Some time ago there was a blogospheric debate about whether a house should be considered an investment. I contended that almost necessarily it has a large investment component, and should be thought of as such. In addition, for many people -although I don’t know how many- housing can be a good investment. Felix Salmon and Ryan Avent disagreed, with Ryan arguing housing was an investment, but rarely a good one, and Felix arguing that it was not an investment at all. Today, esteemed economist Karl E. Case of Case/Shiller fame weighs in on the housing as an investment debate:
But for people with a more realistic version of the American dream, buying a house now can make a lot of sense. Think of it as an investment. The return or yield on that investment comes in two forms. First, it provides what is called “net imputed rent from owner-occupied housing.” You live in the house and so it provides you with a real flow of valuable services. This part of the yield is counted as part of national income by the Commerce Department. It is the equivalent of about a 6 percent return on your investment after maintenance and repair, and it is constant over time in real terms. Consider it this way: when Enron went belly up, shareholders ended up with nothing, but when the housing market drops, homeowners still have a house. And this benefit is tax-free…
…This financial crisis has made us all too aware that we live in a Catch-22 world: the performance of the housing market drives the economy, and the performance of the economy drives the housing market. But housing has perhaps never been a better bargain, and sooner or later buyers will regain faith, inventories will shrink to reasonable levels, prices will rise and we’ll even start building again. The American dream is not dead — it’s just taking a well-deserved rest.
Karl wants you to think of housing as an investment, and he wants you to invest. I’ll agree with him on the first point, and remain agnostic on the second.
He also makes an important point about how housing lacks any true fundamentals like financial investments do:
Real estate sales are unlike other financial transactions. You can place a rough inherent value on a stock or bond by looking at fundamentals: a company’s profits, price-to-earnings ratios, quality of its products and management, and so forth. But a house is worth what someone is willing to pay for it. That’s a very personal, emotional decision….
This lack of solid fundamentals is an important problem with identifying housing bubbles. It is entirely possible for there to be an exogenous increase in the preference for home ownership that will drive up the prices of housing, as well as the price to rent ratio. Capitalization rates, which determine how an individual translates a flow of housing services into a house price, differ among individuals. Demographics can shift in ways that will affect cap rates, for instance average income or age can increase, but so too can the raw preference for home ownership. So house prices went up 15% while rental rates remained constant; what just happened? Is this irrational speculation, or did preferences for home ownership increase?
UPDATE: Felix does some real reporting and gets Case on the phone. I am apparently interpreting his use of “investment” too literally.
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Thursday ~ September 2nd, 2010 at 9:49 am
Lord
Not quite tax free. Property taxes are close equivalents to taxes on those services.
Bubbles due to preferences are of little concern. Show me a bubble in income to support increased debt service, and I would be astounded.
Thursday ~ September 2nd, 2010 at 9:56 am
blokeinfrance
Trust you guys to make it complicated! Not being an economist, I thought that having a roof today is a bit more fundamental that having the promise of a stream of income in 30 years time. Fundamental value must also be a bit easier to measure than stock values. To decide whether to buy a house, compare purchase cost with the cost of renting (both measured today). To decide whether to buy a stock, estimate the future stream of earnings discounted by all other investors’ estimates of future earnings… In other words, a stock’s value depends on other people’s perception (which you don’t know) and the future (which you can’t know).
Once in your house, it does (sort of) become an investment, because it requires maintainance (roughly 1.5 to 2% of capital value p.a.?) which is a sort of compulsory pension contribution paid out of taxed income…
Friday ~ September 3rd, 2010 at 10:07 am
rturpin
Yes, after the financial collapse, people who own a house outright still have it. But do they still want to be where their house is? I suspect not, for those who owned a house in an exurban development, most of whose houses are underwater, far from work opportunities and amenities. There are a lot of places that were valued, wrongly, on the notion that such places would be valued more in the future, despite lack of any locality to something that gives the place value. I encourage anyone thinking to buy a house to spend an afternoon thusly. Walk out its front door, and meander for a about a half-mile circle around the prospective house. Is that possible? Is it pleasurable? Count the creeks and beaches, parks and sidewalks, groceries and bars, laundries and drugstores, banks and businesses. Subtract the highways.
A house in the middle of nowhere is still in the middle of nowhere.