New Haven (Project Syndicate) – A few days ago, I received an email from a person who today punished me for my doubts about investing in housing. He introduced himself as a former U.S. Air Force pilot during the Vietnam War who later became a stock broker and banker before retiring recently. “You, as an educated person, should help and promote real estate ownership,” he wrote.
He responded to my warning about a house price bubble in many parts of the world. According to the latest S&P CoreLogic Case-Shiller Home Price Indices, US home prices rose a record 19.7% last year and now look very volatile. They may rise further for some time, but this may be followed by a severe fall.
Still, my correspondent was at least partially right about what I should say to the public about home ownership. In particular, we need to recognize its big-picture impact on our lives, despite recent extreme price volatility.
But investing in housing in a growing location may not be as secure as long-term betting as many think. Potential U.S. home buyers can logically assume that their term in a home will overcome any obstacle to an upward trend in home prices, ultimately enabling them to benefit from new heights. After all, due to the Great Recession, real home prices in the U.S. fell 36% nationally from December 2005 to February 2012, but then rose 71% above the 2005 high to 10%.
However, I have been arguing for years that the performance of the U.S. housing market since 2005 is not the only relevant example of a long-term home price trend. My historical data show that the price of a real national home was sometimes lower in the 1990s than in the 1890s. In that century, cities spread over cheap land and construction equipment, technology, and transportation became more efficient.
Moreover, the land itself is still cheap: the average price of 1 acre (0.4 hectare) of agricultural land today – on which one can easily grab four or five houses – is only $ 3,380. Yes, agricultural land may be far away from the city, but history shows that as the population grows, the cities begin to sprout new places.
Still, I disagree with my real estate vision of becoming an Air Force pilot banker. “In this country, like all developed countries, real estate is at the core of wealth measured by monetary value,” he writes. “It’s been going on like this for at least a thousand years, and there’s no indication that we’re building any more real estate.”
So, let’s imagine that for the past 1,000 years, house prices have beaten the SPX on the U.S. stock market,
Average 7% annual return in the 20th century (after reinvesting dividends). At that point, the prices of these homes, after compounding, will increase by a factor of 24 and 28 zeros.
But the houses of a millennium ago are still standing today, and the survivors will hardly want to live in them. Moreover, the land on which they lived is often no longer valuable. In biblical times, for example, Ephesus in western Turkey was a coastal city with magnificent buildings. But its once-valuable port has since crumbled, leaving the city’s ruins miles away from the sea.
It’s mostly true that we’re not building any more real estate, if we only consider land in the strictest sense of the word. Land creation, like the artificial islands of Dubai, is not a measurable solution. But we are basically adding new spaces by creating high-rise apartments, creating virtual land in the form of online conference services and electronic storage, and improving transportation so that people can live in remote areas on cheap land.
The emailman then describes his own experience in the US housing market:
“We bought the first house in 1971 for $ 19,000, now the price is $ 300K, the second house is $ 34K, now the price is $ 400K, the third house is $ 130K, now more than 450K, the fourth house is $ 190K, now the price is $ 435K, $ 305K- The fifth house, sold three years later for $ 800K, the current home for $ 300K (reduced leisure time) and the price was $ 450K. “
According to his numbers, the price of the first house increased by a factor of 15.8 (300,000 / 19,000). But over that 50-year period, the U.S. consumer-price index has risen by a factor of 6.7, meaning the actual value of the home has more than doubled. And the compounded annual real value return in those five decades is only 1.7%.
Finally, he noted, “even tax law favors real estate ownership.” That’s true. Homeowners often have tax subsidies; In most countries, the rent charged in owner-occupied housing is not subject to income tax. But these tax subsidies do not seem to be growing and therefore do not support a steady rise in home prices.
But I take the moral requirement of the emailer seriously. Even at current higher U.S. home price levels, buying is still understandable for those who are founded on home ownership and want to move on with their lives. Home ownership can be a trend for the community, activating long-term friendships with neighbors and a sense of security and stability.
Moreover, buying a home with a mortgage acts as a self-regulating system that helps people save more. The discipline imposed on young homeowners through regular mortgage payments is a key driver of retirement savings. And buyers can hedge some of their risks in the home price index futures market.
Make no mistake about it: Homeownership has its benefits. But those who really want to buy now need to be sure that they can embrace what could be a rather volatile and frustrating long-term path to home values.
Robert J. Schiller, 2013 Nobel laureate in economics and professor of economics at Yale University, is the author of “Narrative Economics: How Stories Go Viral and Drive Major Economic Events.” It was first published by Project Syndicate – “Do You Need to Buy a Home in the United States?”