Publication: Investor's Notebook
UNDERSTANDING YOUR HOME AS AN INVESTMENT | |
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Investor's Insight - Monday, January 9, 2006
"A Digest of Investment Opinion From the
World's Leading Financial Advisers"
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UNDERSTANDING YOUR HOME AS AN INVESTMENT
by Scott Burns
Take a few deep breaths.
Big improvement on hyperventilating, isn't it?
Well, what we're going to do for the next few minutes is
take deep breaths about homeownership instead of hypervent-
ilating about housing prices. The difference is important.
Your house is where you live. It's more than a price.
Failing to make that distinction -- between your house as
where you live and as a price -- is one of the reasons so
many people are worried about a housing bubble, etc. It's
also the reason some financial advisers (or salespeople)
are telling us that the return on home equity is zero and
we should borrow against our equity to make it "productive."
That's junk economics.
Here are the four realities that make homeownership a good
thing.
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Homeownership is the key to building wealth. This is true
all over the planet, not just in Boston and San Francisco.
Peruvian economist Hernando de Soto found that owning a
home was the single most important step toward maintaining
a good standard of living and stability. In countries where
homeownership is less common than the United States, the
distribution of wealth tends to be more highly concentrated.
If you examine the consumer balance sheet in the Federal
Reserve flow of funds figures, you'll find that individual
homes always play a large role in consumer net worth. Sim-
ilarly, if you examine the sources of wealth for most house-
holds in the survey of consumer finance, you'll find that
home equity is the single largest contributor to net worth
for all but the wealthiest households.
The economic return of homeownership is high. A home pro-
vides two kinds of return. First, it provides us with shel-
ter services. If we didn't own the house, we would be rent-
ing it or other shelter. Over time, the value of those
shelter services is likely to rise, just as rents are likely
to rise.
Second, a home may also appreciate in value. Add the two
forms of return, and you have the total return of home-
ownership.
Over the last 25 years, homes across the country have app-
reciated at a compound annual rate just over 5 percent,
rising 273 percent. Add 4 percent to 6 percent (of market
value) as a shelter services return -- what economists
call imputed income -- and you have a total return of 9
percent to 11 percent, tax-free. That's in the same ball-
park as the 13.5 percent pretax total return on common
stocks during the same period.
And that's just the national average result. As everyone
knows, residents of some areas did fabulously better than
residents of other areas.
Mortgage financing isn't part of the economic return. Note
that I haven't mentioned mortgages. The economic return
you get from owning a house is independent of whether it
is financed. All the advice about what you should do with
your home equity is about investment arbitrage and debt
leverage. It assumes that you can earn a higher return on
the money you borrow by investing it somewhere else. Whe-
ther your home is debt-free or mortgaged, you will enjoy
the economic return of the home -- shelter services and
appreciation. Whether your alternative investment will
earn more than your mortgage costs in interest and cash
flow is uncertain.
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The return on homeownership is tax-free. One of the reasons
homeownership is such a good investment is that the return
is not taxed. The shelter services we receive are not in
cash, so they are never counted as part of our income. And
price appreciation has been tax-deferrable. Today, it is
tax-free for all but the most expensive homes.
As a consequence, I believe the long-term return on convent-
ional homeownership will continue to be among the best re-
turns we can get -- if we are ordinary long-term homeowners
who enjoy the shelter services of a primary (or secondary)
home.
Are there exceptions?
You bet. If you borrow as much as possible and throw away
the service return by not living in your house, you've got
a problem. Why? Because you're betting that future apprec-
iation, alone, will pay your mortgages.
That's a very different -- and much riskier -- bet.
(Investor's Insight reflects the opinions of experts. It does
not recommend any specific investments, and no endorsement is
implied or should be inferred. For more information, contact
the individual firms cited).
COPYRIGHT 2005 UNIVERSAL PRESS SYNDICATE
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