| In Defense of Housing: There’s No Investment Like Home |
| Written by Jonathan Smoke | |
| 12.03.2008 | |
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Discuss this article on the forums. (0 posts) As we continue to live through the worst recorded decline in home prices, it has become popular sport to deride housing or investing in residential real estate as an outdated and misinformed investment concept that will decline in interest if it hasn’t already. Yesterday’s Wall Street Journal included an in-depth feature article entitled “The Future for Home Prices.” The mocking subtitle gave away the subtext of the financial intellectual elite viewpoint: “Americans still see real estate as their best shot at wealth. It may be wishful thinking.” I will give credit to James R. Hagerty, the author of the WSJ article, as he wrote a very interesting article that covered many facts that actually support the notion that continued investment in real estate is not so crazy even though the point of the article seemed to want to mock the fact that “[m]any Americans still see real estate as their best shot at wealth. In survey after survey, people expect prices to bounce back—in some cases, as soon as six months from now.” Investments in housing have clearly not performed well for three years running. We know that home prices have declined 23% from the peak of prices in June 2006 to the latest reading from September 2008 according to the S&P Case-Shiller 10-City Composite Home Price Index, which is the most widely respected measure of home prices. A few poster-children bubble market cities have seen declines in excess of 30% from their peaks measured by the respective Case-Shiller individual market price indices. Phoenix and Las Vegas top that list of decliners with 39% and 38% peak to current declines respectively. So if you bought a home, or land, at the peak in these markets and if you used a lot of leverage in your investment, you clearly have not done well. Indeed the crisis we have been going through is a result of bad investment decisions coupled with bad and excessive use of credit. Housing gets the blame even though housing was merely the asset and not the mechanism that caused the problem. No one invested in a portfolio of stocks completely on margin with bad credit and no ability to pay the interest, but still the implication seems to be that a home is an inferior investment. If you own a home, would you have done better if you’d invested in stocks? If the measure is the decline from the recent peak, the S&P 500 is down 45% from its peak in October 2007, so recent declines favor housing. Now some stocks deliver income through dividends, but few can deliver the yield that rental income or implied rent (living in your home) provides. Sure, you don’t have to pay property taxes or invest in maintenance, insurance, and association fees to own a stock. But you also don’t get the same tax benefits. At worst, I’m considering the ownership costs and benefits a wash. Real estate also doesn’t perform like stocks. It’s normally not as volatile (bubbles are the exception), and it doesn’t necessarily track how other investments are performing. That makes having some investment in real estate desirable for diversification. While there is risk with any investment, unlike investments in individual stocks, an individual property is never likely to fall to zero value. People inherently get this, and that’s why poll numbers reflect positive attitidudes about housing as an investment even now. These same poll numbers are being used by financial intellectual elites to make people seem ignorant since their point of view is that investing in real estate is foolish. Let’s look at an illustration to see if I am such a fool. I bought my current home in suburban Atlanta in February 2000. So, it's fair to compare the performance of an investment in my home based on the S&P Case-Shiller Atlanta Index to the performance of an equal investment in the S&P 500 Index. I kept this simple by using $100,000 as the investment amount for each so you can easily see how the investments have fared. And, to make the comparisons even, I’ve used the monthly values through September (as a reference, through yesterday the S&P 500 index has declined 27% since the end of September!). I am fairly certain my home hasn't lost 27% of its value since September. Notice that the equity I put in my home, according to the performance of the S&P Case-Shiller Atlanta Index, was worth just shy of 22% more than what I put into it as of September 30. The same investment in the S&P 500 lost almost $15,000 over the comparable period. I enjoyed living in my home for the last eight years. Had I bought my home to rent it out, I would have enjoyed rental income. By contrast, I’ve not enjoyed watching my retirement funds bounce around and ultimately lose my hard earned money. Clearly I didn't set the stage for stocks quite as well as February 2000 happened to be a relatively high mark for the index over the last 10 years. But I am using my actual experience and time frame. If I'd managed to pick the bottom of the S&P over the last 10 years, the stock investment would have performed better, but both would still be positive. Doesn't it say quite a bit about stock performance (and why people are not so positive about stocks) that today's stock value is actually a near a 10 year low? Besides picking a better time frame for stocks, I’m sure someone will read this and argue that my experience with housing isn’t necessarily typical. What if I had bought my home in Phoenix in 2006? Clearly that example wouldn’t compare as well as it would take a bubble market with the asset being bought at the peak. However, I think that Atlanta is more typical a market than Phoenix. And if the purchase had been in Phoenix in the same time frame, as the chart shows, despite having lost 39% from the peak, I’d still be up 39% from my original investment. While utility or income is relatively safe in owning residential property, as these past few years have proven, home price appreciation indeed has risk. Furthermore, the appreciation potential in normal markets like Atlanta is not that exciting (my home has delivered a lousy approximate 2.3% compound annual appreciation rate according to these index calculations). However, despite the potential for some periods of decline, homes generally slowly appreciate. As a case in point, the time horizon I used in the chart encompasses a time frame that starts well before the bubble began and includes all of the fall until now. The compound annual appreciation rate in Phoenix even after the decline is 3.9%. Even the WSJ article acknowledged the expected slow but steady home price appreciation expectation with data from experts: “But, the experts say, you should generally expect house prices to rise just a bit more than inflation and roughly in line with household income.
