Are Homes Even An Asset?
A Case for Homeownership In Any Market
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Money In, Or Money Out?
One of the core tenants of my financial education growing up was the delineation between an “asset” and “liability”.
Assets make you money, Liabilities take your money
In my family, and very much aligned with the definition above, we were explicitly taught that “A house is not an asset”.
The general implication of this statement was, simply, that houses take money from you. And that’s hard to argue.
In an article on the unexpected costs of home ownership, financial writer Dr. Erik Hofmeister, recounts his first home purchase.
You know what’s throwing money down the drain? Buying over $10,000 of “stuff” the first few months of owning my first house, which rapidly depreciated. Lawnmower, toolset, dining room table, new paint, hedge trimmers. It was ridiculous….
There are a lot of expenses of owning a home separate from the mortgage, taxes, and insurance. A new AC unit, a new refrigerator, dealing with flooding.
There’s always something going wrong when you own a house.
This is not to mention the mental costs associated with handymen, DIY projects, maintenance, landscaping etc.
Any home owner will tell you, it is far easier to rent than to own.
So What Is An Asset?
Assets, as far as my family was concerned, made you money month after month, year after year.
These are more commonly known as “Income Producing Assets”, but for simplicity sake we mushed the two together. A very clear example of this is the difference between buying a house to live in, and becoming a landlord to rent it out.
One makes money, one takes money. Asset, Liability.
A Change Of Heart
I would imagine that if this is the first time you’re being told that a home isn’t a good investment—or worse a liability—you might be experiencing a somewhat visceral reaction. Especially if you’re a homeowner.
That’s because home ownership is a charged topic.
Your home is where you raise your family. For most people it’s their largest purchase, and where most of their wealth is stored. It's their identity, memories, and style all rolled into one.
It's incredibly personal.
For that reason, I don't really like to talk about home ownership with friends. I generally chalk it up to, live and let live. But I've always, deep down, believed homes are a "bad" investment.
That is, until recently.
Understanding The Role Of Mortgage Rates
In order to understand home ownership, we first need to understand mortgages.
A mortgage is a special type of loan that a bank gives you for the explicit purpose of purchasing a home. As collateral, if you don't make your loan payments, the bank can "foreclose" on your house, take it for themselves, and kick you out. Remember 2008?
Most people purchase their home with a mortgage.
As with any loan, there is interest associated. In this case, we call the interest the mortgage rate. With each monthly payment, part of your money is going towards paying off the loan and part to paying off the interest.
The lower your mortgage rate, the less money you're paying the bank in interest.
Determining House Price
If you grew up in the 90’s and early 2000’s, then you remember how TV seemed to take a hard left turn towards home improvement shows. Buy, renovate, sell, repeat. The crème de la crème of course was HGTV, gamifying the homeownership experience in every which way.
Now if you've ever watched HGTV, you know that when people are “House Hunting”, the first questions they're asked is,
"What’s your price range?”
Not "What kind of architectural style are you looking for?" or "What neighborhood" or "How many bedrooms". While all of these factors may play a role later on, the initial question is always "How much money?".
You simply cannot live in your dream neighborhood, if you cant afford it. Price range comes first.
Now how do you determine price? A mortgage calculator is a great start. Google provides a really nice clean interface.
You have a few inputs you can control. The first is your loan amount, then your estimated interest rate, and finally your loan term. For the rest of this article we'll exclusively be talking about the most common term which is 30 year fixed.
So based on the calculator above, we have a monthly payment of $1000, and a mortgage value of $166,800 at a 6% interest rate!
Remember, we don't first start searching for houses then see if we can afford them. We see what we can afford, then start searching. This is an important point moving forward.
(In reality this process is iterative. People start with a maximum price they can afford, then search within that price range. Only to find out they can be squeezed for a bit more to buy their "dream home".)
The Power Of 1%
Now here is one of the major points that lead to me change my mind about home ownership.
Let's keep everything in the calculator the same, and simply reduce the interest rate by 1%.
So instead of making a monthly payment of $1000, with a 6% interest rate, we’ll make a $1000 monthly payment with a 5% interest rate.
The price of the house we can afford just jumped from about $168K to $186K.
