Dr. Robert Shiller, the renowned Yale professor and creator of the S&P Case-Shiller Housing Index, recently made several dire announcements about the short-term and long-term prospects for the housing market. Asked for his prediction on housing prices in a recent interview, Dr. Shiller reported that prices might fall another 10% to 25% in the next few years. (Shiller also acknowledges that forecasting the direction of the housing market is as hard as predicting the weather and that we are in uncharted territory on a range of fronts.)
The Housing Market: A History of Poor Performance
Let’s set aside the short-term housing predictions and focus on long-term issues.
Dr. Shiller analyzed the financial benefits of home ownership from an investor’s point of view. His research found that housing prices did not outperform inflation over a one hundred year period (from 1890-1990) and found that buying the “American Dream” as we know it (e.g. buying your home), proved not to be a good long-term investment. Of course, most of us are well aware of how housing prices skyrocketed in the early 1990’s and have since crashed.
In his article, Dr. Shiller argues that home buyers have been raised to believe that building equity in their homes was a great long-term investment—a notion that Shiller refers to as a “massive popular delusion.”
Dr. Shiller’s interview does not touch upon two major economic benefits of home ownership that include:
#1: Taking Advantage of Low Interest Rates
Being able to borrow cheap money (in the form of a low-cost fixed-rate mortgage) can be a substantial opportunity for investors.
These days, individuals with good credit can borrow money (in the form of a mortgage) in many cases cheaper than the U.S. Government. For example, (as of this writing) the yield on the iShares 20+ Year Treasury Bond Fund (TLT) is hovering near 4.2%. Qualified home buyers can lock in a 30-year fixed rate mortgage for as low as 4.5% APR. Once you factor in the tax deduction for mortgage interest, the after-tax rate interest rate could easily be less than the 4.2% the long-term government bonds yield. This means that home buyers with good credit can conceivably borrow money more cheaply than the U.S. government.
If home buyers lock in a low APR─rather than pay for a house in cash or pay down a mortgage—they open up a range of investment opportunities with the extra cash, because, essentially choosing to borrow for a home is a form of financial leverage. Of course, I don’t mean that people should borrow as much as possible against their homes and then speculate on IPOs─absolutely not. However, when a home buyer gets a low, fixed APR on their mortgage and uses the extra money he or she has saved to maximize contributions to tax-advantaged retirement accounts it turns into a win-win for home buyer and investor.
In fact, this is exactly the way a company looks at debt. Imagine a business running a cash surplus with absolutely no debt. The bank offers the company credit. The company declines the offer since it doesn’t need the loan. The bank keeps lowering the interest rate until it’s so low that the company can’t ignore the rate and decides that the risk associated with taking on new debt is overshadowed by the new opportunities the loan will create for the company in the form of new employees, upgraded technology, research and development (etc. etc.).
#2: Long Term Inflation Protection
The second substantial economic benefit of buying a home is inflation protection. When you buy a home, you “lock in” your annual housing cost. Think about it: When you take out a 30-year fixed-rate mortgage at, say, 4.5% (and pay this back in inflation-adjusted dollars over 30 years) you’ve essentially purchased insurance against inflation.
Unlike the cost of food or gas, homeowners don’t have to worry about inflation in housing costs consuming a larger portion of their incomes each year. In addition, homeowners with a mortgage will pay them off with inflated, or less valuable dollars.
A Sober Outlook
Is housing an attractive long-term investment compared to other assets? Dr. Shiller, arguably the foremost expert on the history of the U.S. housing market, argues that we should expect housing to keep pace with inflation (but that’s about it). However, the substantial economic benefits to homeowners simply cannot be ignored—namely the availability of low-cost debt and a cheap long-term hedge against inflation.
- Investing in Real Estate: REITS and Your Home
- Jim Grant’s Alternative to Muni Bonds: REITS
- U.S. Investor Behavior: The Government Report
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