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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 Florida. 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 US 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 Fed 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, the Fed's
low-interest-rate bubble artificially inflated housing prices beyond what
made sense for our economy to sustain.
If US companies such as Apple are creating greater
abundance in society, it makes sense for housing prices to grow with greater
wealth. But, bringing those prices higher on a wave of printed cash does not
make us 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.
[Treating houses as investment vehicles – a
strategy pushed by federal government policy – is one part of the
complex conditions that have created the current American debt crisis. Start learning about it, so that
you can be among those who not just survive, but thrive during the
challenging times ahead.]
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