by Morgan Housel
I've come to believe that for millions of Americans, a house is a large liability masquerading as a safe asset.
Not just because of the recent housing crash -- although what an eye-opener that was --but because after watching real estate implode last decade, the average American still believes their home will make a great long-term investment. The best long-term investment, even.
As my colleague David Hanson wrote last week, a recent Gallup poll shows that Americans now believe housing is the best long-term investment, beating out stocks, bonds, and gold.
They might be right, only because the average stock investor does so poorly that a home may indeed be their best investment. But housing has historically been a terrible bet for people who think it will return more than inflation. To show you what I mean, I have to tell you about my visit to Yale economist Robert Shiller's office a year ago.
Shiller -- who won the Nobel Prize last year -- is regarded as the world's foremost housing expert. He has married historical data with deep insight into human psychology to offer some of the best housing analysis anyone's ever produced.
Not only is Shiller brilliant, but he's one of the nicest guys I've ever met; he is easy to talk to and puts things in clear, easy-to-understand language. As we sat in his office eating donuts and drinking coffee, I asked him, in the broadest terms I could, what homeowners should expect out of their homes in the long run.
"The housing boom in the early 2000s was driven by a sense that housing is a wonderful investment. It was not informed by good history," he said. Most people now agree on that much.
"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," he explained.
By that, he means a home gives you a place to live, a place to sleep, a place to store your stuff.
But that's it. Americans believed -- and still believe -- that the value of their home will increase above the rate of inflation.
And that, Shiller says, is wrong.
"Capital gains have not even been positive. From 1890 to 1990, real inflation-corrected home prices were virtually unchanged."
Shiller -- a pioneer of behavioral finance and one of the calmest, levelheaded economists I know -- becomes animated at this point, almost irritated. Debunking the notion that housing is a great investment is one of his favorite topics.
Housing prices, he argues, could decline over long periods of time -- decades, even.
"Why is that?" he asks me. I really don't know.
"Well, I think you have to reflect on the fact that it's done it before. Home prices declined for the first half of the 20th century [adjusted for inflation]. Economists discussed that back then. Why are they going down? The conclusion was... of course home prices go down. There's technical progress. They are a manufactured good. Back in 1900, homes were handmade, you know, craftsmen. But now, in 1950, we can get all kinds of power tools and prefab. And [construction workers] were just better in 1950 than we were in 1900. So of course prices will go down."
Shiller also mentions that certain homes go out of style over time, dragging down prices. "What kind of houses will they be building in 20 years?" he wonders aloud. "They may have lots of new amenities. They will be computerized or something in some way that we can't anticipate now. So people won't want these old homes."
His animation peaked with a line I'll never forget.
"To me, the idea that buying a home is such a great idea is just wrong. They may very well decline for the next 30 years in real terms."
Real home prices may decline for the next 30 years.
The best thing about Shiller, and what sets him apart from your typical pundit, is that he has data to back up every point he makes.
In the early 2000s, Shiller wanted to see what nationwide home prices looked like over the long term. He was shocked to learn that no one had ever actually put that data together.
He dug around in libraries, crunched the numbers, and came up with an index that measured nationwide home prices going back to the 1890s.
This was a first. "The strange thing is, nobody else had ever made a plot like that. I can tell you, no one had ever seen that picture," he told me, shaking his head in disbelief. "People plot all kinds of data. Why wouldn't someone have done that? I still haven't figured it out."
The chart, measuring nationwide home prices adjusted for inflation, was this one:
From 1890 -- just three decades after the Civil War -- 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%.
The reason Shiller warns that home prices could fall going forward is the simple observation that, heck, they've done it in the past. It's what history tells us to expect out of our homes. The entire idea that home prices increase in real terms over time is a figment of the 2000s housing bubble.
It's important to reiterate what a home does do: It provides a place to live. A place to raise your kids. A place to spend the holidays with your family. A place to barbecue with your neighbors. Even a place to rent out. That has tremendous value, of course. Shiller owns a home. He'd buy another if he needed one. "Basically, if I were in the market right now because I wanted a house, I would buy a house," he said.
