Saturday, March 03, 2012

GUEST POST: Houses are homes, not investments

Guest post by Vedran Vuk of Casey Research 

Recently, my parents were considering purchasing some real estate. As the financial professional in the family, they asked me, "What do you think? Will it go up in value? You know... not now, but eventually?" I've heard the same thing over and over again. In response, I shared my opinion: "Would you pay the current market price to live there even if its value never increased?" If the answer is yes, buy the property." Essentially, is the house worth it as a home, not as an investment?

In the past few decades, the concept of home ownership has been completely turned on its head. Previously, homes were considered a very long-term consumption good. Do you think anyone in the 18th, 19th, and prior centuries ever considered tripling the value of their homes by retirement time and selling them to move beachside? In the vast majority of cases, such ideas never crossed their minds.

Yet, somehow along the way, this became a reasonable investment expectation. Even today, home buyers still make their purchases with the hopes of escalating prices. But are homes really wise investments?

Consider the difference between your house and an investment such as Apple (NASDAQ: AAPL) stock. At a major company, the opportunities can be truly limitless. Apple can produce cashflows from computers, iPods, iPads, and future innovations that are just dreams and concepts today. If the local market is oversaturated, Apple has the option of spreading out all across the world. As a result, Apple's stock price has gone from $17 in 2005 to $540 today. Can your house do the same? Unless there's a hyperinflation ahead or your house is located in the New York City or London of the 21st century, the answer is no. Why? Because your house is ultimately a product--and products have an upper bound to their prices.

To understand this difference, there's no need to drag out the Case-Shiller Index or analyze complex statistics. Suppose one bought a single-family house over a decade ago for $200K. At the peak of the housing bubble, the price reached $500K; to his joy, the owner sold it and moved thereafter to retire in the Bay of Plenty. Can the house's price go higher from here? With Apple, the stock price can just keep climbing with greater profits and innovations. But is that true with real estate?

For the sake of argument, let's say that prices do keep rising. Eventually, the second owner sells to another buyer for $1 million a decade later. Guy number two also peacefully retires in bounty. Well, where does that leave the third guy? Unless real salaries make an incredible jump in the same time period, no one will be able to afford the home next. The median worker earning $51K won't be selling such a house for retirement; instead, it will take him until retirement to afford it. In many ways, this "investment" more closely resembles a Ponzi scheme. (Yes, Ponzi schemes work: for those who get in early and get out - as the recent real-estate bubble demonstrated.) Ultimately, there's an upper bound to housing prices - they can't continue rising perpetually with no end.

The same is true of any product. At $300 for the newest iPod Touch, Apple might be doing well, but at $10,000 per unit, there likely would be very few buyers. As a homeowner, you're not holding a company that can innovate, cut costs, and enter new markets. You're ultimately holding a product which must be either sold to the next user or leased to the next renter. Houses are a good created for a specific use - to put a roof over one's head. They are not magical money machines. Previous generations understood this very simple concept. One built a home as a place to live and escape the elements - and worse yet, the squalor of tenement housing. Homes were not retirement tools, but rather long-term goods.

Unfortunately, policy makers still view homes as investments and are always worried about low prices. But is it really healthy to play another round of the same Ponzi scheme? Suppose the Reserve Bank manages to inflate housing prices again. There will be another boom in which some folks will make a tremendous amount of money. Eventually, housing prices will hit an unrealistic upper bound. Again, home prices will violently drop, resulting in homeowners deeper underwater than now. Of course, the banks will again take a hit as the mortgage holders. As long as real incomes trail the rise in housing prices, there will ultimately be a correction of some sort.

So, do I think the current real estate market is just fine? No, of course not; but I don't think shocking houses prices back into a bubbly stratosphere is the solution. Ideally, I'd like to see increasing housing prices, but only at the pace of real growth in society's wealth. Over the last few decades, houses grew in value for good reasons and bad. On the good side, the economy had been expanding. On the bad side, central banks’ low-interest-rate bubble artificially inflated housing prices beyond what made sense for economies to sustain.

If US companies such as Apple are creating greater abundance in society, it makes sense for US housing prices to grow with greater wealth. But, bringing house prices higher on a wave of printed cash does not make anyone wise investors, but rather willing participants in a Ponzi scheme where someone else will be left holding the bag. Though that might be an attractive solution for those underwater on their mortgages, it's no solution for the economy as a whole--nor for the next buyer, or the next but one.

Vedran Vuk is a senior research analyst with Casey Research

Labels: ,

5 Comments:

Blogger maxx said...

Vedrun Vuk is ignoring the cash flow and concentrating only on capital gain. If I bought a house for $200,000 I could do so with a down payment and a mortgage for the balance, over 20 years or so the house would be paid off leaving the rental income less costs. If I managed to acquire three properties and the capital value of them increased not one iota, by retirement time I would have a tidy income without having to sell anything.
On the other hand I would not have been able to buy $200,000 worth of Apple shares in 2005, for a start they pay no dividend to service the debt and secondly it would have been a considerable gamble; if everyone thought that Apple was going to be so successful the 2005 price would have been considerably higher.
The housing investment is a simple way for an average person to gain a reasonable asset with low risk and doesn’t require a capital gain, the cash flow is the important part.

3/03/2012 12:47:00 pm  
Anonymous Mike Daniel said...

Ha, that is highly input of you. Whatever you wrote here about the issue of houses are homes not investments seems to me pretty worthy to read for. Thanks mate.

3/03/2012 06:54:00 pm  
Anonymous KP said...

The biggest reason for house price increases lies at Govt's door. Their constant inflation of the currency means the dollar numbers go up every eyar, adn becasue houses are so long-term people see a big difference in buy and sell figues.

Meanwhile they bring in bookloads of new laws about how to build a house, all of which force prices up. Couple that with their restriction of land use creating artificial shortages, and demand over-runs supply.

If they were forced back out of their fiat money Ponzi scheme and were not allowed to interfere with what people did on their own land, I expect we would see the common price decreases we see for all other manufactured articles.

Too bad if you bought a shipload of Commodore computer shares instead of Apple...

3/03/2012 07:33:00 pm  
Anonymous TomSachdeva said...

I think it is about time that we should learn from eastern economies where there is no free flowing credit and everybody buys a home with cash.
Even look at Canada , nothing happened to housing market because there were stringent lending rules by the banks, not like US NINJA loans( No Income no Job ) . The Americans have to rectify there spending habits.

3/04/2012 05:50:00 pm  
Blogger Heisenbug said...

I was thinking about Apple today - saw a young guy on Twitter telling everybody to buy Apple stock, they have huge upside, etc. My problem with Apple is that their market is luxury consumer goods: when the sovereign debt crisis finally hits for real their market is going to vanish so fast your eyes will bleed.

I agree, though (and have for some years) that you can't reasonably view a house as an investment. My family thought I was mad; half of them probably still do. Even considering cashflow cashflow it's still a huge loss IMHO. You've paid interest that was probably twice what the house is worth - that's enormous potential capital vanished, essentially for nothing. Maybe your tenants paid that for you; it's still money that's essentially lost to you that can't be put to some more productive use.

Then again, I'm not exactly a genius. If I were I'd be rich :)

Cheers

Richard

3/05/2012 10:46:00 pm  

Post a Comment

Respond with a polite and intelligent comment. (Both will be applauded.)

Say what you mean, and mean what you say. (Do others the courtesy of being honest.)

Please put a name to your comments. (If you're prepared to give voice, then back it up with a name.)

And don't troll. Please. (Contemplate doing something more productive with your time, and ours.)

<< Home