Rent or Own? Some thoughts on the true value of real estate

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I’m always telling people that historically speaking, real estate has never been a good investment. Now, I don’t really invest because 1) I don’t have any money and 2) I have the worst sense of timing anyway. So good investment/bad investment is generally irrelevant, but I do like to track social trends and lately, whenever I diss real estate, people get a little nervous.

There are a few reasons for this

  • It’s real estate, not like paper stocks, so it must always have some value right? Wrong! If nobody wants your house, it has no value. That thought makes people really nervous, but tell me what the value of house in Love Canal is?
  • They’ve always been told that “they aren’t making more land” so the price has to appreciate. Of course, that’s wrong too – unfortunately, we are making more land through thousands of acres of wetlands destruction, but that’s another story. Again, it’s just supply and demand.
  • People tend to see the huge gains made over the long-term of home ownership, not realizing that, in fact, stocks over the same period have historically gained twice as much value as a home. People typically fail to account for inflation, interest paid on the mortgage, taxes and other costs.

The sad fact is that for the 100 years prior to 1995, home prices basically tracked inflation. Now, that just concerns prices before subtracting debt service, taxes and so forth. Even at our historically low interest rates (now on the way up of course), debt service, the total interest paid, is typically more than the cost of the home itself on a 30-year loan. So take the price and double it. Then taxes of say 1% of purchase price per year for thirty years add 30% to the cost. Finally, of course, there is insurance and upkeep and so forth. When all of this is added up, housing tends to be a bad investment, plain and simple.

So who cares?. Unfortunately, a lot of Americans who have been told that home ownership is the path to the good life. This dream is a compelling lie that consumers tell themselves, encouraged by marketers, that is realtors and mortgage officers. The story sounds so good and makes so much sense, that people don’t crunch the numbers, they instead convince themselves of the lie. Check out Seth Godin’s book All Marketers Are Liars: The Power of Telling Authentic Stories in a Low-Trust World for an interesting perspective from one of today’s most famous marketers for a bit more on this phenomenon (BTW, I just finished reading it and would describe the book as thought-provoking and worth reading, but not on my “must read” list).

This has had the ill effect of encouraging people to spend based on the perceived value of their house and had driven consumer spending and, here’s where we get to the nasty part, consumer debt for all the stupid stuff that we don’t really need: 3000 square foot homes, widescreen tvs and luxury SUVs. In fact, I would say that homeownership myth is a major contributor to global warming as it fuels spending beyond our means, in particular by building mammoth, energy-intensive homes that take huge amounts of energy to build (concrete, for example, takes huge amounts of energy and those mammoth foundations don’t come cheap from a CO2 point of view) as well as to run (unless you are among the 0.01% of people building net-zero homes, that McMansion takes energy to heat and cool and illuminate).

Anyway, all of this is a long-winded way of saying that the current meltdown in the housing market is basically a result of the same thing that resulted in the stock market meltdown. Namely, people fail to look at things in the long term and believe the rules have been rewritten.

Hopefully the current meltdown in the mortgage market will make people a little more rational. Will it keep people from owning their own house? Yes. Is that a bad thing? Not necessarily. In a market where homes can’t be sold, it should be an excellent time for great deals on rent. If the money saved by not owning a home gets put into a good international index fund, that’s probably better than putting it into a house anyway.

Of course, getting investment advice from me is like getting advice on scrupulous adherence to the Bill of Rights from Alberto Gonzales.

If Seth Godin’s book isn’t a must read, Dean Baker’s recent report on the Housing Meltdown is.

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