Karl Case, an economics professor at Wellesley College whose name adorns the S&P Case-Shiller home-price indexes, has studied U.S. house prices going back to the 1890s. Over the long run, he says, home prices tend to increase on average at an inflation-adjusted rate of 2.5% to 3% a year, about the same as per capita income. He thinks that long-run pattern is likely to continue, despite the recent choppiness. Other experts make similarly modest predictions. William Wheaton, a professor of economics and real estate at the Massachusetts Institute of Technology, says he expects house prices to increase at a rate roughly one percentage point higher than inflation over the long term. Celia Chen, director of housing economics at Moody's Economy.com, a research firm, expects house prices to increase an average of around 4% a year over the next couple of decades.” I don’t know about you but being offered an investment that will deliver income and a return above inflation sounds pretty attractive, especially now as we live through such a volatile period. Also, considering that home prices have generally fallen in most markets, longer-term appreciation is likely to be less risky now than at any point over the last decade. Perhaps the most important reason why individuals think highly of real estate investments even now after all we know about the downside risks is that they can understand real estate and what makes one property a good investment while another one maybe not so good. Paying a good price for a house is not the same random walk of investing in stocks. If you do your research and know about property sales and neighborhood factors, you can improve your chances of seeing higher long-term appreciation. While I have used the S&P Case-Shiller index as the proxy for my specific home’s appreciation, my own research has shown that these market indices only explain about 40% of the price trends happening in individual neighborhoods or homes. Therefore, my actual appreciation could be and probably is better than this calculation, assuming I bought at a good price, picked a great location and have managed the upkeep of my home better than the average for Atlanta. When you look at markets the size of Atlanta, it is not crazy to assume an intelligent and informed investor can do better than average in buying well, picking better than average submarkets and neighborhoods, and managing the asset better. Just in case anyone mistakes my arguments to support “flipping houses,” I don’t think such short-term opportunistic investments in residential real estate are a smart investment strategy for most people. I believe most people understand that too. Real estate is clearly less liquid and has more transaction costs that make short-term investments riskier and less likely to return a net gain. My favorite quote in the WSJ article was from another vaunted expert: "Some experts say it’s a bad idea to count on your home rising in value at all. People should think of their own homes mainly as places to live, not as investments, advises Kenneth Rosen, chairman of the Fisher Center for Real Estate at the University of California, Berkeley. Sure, home mortgages provide tax benefits, and most homes appreciate in value over the long run, he says, but there is always risk."
So, if there’s risk involved you shouldn’t consider something as an investment? Isn’t that the very idea of an investment? Perhaps we should put our savings in our mattresses—that way we’d limit any downside risk and we’d maybe get some cushion utility from the bills. The article continues to reveal the long-term wisdom of the masses even though its intention was to doubt it as being smart: "For all of those forecasts, many Americans are undaunted. Consider three surveys, all from October.
In a poll of 2,000 adults, real-estate-data provider Zillow.com found that 61% believed the value of their home would either remain level or rise over the next six months. Another survey of more than 1,000 homeowners, sponsored by real-estate-services firm Realogy Corp., found that 91% thought that owning a home was the best long-term investment they could make. And an online survey of 5,000 people commissioned by Citigroup found that just 32% believed it was a good time to invest in stocks—but 51% said it was a good time to buy a home." If such large numbers believe in investing in homes and that now is a good time to buy, doesn’t this bode well for housing over the long term? We may be overly optimistic about our own homes in the very short term, but as long as the majority of folks feel better and more secure about investing in real estate, the returns will be there. And even in these dark years like 2008, I prefer to ignore my brokerage statements and instead snuggle up next to the fireplace I own over which I should have a sign that reads “There’s No Investment Like Home.” 
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