It’s important to note, our monthly payment didn’t change at all. We still pay $1000 a month either way, the only thing that changed is how much interest we’re paying the bank.
Why Do Mortgage Rates Matter?
The lower the interest rate, the higher the price of the house you can afford with the same monthly payment.
So for instance, if you've allocated $1000 a month towards a mortgage payment, the mortgage rate can wildly effect the value of the house you can afford over a 30 year fixed term.
At 9% you can afford a house worth $124,500.
At 4% you can afford a house worth $210,000.
At 1% you can afford a house worth $312,000.
That’s a pretty big difference. What does that mean for the price of houses?
Well considering mortgage rates are public information, both the buyer of a house and the seller know when they are low, and when they are high. As we saw above, when mortgage rates are low, you can afford “much more house”.
So with falling interest rates, a house that was worth $124K can now become worth $312K, and you, the buyer, will gladly pay the higher price.
Because the difference is never realized. You keep to your budget and pay $1000 per month either way!
Historic Mortgage Rates
Let's try a quick experiment. I took the historic interest rates from 1973-2021 directly from The Federal Home Loan Mortgage Corporation. I then used that data to determine “how much house” you could afford at $1000 per month.
If you bought a house today at 1973 interest rates, and paid $1000 a month, the value of your house would be $136,000.
If you bought a house today at 2021 interest rates, and paid $1000 a month, the value of your house would be $237,000.
This shows that the interest rate that we purchase a home at, can actually determine the price of a home, and account for some pretty big swings in prices.
With the exceptionally high interest rates of 1981 at 17%, the "value" of the house you can afford would be about 70K. That same house at 3% interest would be about $220K.
Nothing changed about the house, just the rate at which you could purchase it at.
Pretty wild, right?
Your Rent Is How Much?
For the majority of U.S. history – or at least as far back as reliable information goes – housing prices have increased only slightly more than the level of inflation in the economy - Sean Ross
My grandpa, an old New York business man through and through, just celebrated his 92nd birthday. One of his favorite stories to tell me, is about how years ago, he used to sell cans of coke for a nickel on the boardwalk at Coney Island.
Today, he’ll laugh at how cars cost 50 times more than when he was growing up, and he nearly fell out of his seat when he heard how much my rent in San Francisco was.
This is classic inflation. The cost of goods and services go up a bit each year, and over a lifetime, can lead to a radically different pricing.
Inflation, as it turns out, plays an important role in this story.
My Grandpa’s House
In 1973 my grandpa bought a brand new house on the Jersey Shore. For simplicity sake, let's say his mortgage payment was equal to $1000 in 2022 dollars. Therefore his actual mortgage payment in 1973, adjusted for inflation, was $167 per month.
Now I can’t be sure what his mortgage rate was, but we can take the average from the year 1973, which was 8%, and do a bit of math.
With a payment of $167 per month, and an 8% fixed mortgage rate, the value of my grandpa’s home was $22,700.
Flash forward to 2022, at 92 years old he’s finally ready to sell the old house on the shore. The offers come rolling in, it’s a bidding frenzy, but he finally accepts an offer for $237,000.
This is the deal of a lifetime. He 10X his investment, and made $215,000 in cold hard cash!
Or did he?
What’s Going On Here?
To understand how inflation effects the price of houses in the United States we need to make use of something called the Case-Shiller Index.
This compares average real estate prices in the Unites States, vs the inflation rate. Using this index, we can determine if my grandpa did indeed make a killing on his 10X house sale!
Take a look at the graph above. Between the years 1890 and 2000, a 110 year period, the index fluctuates between 0.4 and 0.6.
What this means is, the price of homes and the inflation rate, have stayed in near lockstep for over 100 years. If one goes up, or down, the other follows. Only recently is the price of housing increasing in relation to the inflation rate.
In a 2015 interview with the Nobel Prize winning creator of the Case-Shiller Index, Morgan Housel concluded that much of the financial gains realized through home ownership are actually a mirage.
A home is typically the asset people hold the longest. They sell stocks after a few months, but keep a home for years, or decades.
When you own something for that long, the returns you think you earned can be overwhelmingly due to inflation.
The Consumer Price Index has increased six-fold since 1970. If you bought a house for $30,000 in 1970 and it's worth $180,000 today, you've earned nothing after inflation. You think you've made a fortune, but you haven't gone anywhere. Add in property taxes, insurance and repairs, and you're down.
