Homes May Not Be so Sweet as Investments
Is a home really as safe an investment as many Americans believe?
A study by two Yale University finance professors says it isn’t, though critics argue the report is flawed.
The study’s authors, Matthew Spiegel and William Goetzmann, found that buying at a cyclical peak of a local housing market can be very costly.
The professors studied home price trends in all 50 states and the District of Columbia from March 1980 to March 1999.
They found that 44 states suffered at least one period in which a homeowner would have lost money by buying a house and selling it five years later. Their calculations included the cost of Realtors’ commissions.
In other words, once home prices peak in a local market they may not recover for years. And homeowners who want or need to sell during downturns can suffer sizable losses.
In the Los Angeles/Long Beach market, the typical buyer between spring 1989 and spring 1993 lost money selling five years after the purchase date, Spiegel said.
People who bought in the winter of 1990 suffered the worst hit selling five years later--a 21.2% loss, on average.
Chiefly because of such bouts of price weakness between 1980 and 1999, housing was a far worse investment than either stocks or bonds, the authors concluded.
In that two-decade span, the average annual total return of the Standard & Poor’s 500-stock index was 17.9%. Long-term U.S. Treasury bonds averaged 10.7% a year. And even 30-day Treasury bills, among the safest of all investments, returned 6.9% a year.
By contrast, home values nationwide rose about 4.2% a year in the period, on average--just slightly more than inflation, which averaged about 3.7%, according to the study.
A few metropolitan markets fared better. New York home prices, for example, appreciated at a 7.4% annual rate, while San Francisco prices rose at a 6.6% clip. But even those paled next to returns on stocks and bonds.
“[Homes] are very risky investments,” Spiegel argues. “It’s not unusual to find yourself behind the eight-ball if you buy a house.”
But other economists say the study overstates the risk and understates the return on housing.
The last two decades saw an unprecedented stock rally that is unlikely to repeat, they say, so the stocks versus housing comparison doesn’t hold up. Also, the study period excluded the dramatic plunge in stocks that began a year ago.
Moreover, many people view the tax advantages of home ownership, compared with renting, to be too good to pass up. Most homeowners can take a tax deduction for all of their mortgage interest as well as for property taxes paid.
Homeowners also enjoy the benefit of high leverage.
Imagine two people with $50,000 to invest. One puts the money into a portfolio of stocks while the other uses the sum for a 20% down payment on a home.
For the stock investor to double his money the portfolio would have to double in value. But for the homeowner to double his money the house would have to appreciate only 20%.
That’s because the $50,000 down payment bought a $250,000 home. So if the home’s value rises 20% to $300,000, the homeowner has actually doubled his cash investment in the home.
And for people who sell at a profit, the tax situation can be far better for homeowners than for shareholders.
Most stockholders face long-term capital-gains taxes of 20%. But homeowners can entirely exclude the first $250,000 of profit on a home from capital gains taxes. Married couples can exclude the first $500,000 of profit.
Offsetting those advantages, to varying degrees, are the many costs associated with the upkeep of a home, experts note. Those costs can make it difficult for home buyers to calculate the true return on their housing investment.
Spiegel says his study isn’t anti-housing.
“There’s nothing wrong with buying a nice house,” he said. “But if you’re throwing every nickel into your house because you think it’s a great way to make money for your retirement, I wouldn’t do that.”
