Housing can’t be a good investment and affordable
cityobservatory.org
cityobservatory.org
Imagine if house prices tomorrow were to increase by 10% across the board, throughout the country. Who exactly would that help? Not the vast majority of home-owners who own a single home. They're still going to continue living in their house, and will be unaffected by the 10% increase in any meaningful way. And if they ever decide to sell the house and claim the 10% increase as profit, where are they going to live next? They will just have to buy/rent another house, where their earlier profit will be going entirely towards paying the higher housing prices for their new home.
So what you really have is a situation where all the renters face dramatically higher costs of living, the single home owners are mostly neutral, and the upper-class with multiple homes suddenly find themselves with a windfall. And we think this is cause for celebration?
Personally, I can't wait for the next housing crash.
The banks. I don't even think they pretend otherwise at this point?
The people I hear this the most from are in the middle class, the ones who are most likely not to benefit from the increases.
I hope this thinking stops.
Over the last few years a large part of the reason in the increase in the value of homes has had to do with historically low interest rates and a statistically low inventory due to the number of homes underwater or with low equity. The Boomers are just starting to retire, over the next decade many will attempt to do as you describe creating a glut of homes for sale, while the median household income has continued to decrease making it impossible for the generations coming behind to absorb those homes based upon their income and Demographics, remember Gen X is much smaller than the Boomers and the Millenials have not come into their own yet.
There is a small argument that this is why we use leverage when buying house.
There's also the idea that 10% growth is hit with a 6%+ transaction fee because of real estate agents, brokers, and lenders.
But there are other drivers of housing costs too, for example real estate agent fees, serve to guarantee that no one can actually afford to sell a house for less than they paid for it.
Bottom line, is unless you happen to be lucky enough to live in a neighborhood experiencing >10% growth, its likely your just getting a refund on years of paying a significant portion of your income on housing.
That just makes it harder to sell if you haven't built up much equity. And if you're going to sell houses before you build up equity, you would've been better off renting anyway.
So if you run the numbers of what I pay to own vs. what I pay to rent (because homeless is not a desirable option), then I think you'll find that housing appreciation helps the owner (if after many years the owner sells and then moves into something smaller, or else sells and then rents).
AKA, your rent would be significantly less than the cost of taking out a mortgage to own the same properly.
Obviously that isn't the case, and there are a number of reasons, starting with artificially low interest rates, government tax incentives for home ownership and backstoping 30 year mortgages for homes that weren't peoples primary residence.
Since home equity is a gateway to access to lower-cost credit, those people are exactly who would benefit.
Having a lower cost of borrowing is, ceteris paribus, a benefit. For one thing, it increases the range of uses which are net productive.
Not unaffected - property taxes would increase by 10% in many jurisdictions (where no cap exists), and other costs like insurance and maintenance would likely increase by lesser amounts.
As to why people celebrate this trend:
Lets say you bought a $400,000 house with $50k down (12% down). You have 88% LtV. Which means you have PMI and all sorts of extra fees on there.
If prices rose 10%, to $440,000, your LtV is now 79.5%, which means you qualify for a standard refinance and can knock PMI off of your payments.
So now you have a lower monthly payment (no more PMI).
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If you flip the house, you would have made $90k on a $50k investment, or a 80% growth of your money.
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There are plenty of ways to benefit from increased equity. And no, the bank definitely doesn't benefit. The homeowner does.
Because we've made it national policy that people should have most of their usable savings in a home, meaning they benefit from policies that push its price up.
Then pat ourselves on the back for letting the poor play a lottery where maybe one in a thousand of them get to live to live in artificially-cheap "affordable housing" set-asides, while at the same time displacing someone who's actually in the ballpark of affording the area.
(I'm talking about the affordable housing lotteries that decide who gets those units, not the regular money-lotteries, to be clear.)
This is one of the greatest insanities our culture has developed.
I am confident wages would rise were it the case workers owned their houses free and clear. The economic stimulation from investing the surplus (between inflated and historically realistic prices) would be incredible. I even think it would help class and race tensions considerably.
Personally I think it's financially absurd, but then again I'm a single guy. If I had 2 kids in college, a spouse that just lost a job, medical emergency, I could see how tempting home equity might be.
Bingo my friend!
I've been preaching it for years.
There is one prominent nation I know of that depreciates housing. That is Japan.
http://freakonomics.com/2014/02/26/why-are-japanese-homes-di...
As always, the people of glorious Nippon are superior lifeforms in every way. <polite bow>
TL;DR: A good investment has to grow in value over inflation, and if housing grows in value at even a decent rate, it compounds out of affordability. As an example, housing in San Fran has grown at 2.5% over inflation.
Housing is the exception to this rule. Yes you want your investments to beat inflation, but unlike an index fund, or a stock, or a commodity, you need housing (you have to live somewhere). You have to either rent or buy (or live off the land in the woods, which can be illegal many places). When you rent you are throwing your money away, you will never see that money again, period. The one other alternative is to purchase, even if you lost a small percentage on your "investment" buying a home, isn't that better than just throwing your money in the trash and losing 100% of it? An investment that isn't great is still better than an investment that absolutely sucks.
http://www.nytimes.com/interactive/2014/upshot/buy-rent-calc...
http://www.wsj.com/articles/SB100014240527023039481045795342...
Buying seems to be better in most cases but not all.
Edit: relevant MrMoneyMustache article, saying how in a very expensive city (Toronto) it's better to rent:
http://www.mrmoneymustache.com/2015/07/27/rent-vs-buy/
For my country (Uruguay), for almost all houses barring mansions or waterfront properties, if you plan to stay more than a few years, it's better to buy. The rent vs mortgage relationship is ridiculous (and investors love it).