But what about grandpa? What about his big 10X flip? Almost there.
Mortgage Rates And Inflation Combine
As a final experiment, I thought it would be interesting to take the annual inflation data, and compare that to the mortgage rate data we looked at previously.
The blue line we’re familiar with. It shows how, at different historic interest rates, you could afford homes with wildly different values, all while paying the same $1000 per month.
The green line, however, is new. It accounts for inflation.
In 1973, $167 had the same purchasing power as $1000 today.
In 1987, $412 had the same purchasing power as $1000 today.
In 2010, $790 had the same purchasing power as $1000 today.
The green line accounts for these changes. The green line, is the money line.
The important thing to understand here is that, if you buy or sell, anywhere on that green line, you’ve made zero profit. Zero.
Buy in 1984 for $32,000, and sell in 1999 for $91,000. That’s zero profit.
Buy in 1997 for $79,000, and sell in 2015 for $178,000. That’s zero profit.
And now, finally back to grandpa. He bought in 1973 for $22,700, and sold in 2021 for $237,000. Bought on the green line, sold on the green line. Zero profit.
Houses, What Are They Good For?
If you look at the history of the housing market, it hasn't been a good provider of capital gains. It is a provider of housing services - Robert Shiller
When we look at the historic value of homes, we come to the realization that they are not “investments” that are going to be appreciating in real value over time.
When comparing home ownership to that of a traditional investment, like the S&P 500, Morgan Housel reiterates that,
From 1890…through 2012, home prices adjusted for inflation literally went nowhere. Not a single dime of real growth.
For comparison, the S&P 500 increased more than 2,000-fold during that period, adjusted for inflation. And from 1890 to through 1980, real home prices actually declined by about 10%.
Houses, are first and foremost a place to live. A place to raise a family, create memories, and make your own. This is a unique feature to homeownership that is not shared with other traditional assets.
The trouble starts when we believe that the place we live in, needs to also be making us money. The fact that our homes aren’t wealth creation machines isn’t a bug in the housing market, but rather, a feature.
It simply requires a reframing.
A House As A Stable Asset
While home prices may appear to be appreciating, the reality is, we need to be comparing their value to:
The mortgage rates they can be purchased at.
The rate of inflation.
When we take these two factors into account we see virtually no growth in home value, but also, no serious decline in value either.
In an article advocating homeownership during the extremely hot housing market of 2022, Portfolio Manager at Ritholtz Wealth Management, Ben Carlson observed that,
In the past 35 years, national housing prices have only fallen twice.
This “lack of declining value” is very different from other assets like gold, stocks, bond yields and bitcoin, which regularly experience value loss.
Another intriguing property of mortgages is that, in general, your wages increase over time but your mortgage payments do not.
So if you purchased a home in 1973 for $167 per month, you’d be paying $167 until 2003! Anyone who's rent has increased $100 per month in a single year, knows how great of a deal that is.
This can be a particularly useful feature of mortgages during high inflation periods, as Nick Maggiulli explains.
If inflation stays high, the payments you make on your mortgage will shrink (in real terms) over time.
My grandparents saw this happen first hand after buying their first home in 1972 right before the high inflation of the 1970s kicked off. One decade after they bought their home and their mortgage payment had been cut in half (in real terms).
Bringing It Home
While a home may not be the best vehicle for wealth creation, it is an excellent purchase for two reasons.
The first is, maintaining the value of your money. While there will be monetary loss, due to taxation, repairs, remodels, furnishing, and maintenance, these are simply baked into the the cost of living.
Once we recognize that in real terms, homes are not appreciating in value, it seems inappropriate to classify them as an “asset”. Instead we should reframe them as a store of value with different properties than cash.
The second is that, we all need somewhere to live. While it might not be the most productive asset, homes do hold their value very well.
Even in a down market, as a homeowner, you have the optionality to recoup some of your money through a sale. While renters do not. But as long as homeownership is a net negative for us financially, I’ll have a hard time recognizing it as an asset.
When considering we’re all simultaneously fighting inflation and a need for housing, the case for home ownership on the basis of stability, rather than wealth creation, is a compelling one.
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