"There are only two ways of telling the complete truth—anonymously and posthumously."Thomas Sowell

Friday, August 19, 2005

Puncturing the Housing Investment Balloon

An interesting story in today's New York Times outlines the largely illusory nature of gains in personal wealth created by rises in housing values. The story makes it clear that the stock market is still by far the best form of investment:

The housing boom of the last five years has made many homeowners feel like very, very smart investors.

As the value of real estate has skyrocketed, owners have become enamored of the wealth their homes are creating, with many concluding that real estate is now a safer and better investment than stocks. It turns out, though, that the last five years - when homes in some hot markets like Manhattan and Las Vegas have outperformed stocks - has been a highly unusual period.

In fact, by a wide margin over time, stock prices have risen more quickly than home values, even on the East and West Coasts, where home values have appreciated most.

When Marti and Ray Jacobs sold the five-bedroom colonial house in Harrington Park, N.J., where they had lived since 1970, they made what looked like a typically impressive profit. They had paid $110,000 to have the house built and sold it in July for $900,000.

But the truth is that much of the gain came from simple price inflation, the same force that has made a gallon of milk more expensive today than it was three decades ago. The Jacobses also invested tens of thousands of dollars in a new master bathroom, with marble floors, a Jacuzzi bathtub and vanity cabinets.

Add it all up, and they ended up making an inflation-adjusted profit of less than 10 percent over the 35 years.

That return does not come close to the gains of the stock market over the same period. The Standard & Poor's 500-stock index has increased almost 200 percent since 1970, even after accounting for inflation.

The article notes that real estate is a good investment, but for the traditional reason: "You can live in the house you own." If you sell your house, you have to buy or rent housing somewhere.

The article doesn't talk about the ubiquitous practice of taking out home equity loans, which is an additional danger in seeing one's home more as an investment than as simply a place where you want to live.


Kathy Hutchins said...

A couple of comments: you can't compare returns in the stock market to returns from capital gains to residential real estate without adjusting for the different tax treatment of the two vehicles. The once-every-three-years exclusions on capital gains from sale of a primary residence makes a big, big difference in after-tax profit.

Also, if the returns in the stock market are as good as you claim, it seems like it would be economically rational, at today's interest rates, to borrow against home equity and purchase stocks.

Everyone keeps talking about a housing bubble, yet housing starts and building permits just keep setting records month after month. In my neck of the woods, they're getting close to total buildout unless local zoning rules change radically. Real estate may not look good to these guys, but it's the only thing I've ever made any money at.

S. T. Karnick said...

Capital gains is an important factor, but you must include property taxes when considering investments in housing, and those taxes are high and rising.

Kathy Hutchins said...

Unless you're a nomad, you're going to pay property taxes one way or another. Either it comes out of your mortgage escrow or it gets folded into your rent. And property taxes themselves get preferential tax treatment from the Feds if you own, and if you itemize. It's all very complicated, isn't it?

Tom Van Dyke said...

We civilians are about ready to lay you economists end to end until you reach a conclusion.

Kathy Hutchins said...

Never work. You could lay us all end to end and we'll still never reach a conclusion.

"Whenever I ask England's six leading economists a question, I get seven answers -- two from Mr. Keynes." -- Winston Churchill

Very geeky economist joke:

Q: How many econometricians does it take to screw in a lightbulb?

A: To figure out the answer to this question we need a nonparametric approach because econometricians are not normal.

More economist jokes here. Lawyer jokes are a lot funnier, though.

Greg said...

Loved the Churchill quote. Can't get enough of those!

Tlaloc said...

You know a field is in disrepair when they finally begin to mock their own competence.

Ah well. I might point out, purely as a layman that the investment return on a house might have to include the qualitative factor of not living in a cardboard box while managing your stocks.