I’m puzzled by Daniel Inviglio and Felix Salmon’s war on housing investment. Felix argues that:
“Some people are looking to buy a home — that’s understandable, given that everybody needs shelter. And some people are looking to invest money with a long-term time horizon. And some people even fall into both categories at once. But that’s no reason to desperately try to conflate the two, and to describe yourself as being ‘in the market for a home as a long-term investment’…. homes aren’t investments, they’re places to live. If you can buy a nice house for less than you’d otherwise pay in rent, then go ahead and buy — no matter what the market looks like, or where mortgage rates are. On the other hand, if you’re looking for an “investment”, stick to securities. You can sell those much more easily when you need some money, and they won’t drive you into possible bankruptcy and homelessness if they go down rather than up.”
Felix is arguing that housing should only be considered a consumption good, and you should only be willing to pay the net present value of the future stream expected rents. In fairness, Daniel at least concedes that housing is inherently an investment, whether you want to speculate or not. He does, however, ultimately agree with Felix that “If you’re looking to use capital in order to speculate on an investment to maximize return, then by all means do not buy a house now or ever”. Both seem to be suggesting that securities or other investments are perfect substitutes for housing investment, and even more than that they’re arguing that securities are always better investments. There are several reasons why housing as an investment is different than securities in a way that makes it an optimal investment for some people.
I should note that I’m not arguing that now is the time to buy, or that I would even know when that was. I am simply arguing that sometimes owner-occupied housing investment is optimal as an investment and as consumption.
It is also important to note that many of the benefits of housing investment given below are actually driven by the fact that you live your house, which means a lot of the investment benefit of buying a home is inseperable from living in it. Contra Felix, there is definitely good reason for some people to conflate the consumption of and investment in housing.
1: Leverage – Securities are not a perfect substitute for housing investment because two 20-somethings with steady jobs and good credit scores can’t get a 80% LTV loan for $200,000 to buy stocks and bonds. You can, get that loan to buy an owner-occupied house. The reason you can borrow heavily to invest in a house and not securities is that you live in the house, and so banks have a greater confidance you will pay them back. You can make a hugely leveraged bet on a housing investment that you can’t on securities. This alone makes housing investments very different than securities.
2: Diversity – Housing markets are very local in a way that securities are not. As this paper by Bosch, Morris, and Wyatt shows, housing can be an optimal investment if it’s covariance with the rest of your portfolio is low. There’s no security that allows you to invest in a neighborhood like a house does, and diversify your portfolio in the same way as investing in a home.
3: Rental Price Risk – Buying a home allows you to insure against rental price increases and volatility. Say you live in a neighborhood that you believe is going to clean up, crime will go down, housing stock will improve, and rent is going to go from $500 a month now to $1,000 in three years and then grow at 8% a year perpetually. Investing in a house allows you to insure against having to pay that higher rental price in a way that rental markets may not. Long-term leases may be available, but they may not.
4: Local Markets – When you speculate in the market for securities your investing in a highly liquid, highly global market where your ability to “spot a deal” that the market hasn’t is slim to none. Housing markets are extremely local; block by block even. It’s much easier to spot a trend that others haven’t, and have local knowledge that others don’t, when the relevent market is your neighborhood. The idea that you’re better at predicting future prices on your block than all your neighbors, and even all the rubes in your town, is a lot easier to believe than it is to believe you’re better than the market at predicting the future path of G.M. stock. Your knowledge of local markets may also allow you to make improvements to your asset to increase it’s value in a way that matches the local tastes. This might even be a skill of yours. You can’t make improvements to GM stock.
Overall, a housing investment is more like buying a small business than it is like a security investment. In fact, it is buying a small business; the business is being your own landlord. Being a landlord is more likely to be a profitable venture if you have reliable renters who you can trust. As a landlord, you’re the best renter you could ever want, which makes being your own landlord less risky than being someone elses landlord. This is because being your own landlord solves the principal agent problem inherent in the rental relationship; the owner/renter interests are exactly aligned.
These are all things you can’t get in a security, and reasons why the consumption of and investment in housing should be conflated. If someone sees Felix Salmon and Daniel Inviglio buying up dozens of homes in the D.C. area let me know. Then we will know why they are discouraging owner-occupied housing investments; the soon to be launched Inviglio-Salmon Realty, Inc. Until then, I am puzzled by their war on housing investment.
[UPDATE: Fixed link to paper, but still can't find an ungated version. If anyone knows of one let me know.]
15 comments
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Tuesday ~ December 8th, 2009 at 1:47 pm
Nick Rowe
Good post. I especially like the way you cover the principal-agent problem.
I had my own crack at this same question:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/06/investment-in-housing.html
I think the key thing that bothers people about talking about housing as investment is that it is also a commitment to purchase a consumption stream. So if you move out of your parents’ basement and buy a house, for example, you have made an investment, but have also decided to consume the “dividends” from that investment.