The problem is that Americans expect more out of their homes than just a place to live. In 2010 -- years after the housing bubble burst -- Shiller's surveys showed Americans still expected their home to appreciate by more than 6 percent a year over the following decade. If history is any guide, that's probably about twice as fast as they'll actually appreciate by. Despite the housing crash, people still expect stock-like returns out of their homes.
Since a home is most Americans' largest asset, you can see how this becomes a problem. When you have inflated expectations about the largest asset you own, you walk down the path of financial disappointment. The value of American homes fell by nearly $7 trillion from 2007 to 2011. People who thought their homes would return enough to pay for retirement learned that Mr. Market carries a sledgehammer and takes no prisoners.
Everyone should live in a home they can afford and provides the lifestyle they desire. But assuming it's a superior long-term investment, one to rival stocks, is dangerous. There's just no evidence backing it up.
I think people run into two problems when thinking about the value of their house.
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.
Yes, you got to live in the house. That's huge. But it doesn't make living free. If you have a mortgage, you're paying interest. If you own outright, or have a lot of equity, there's an opportunity cost of having money tied up in an asset that barely keeps up with inflation when you could have had it in something else, like stocks. Say you and I both have $250,000. I buy a house for $250,000 cash, and you rent a house across the street for $1,000 a month and put $250,000 in the S&P 500. After 20 years, I'll have a house worth $200,000 in real terms, and you'll have a portfolio of stocks worth $330,000 adjusted for inflation (assuming the market's average real rate of return, and a 2 percent inflation rate on my rent payments). The difference between those two amounts is the opportunity cost of owning a house (and I didn't even include taxes, repairs, or insurance). In reality, it's hard to rent the same house for 20 years straight, and a lot of regions don't offer attractive rentals at all, so this probably isn't feasible. But it shows that the decision to own can be more about lifestyle and stability, not financial returns.
So, by all means, own a home. Just keep your expectations in check.
Building permits/total housing units: 0.15% Decline in building permits 2005-2011: -60.29% (11th smallest) Building permits 2011 YTD: 8,136 Total housing units: 5,567,315 At the beginning of 2011, a number of new, restrictive building codes went into effect in Pennsylvania. This caused a rush among builders to secure permits, with housing permits increasing a massive 117.8% between November and December 2010, according to the Philadelphia Federal Reserve. The state's housing market has not been doing well since. Permits issued from January to June 2011 fell 16% compared to the same six-month period one year earlier. The national average for permits issued in the first six months of 2011 compared to the first six months of 2011 is a decrease of 6%. Read more at 24/7 Wall St.
Building permits/total housing units: 0.14% Decline in building permits 2005-2011: Building permits 2011 YTD: -77.09% (11th largest) Total housing units: 721,830 Maine has seen one of the largest decreases in building permits in the past six years. This is unsurprising as home sales in general declined substantially. Home sales for June 2011 decreased 21.39% from June 2010, according to the Maine Association of Realtors. The state's median sales price also decreased 1.37% over this same period. According to numbers from the Census Bureau, Maine has the highest vacancy rate in the country, reaching 22.8% in 2010. However, this number also includes empty vacation houses. Read more at 24/7 Wall St.
Building permits/total housing units: 0.14% Decline in building permits 2005-2011: -61.85% (12th smallest) Building permits 2011 YTD: 11,033 Total housing units: 8,108,103 New York State's housing market is among the largest in the country. As a result, the number of permits is minuscule when compared to the state's total housing units. Although new home sales decreased in the first half of 2011 from 2010, the number of permits actually increased slightly during that period, from 10,189 in 2010. This is significantly lower than 2005's 28,921 permits. Read more at 24/7 Wall St.
Building permits/total housing units: 0.12% Decline in building permits 2005-2011: 69.55% (24th smallest) Building permits 2011 YTD: 3,402 Total housing units: 2,808,254 Despite having a healthy economy compared to much of the country, Massachusetts' housing market is beginning to face serious troubles. In June 2011, sales of single-family homes in the state decreased 23.5% from the year before, reaching the lowest level since 1991, according to the Warren Group, a New England real estate research firm. With so few home sales, it follows that not many new homes are being built. Year-to-date, building permits for 2011 are about one quarter of what they were in 2005. Read more at 24/7 Wall St.