I've actually done a 10 year DCF analysis for SF and in many scenarios, a rent controlled apartment whose rent becomes cheaper over time (since SF rent controls are at 1% while inflation is 3%) can be a significantly better (and less risky) investment than owning.
There is this false concept that rent is "throwing money away" but that's not true in many cases; there's an opportunity cost of your down payment, property taxes, etc. with house ownership. NYTimes has a nice web calculator to help figure it out for you: http://www.nytimes.com/interactive/2014/upshot/buy-rent-calc...
Key reasons why renting could make sense 1 house ownership is incredible risky due to high down payments 2) rent control laws makes renting actually cheaper over time
I've also done the DCF analysis and found that it's about a wash assuming a 10% discount rate and 10-year rent vs. buy-then-sell-with-payoff.
One problem with your analysis is that I think anti-rent control sentiment is growing in SF as the city's politics moderate overall. You could very well get Ellised out of your place and then the entire analysis goes out the window (though I suppose you could probabalistically factor this in, including the Ellis payment, but then, you really should work on Wall Street building option and mortgage payout models, shouldn't you)
A few interesting observations from the DCF:
(1) In expensive markets like SF, the mortgage interest break is a huge deal. Consider that most buyers will be in a pretty high marginal bracket, CA has obscenely high taxes, and you'll be paying a ton of mortgage interest on a $1MM+ loan.
(2) Not surprising, but your inflation/growth estimates for price vs. rent are the most important parameters. I don't think anyone could've foreseen the 10% year-over-year growth we've had for the better part of the last 5 years in rent. You just can't foresee everything in a model. (And to be perfectly honest, I can't stand the smugness of the luck-masquerading-as-skill crowd these days. Because sure, you "just knew" Google was going to be huge when you worked at some random startup back in 1998. And you "just knew" housing would go up like it has.)
(3) I really buy the "forced savings" argument. Sure, you could theoretically do better running a "lean" operation and investing, but do most people have the discipline to do it? I might, and I certainly am now, but I'm not sure. Getting locked-in with a payment you know you MUST make is a powerful psychological anchor that might change behavior around, say, buying a new car, or a vacation, vs some abstract and sort of arbitrary savings goal.
Only if you consider both the asset value plus value extracted (e.g., in the case of stocks, both market value and aggregate value of dividends.)
In the case of housing, this means that the market value plus the aggregate of the value derived from owning the homes (the utility of living in it, rents derived from it, etc.) must, in total, grow faster than inflation.
Investment: the action or process of investing money for profit or material result.
Profit: money in - money out.
You're just trading the stream of money that goes into rent for the stream of money that goes into taxes and interest on your loan.
You can't say "owning is better than renting" or vice versa without crunching the numbers for your particular situation.
When I bought my first house I was paying out more every month (by quite a bit) than I did as a renter. Then I rented for awhile and bought my current place, in which I come out ahead vs renting.
Housing prices would be a lot lower(and more affordable) were it not for all the money unnecessarily doused on it.
Because prices are so high buyers must participate in credit markets which is like socio-economic ankle weights for poor people. They either get screwed or excluded(and screwed).
EDIT: The Higher Prices also ensure that people need continue to work to "pay off" their mortgages. If housing prices weren't artificially high they'd already be "payed off" having been payed for with savings. cf: https://news.ycombinator.com/item?id=12131855
Shouldn't the value of the house asymptotically aproach zero, given long enough timeframe? I mean, at some point, like maybe in 100 years it should eventually rot and collapse. Or you can keep fixing and redecorating it, but that also costs money.
More to the point I don't think many houses have reached that point. In my casual observation new construction tends to be either not single family homes (different economics) or on undeveloped land. Teardowns are relatively rare in old neighborhoods (though additions and renovations are quite common).
It doesn't matter if the value of your home goes up, just that instead of being empty handed after 30 years of paying rent, you will have a huge financial asset.
You cannot just treat housing like a stock, since it is also a way to get good jobs and children in good schools.
Let's look at a couple numbers. Over the long term, on average, U.S. homes do not appreciate faster than inflation.
> Home prices look remarkably stable when corrected for inflation. Over the 100 years ending in 1990 — before the recent housing boom — real home prices rose only 0.2 percent a year, on average.
http://www.nytimes.com/2013/04/14/business/why-home-prices-c...
Yet, despite that, home ownership is correlated with net gains in household wealth.
> Overall, owning a home is consistently found to be associated with increases of roughly $9,000-$10,000 in net wealth for each year a home is owned. Also consistent with earlier studies, African-Americans are found to benefit less from owning a home, but each year of owning is still associated with gains in net wealth of between $6,000 and $8,000, which is substantial considering the generally low levels of wealth among African-Americans generally.
http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/hbt...
So how does this make sense?
Well first, home prices on average keep up with inflation, which is a strictly better rate of return than just holding cash. So even if just think of it as a vehicle for pure savings (wealth preservation), home ownership is better than no investment.
But you can also easily and relatively safely leverage up to buy a home. With a 20% down payment, if the home appreciates at inflation 2.5%, your actual rate of return will be 12.5% before expenses and payments!
But what about expenses and payments? Well--you have to make them anyway, even if you're renting.
But aren't mortgage payments usually more expensive than rentals? At first they might be, but with a fixed-rate mortgage, the nominal monthly payment doesn't go up. So again, inflation helps out: every year the real cost of the monthly payment declines. Good luck finding an apartment with rent control for 30 years.
Finally there are the tax advantages. Every one knows about the mortgage interest deduction, but potentially more powerful is the capital gains exemption of up to $250,000 per person.