Here is another idea I got from Felix Salmon: we are born with a short position in housing (because we need somewhere to live), and someone who buys a house isn’t so much making an investment (taking a long position in housing) as they are covering that short position. This is another way of looking at your point 3, insuring against future rent fluctuations. http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/07/we-are-born-with-a-short-position-in-housing.html
Tuesday ~ December 8th, 2009 at 5:27 pm
geaugailluminati
what other investment might need an occassional roof or furnace replacement, or periodic painting, or a weekly mowing of the lawn?
Tuesday ~ December 8th, 2009 at 6:54 pm
steve
Let’s see about those points:
1) Leverage. Yes, you can get a big loan and pay massive amounts of interest (only 30% or so that is deductable) on your investment. Each month when you see that $15 going to the balance, you can really be proud of your investment smarts. Better hope for another housing bubble.
2) Diversity. You still have to buy in the cheap place, wait for the bubble to bring it up, then sell and move to another cheap place to start over. If you miss out on that timing, you are out of luck. It is just too bad if you like where you live now, you only make money when you sell and go to some cheaper place that is likely to be less desirable to live in. Kind of sad to always be leaving the place when/if it gets nice.
3) Rental price risk. Lots of numbers there, all have to somehow be coming together on your side with you making the correct choice to cash in and move to a worse location. See #2.
4) Local markets. Well, that is nice to be able to speculate in a smaller area, it does reduce your speculation costs, but you assume that the local real estate agent is dumber than you. That certainly may apply for many of them, but it does not take a lot of smart ones to deal you out of the bargains. Most folks don’t have the inside knowledge. Check out how many real estate agents have rental homes on the side. This is a real investment, but you don’t live there.
Basically your house is an investment when it sends you a check each month the covers all the time and expenses and gives you a profit. Mine does not. Even now that I have it paid off, I still have taxes, insurance, repairs, maintenance, etc that end up costing me about the cost of a decent studio rental in my town. Of course I have more space, but as my own landlord I have a job to do rather than being just another one of those goof-off tenants. Now if I was a slumlord, I might be able to make enough off myself to really profit…
Tuesday ~ December 8th, 2009 at 6:56 pm
MyName
@geugailluminati:
I think he answered that in his article: an investment to buy a small business, or being a landlord of some sort.
Wednesday ~ December 9th, 2009 at 12:03 pm
John
One successful small real estate investor I know who has been dabbling for 40 years and now owns probably 25 small individual or multi family buildings states this as his reason for choosing real estate rather than securities. In a nutshell the securities market is rigged in favor of insiders who skim off the cream and leave the typical small investor with the crumbs if he’s lucky. Of course the real estate market is vulnerable to the same inside plays but they are much more easily avoidable unlike securities where they are essentially invisible. Otherwise all the same rules apply: buy low, positive cashflow from the get go, sensible leverage, economical improvements, the right tenants etc etc . My friend when he tots up his book (and he literally does keep a book) claims an averaged 40 year return on his portfolio of around 16%.
Wednesday ~ December 9th, 2009 at 6:22 pm
A House Is Not A Home, It’s An Investment « Around The Sphere
[...] Adam Ozimek: Felix is arguing that housing should only be considered a consumption good, and you should only be willing to pay the net present value of the future stream expected rents. In fairness, Daniel at least concedes that housing is inherently an investment, whether you want to speculate or not. He does, however, ultimately agree with Felix that “If you’re looking to use capital in order to speculate on an investment to maximize return, then by all means do not buy a house now or ever”. Both seem to be suggesting that securities or other investments are perfect substitutes for housing investment, and even more than that they’re arguing that securities are always better investments. There are several reasons why housing as an investment is different than securities in a way that makes it an optimal investment for some people. [...]
Wednesday ~ December 9th, 2009 at 9:36 pm
Do You Have To Move To Detroit To Gain From Rising Home Prices? « Modeled Behavior
[...] by Adam Ozimek Felix provides some counterarguments, and a dash of -probably deserved- snark, to my defense of housing investment. I’ll try and respond, sans snark but with [...]
Thursday ~ December 10th, 2009 at 9:49 am
Housing Can Indeed Be a Good Investment | Reaction Radio
[...] provides some counterarguments, and a dash of -probably deserved- snark, to my defense of housing investment. I’ll try and respond, sans snark but with [...]
Thursday ~ December 10th, 2009 at 10:11 am
winstongator
This question should be looked at from a different angle, and in relation to my biggest question about the housing bubble – why the geographic dependence? My theory is the prevalence of property speculators/investors/vacation home buyers – whatever you want to call them. They ‘invested’ where property looked to be the best ‘investment’ – FL, CA, NV, AZ, and then ski type places in Idaho & Utah (look at some of the smaller failed banks in those regions). What drove a lot of this was the lax enforcement of tougher loan standards for non-owner occupied homes. People were buying 2nd, 3rd, 5th homes with 0-10% down. Then using pay-option arms giving a pay rate of 2%, when for a 2nd+ prop should have been in the 8% ballpark. Add 20% appreciation to your first ‘investment’, you can cash out and triple down!