Building permits/total housing units: 0.12% Decline in building permits 2005-2011: -76.61% (12th largest) Building permits 2011 YTD: 6,184 Total housing units: 5,127,508 Ohio has suffered, and continues to suffer, greatly from the housing crisis. Over 8,000 homes were foreclosed in July 2011, the ninth-largest amount in the country, according to real estate company RealtyTrac. With such a high foreclosure rate, currently at one in every 608 housing units, housing is already too inexpensive for people to want to build. Ohio has therefore had one of the greatest decreases in building permits in the country over the past six years. Median existing home sales are also down in many areas of the state, according to data from the National Association of Realtors. In Toledo, prices are down 17% from one year ago, the third largest rate in the country. Read more at 24/7 Wall St.
Building permits/total housing units: 0.09% Decline in building permits 2005-2011: -74.06% (14th largest) Building permits 2011 YTD: 1,403 Total housing units: 1,487,891 Connecticut has had one of the greatest declines in the number of new building permits in the country. This trend saw a small turnaround in June -- the first monthly year-over-year gain in 2011 in new construction, according to the Connecticut Department of Economic and Community Development. However, the Hartford Courant reports that for "the first six months of the year, residential construction was down 30 percent compared with the same period in 2010." June was also the first increase in home construction in five years. Read more at 24/7 Wall St.
Building permits/total housing units: 0.09 Decline in building permits 2005-2011: -82.19% (7th largest) Building permits 2011 YTD: 4,250 Total housing units: 4,532,233 Michigan is one of the states that has suffered the most from the recession. The state's unemployment rate peaked around 15% in 2010. It is now at 10.5%, which is still significantly higher than the national average of 9.2%. The state has a vacancy rate of just under 15%, which is one of the highest in the country. New building permits have also decreased by over 80% since 2005, also one of the highest rates in the country. The state may now be more focused on tearing down old buildings than building new ones. Read more at 24/7 Wall St.
Building permits/total housing units: 0.09% Decline in building permits 2005-2011: -84.18% (3rd largest) Building permits 2011 YTD: 4,897 Total housing units: 5,296,715 Illinois has seen an almost 85% decrease in new housing permits since 2005. This is the third largest drop in the country. There are a number of initiatives being made across the state to improve the housing markets. In Chicago, for instance, Mayor Emanuel has made a number of changes to increase the speed with which building permits are issued. Additionally, a "Micro-Market Recovery Program" has been introduced to slow the city's foreclosure rate. Read more at 24/7 Wall St.
Building permits/total housing units: 0.09% Decline in building permits 2005-2011: -72.71% (17th largest) Building permits 2011 YTD: 774 Total housing units: 881,917 West Virginia's decline in building permits has slowed to almost a crawl. In the first six months of 2005 the state issued almost 3,000 permits. For the first half of 2011, that amount decreased to 774. If every permit were to result in a new housing structure, those homes would represent less than 0.1% of the total housing units in the state. Despite all this, construction is one area that is benefiting the state. According to the organization WorkForce West Virginia, 700 construction jobs were added in-state this past July -- the largest amount of jobs added in the private sector. Read more at 24/7 Wall St.
Building permits/total housing units: 0.07% Decline in building permits 2005-2011: -70.81% (22nd largest) Building permits 2011 YTD: 312 Total housing units: 463,388 Foreclosure filings increased 4% in Rhode Island from the first six months of 2010 to the first six months of 2011, according to RealtyTrac. Foreclosures dropped by 29% for that same period on the national level. Rhode Island home sales decreased 20% from one year ago in the second-quarter, according to the Rhode Island Association of Realtors. Additionally, median home prices have dropped 2%. These numbers indicate that Rhode Island's housing market is not recovering at the same pace as the majority of the country. For this first six months of this year, the state has issued a mere 312 building permits, the smallest number in the country. Read more at 24/7 Wall St.
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