflation. Even so, the stock market’s total inflation-adjusted return over long periods is at least 6-7%, or 9-10% nominal returns. A few percentage points don’t seem like much, but compounded over time, this is a huge discrepancy.
It is also true that stocks can be more volatile than housing, but this is simply the risk-reward tradeoff. If housing has much lower returns, then it makes sense it can be less risky in terms of volatility. Yet this doesn’t account for the illiquidity of housing. Stocks can be sold at almost anytime if cash is needed, but a house certainly cannot.
Finally, the author breezes over the other risks of housing and waves them away as not that big of a deal. For example, especially for younger people, making a downpayment on a home means putting almost all of their net worth into one single asset. You wouldn’t put over half of your entire life’s savings into one stock, so why would you do so with one house?
Or take the idea that rents are volatile and can price you out of a neighborhood. True, but the other side of that coin is that if you are renting, you can move out of a deteriorating neighborhood. If you buy a home, you take on the risk and reward that the neighborhood could go up or down in value.
What about the idea that a mortgage forces you to save? Perhaps some people like or need this type of legal enforcement to build equity, but it is odd to saddle yourself with debt to ‘save’ more. Much easier than going through the mortgage process is setting up automatic withdrawal from your paycheck or bank account to go into retirement or other savings vehicles.
In conclusion, housing can be a better financial move in many cases, especially with our current tax code and federal mortgage subsidies skewing incentives toward home ownership. But #BeResponsible and don’t ever make the mistake of thinking housing is always a good investment.
Chris Kuiper, CFA is currently a student and researcher at George Mason University, pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.