The areas that were seen as the best ‘investments’ turned out to be the worst places to invest. This fact alone should sound alarm for those advocating housing as an investment.
Thursday ~ December 10th, 2009 at 3:03 pm
A home is a home - Economics -
[...] SALMON and Adam Ozimek have been having a debate over whether homes should be thought of as investments. This, to me, is a fairly easy question. [...]
Thursday ~ December 10th, 2009 at 3:24 pm
Questionable Investment Ideas « Rortybomb
[...] appreciate Adam Ozimek’s defense, and his rebuttal to Felix’s critique but this gives it away: “Say you live in a [...]
Friday ~ December 11th, 2009 at 9:56 am
Tom if FL
I don’t think of houses as investments. You have to live in a house. You might sell a house for a profit but most likely you’ll be back on the market looking for another house that has also appreciated, unlike stocks where you have sector rotation. Now you could sell a house in an expensive market and buy another house in an inexpensive/beaten down market and hope for some kind of arbitrage but this is more speculation than investment. In my opinion, unless you are a landlord using other peoples money to pay down a mortgage, and writing off the depreciation, you aren’t really a real estate investor. Bottom line to me, is if you have enough money for a deposit, don’t plan on moving for 10 years, and your mortgage payment is less than comparable rents, home ownership is probably a good idea. Then one year you’ll need a new roof, windows, etc and then you’ll think it’s not such a good idea.
Friday ~ December 11th, 2009 at 12:38 pm
K and J Investigations and Case Management » Chasing Myths: “A Home is a Home.”
[...] of no return. Here is an excerpt from the article: FELIX SALMON and Adam Ozimek have been having a debate over whether homes should be thought of as investments. This, to me, is a fairly easy question. [...]
Friday ~ December 11th, 2009 at 12:59 pm
najdorf
To point #3/#4: as someone living in a Brooklyn neighborhood that would have been a great place to speculate on housing prices increasing since the 70s, it would be easy for me to say that you’re right – I certainly wished I owned a home bigger than where I rent at past prices. But I don’t believe that a meaningful number of people can reliably identify these opportunities, because too much of a home’s value is outside of rational or individual control.
The best bargains in housing are buying in a neighborhood with boards over half the windows and drug dealers hanging out on the corners, which will gentrify in the future due to some intangible yuppie appeal lurking below the filth. How can an individual predict whether a bunch of other individuals will come buy in this neighborhood? How can an individual predict the sort of socioeconomic changes that will induce the drug dealers to move to a different neighborhood or at least be kind enough to bring their business indoors and refrain from shooting one another? Sure, some people will call it right, because like stocks, someone has to own all the housing stock in the country. Lots of other people will buy too high and lose, buy reasonably but not make much profit, or buy in a neighborhood with good bones too soon and realize that they don’t want to tolerate the hassles of living there and maintaining a dilapidated property while surrounded by neighbors who don’t care.
An example of what I mean is all the new condo developments in marginal Brooklyn neighborhoods. These are some of the worst projects you’ll ever see – poorly-constructed, inconsistent with the architecture of their neighborhoods, over-leveraged, and inaccessible to the kind of buyers who actually want to live in these neighborhoods. But the people who built them or bought the few units that have sold thought they were doing exactly what you suggested – making a highly-leveraged bet on currently cheap neighborhoods that were likely to rise in value in the future.
I would love it if owning a house were a good investment for the typical person in my situation – I hate paying rent, love investing, and intend to live in a house. I suppose you’re right that there are some circumstances in which investing in a house is a good investment, but the big factor you left out entirely is PRICE. If the house is cheap enough relative to renting/income, of course it’s a good deal. When you look at today’s housing market, you have to acknowledge that cheap houses are only available in places where there are good reasons for housing to be cheap – far from jobs, bad houses, bad neighborhoods, etc. In most places where a reasonable person would want to live, housing prices are high relative to income and rents. Until you get enough of a shock to drive idiots out of the market and get prices still lower, housing will only be a valid investment for speculators and specialists. You need to hear the average person saying “Housing is a bad investment and I won’t touch it” – then it may be time to lever up. On the other hand, as others have pointed out, in order to profit you have to wait until idiots want to buy houses again and then move out of your nicely gentrified home to sell to them. All in all this seems like a pretty conditional investment plan that’s unlikely to be realized in the world.
Wednesday ~ February 3rd, 2010 at 10:42 pm
The Housing Investment Hornets’ Nest « Modeled Behavior
[...] to go and stir up the “are homes investments?” hornets nest again. In order to avoid a 10,000 word debate with Felix Salmon, I’ll try to keep this brief and [...]