Deadman's picture

    How The American Dream helped create this American nightmare ....

    You hear a lot of conservatives nowadays wanting to place blame for the country's current economic crisis on the Community Reinvestment Act of 1977, which encouraged commercial banks to lend money to borrowers in low-income areas.

    The implication is that the CRA, enacted and significantly expanded under two different Democratic administrations, led to the creation and proliferation of the risky subprime mortgages that have brought the U.S. banking system to the brink of collapse.

    Never mind the fact that CRA-regulated commercial banks originated less than half the total subprime mortgages or that at least as much share of the blame for how things got out of hand has to be placed on the Republican-led repeal of the Glass-Steagall Act, which allowed investment banks and other less regulated institutions to engage in similarly risky lending (and to do so without the leverage restrictions placed on commercial banks).

    But conservatives do have a point (even if it's not the one they really intend to make): This country's myopic focus on home ownership as the be-all and end-all of The American Dream did indeed help spawn the housing and credit bubble, and the CRA is just another in a long list of government policies that have encouraged home ownership as an important component of economic development and societal stability.

    OK, maybe I'm just a bitter renter who's trying to justify his lifestyle and puny net worth, but I do wonder ... is home ownership really that important?

    The National Association of Realtors certainly thinks so, and some of their rationale makes sense. For society as a whole, home ownership may in fact offer some advantages, as people who buy their homes are more likely to be invested in their communities and neighborhoods than renters. However, I would think these benefits have diminished over time as the nation has developed and become more settled.

    Encouraging broad home ownership probably also acts as an alternative means of reducing income inequality in a capitalist economy, and at the same time instills in citizens the importance of private property rights, both of which lead to increased stability in our society. Given that our national savings rate is negative, home ownership also encourages people to invest and save funds they might otherwise not.

    But that capital comes at a cost, an opportunity cost. Homes are static entities, non-productive investments. By themselves, homes don't create anything of tangible value.

    And homes are not particularly good investments, either. Robert Shiller did a hundred-year study and found that homes increased in value about 3% a year on average, not much more than the rate of inflation, with only a couple of temporary periods of dramatic outperformance.

    Another study by two professors, Roger Ibbotson and Jack Clark Francis, found that housing increased in value about 8.6% a year from 1978 to 2004. Not bad, but not as good as commercial real estate at 9.5% and well behind stocks at 13.4%. (Granted, you can't live in a stock).

    The math gets a bit better when you account for the substitution costs of renting, but a lot worse when you include the other costs associated with home ownership - and there are plenty of them, such as mortgage interest, insurance, upkeep, refurbishing and property taxes. The WSJ estimated that a $300,000 house could end up costing an owner more than $1 million over 30 years. And that excludes the costs of buying and selling a home, which can add up to as much as 10% of the transaction value and make moving to a location that better suits one's needs or skills a much more expensive prospect than it'd otherwise be.

    A good trader friend of mine, who used to live in a rented NYC apartment, described his St. Louis home as a 'money pit' and usually wishes he was still renting.

    Unlike with stocks, where diversification is possible and laudable, owning a home often requires a person putting almost of his or her eggs in one basket. And if you bought a home in the last couple of years, that's a much smaller basket now.

    Bottom line: Obviously, every locality is a bit different, but I think owning a home can make sense for people who plan on staying in the same place for about 5-10 years, or who enjoy the responsibilities of upkeep and maintenance (I, however, recoil at the prospect of lawn mowing and do-it-yourself repair projects).

    But even in the best of scenarios, home ownership is rarely the best path to getting rich. And as we've found out in recent months, making it a key goal for a society - at the expense of other worthwhile goals and values - can lead to a rather unwise deployment of capital and some really nasty unintended consequences.

    Comments

    Interesting post. Buying in New York has always seems especially problematic to me b/c of maintenance costs and taxes. Furthermore, during the last decade, apartment prices have outpaced rent increases to the point that if you buy a new apartment with say 20% down and then rent it out, you take a substantial loss, suggesting that housing prices are out of whack here.

    But one point that your post misses. Over time, an owner's interest payments go down, whereas rents go up. After 30 years, you have the real estate asset and no costs mortgage costs. A renter who invested instead of buying may have more valuable stock assets, but he's still paying rent that has increased faster than inflation. Let's say I buy a studio for $300K which I could rent for $2K/mo. Let's go with the WSJ's estimate that buying a $300K place costs $1M over 30 years. In 30 years, if rents keep pace with the 8.6% annual real estate increase, you'll be paying $23K/mo, and you will have paid $3M in rent over the whole period. And of course after that, the mortgage is paid off, and the relative saving from buying continues to go up.

    Another way to think about it is to treat the amount you save on rent as income. As a simple investment, stocks outpace real estate, and real estate has more costs. But even if you take a loss for the first few years, the "income" ultimately covers the costs plust the investment differential. You're essentially a residential real estate investor, but you get a big tax break and don't have pay management costs for tenants.


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