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The Only Thing “Lousy” Was the Advice!

We read an interesting article in the Wall Street Journal on Monday titled A Home Is a Lousy Investment. It was written by Mr. Bridges, a professor of clinical finance and business economics at the University of Southern California’s Marshall School of Business. The essence of the piece is that owning a home is not a good financial investment for younger generations. The subtitle:

“Today’s young people would be foolish to imitate their parents and view ownership as the cornerstone of personal finance.”

Today, we would like to counter some of the points made by Professor Bridges. The professor looks back on California home values over the last thirty years and begins with the assumption:

“If a disciplined investor who might have considered purchasing that median-price house in 1980 had opted instead to invest the 20% down payment of $19,910 and the normal homeownership expenses (above the cost of renting) over the years…

There are several challenges with these givens. Let’s break them down.

“a disciplined investor”

There is no doubt that discipline in savings is important. However, studies show that homeowners attain greater wealth because of ‘forced’ savings. The Joint Center for Housing Studies at Harvard University released a study, America’s Rental Housing: Meeting Challenges, Building on Opportunities. They explain:

“In addition, renters have only a fraction of the net wealth of owners. Near the peak of the housing bubble in 2007, the median net wealth of homeowners was $234,600—about 46 times the $5,100 median for renters. Even if homeowner wealth fell back to 1995 levels, it would still be 27.5 times the median for renters.”

“invest the 20% down payment”

The professor’s math supposes a 20% down payment. What about the people who put 5% down or 10% down. What about those who purchased a home with an FHA mortgage putting 3% down; or our veterans who used a VA mortgage to purchase a home with no down payment?  (For those who think low down payments have caused the current foreclosure challenge, the difference in default rate between a 5% down deal and a 20% down deal is less than 1%).

“normal homeownership expenses (above the cost of renting)”

It’s great that Professor Bridges looked at data over the last 30 years. History is important. Foresight is much more valuable than hindsight however. In most parts of the country, homeownership is currently less expensive than renting. There is not MORE money to invest if you rent. There is LESS. In their report mentioned above, Harvard University found:

“Rental markets are now tightening, with vacancy rates falling and rents climbing. With little new supply of multifamily units in the pipeline, rents could rise sharply as demand increases.”

Trulia, in its second quarter 2011 Rent vs. Buy Index, stated that buying a home has become more affordable than renting in nearly four out of five (78%) major cities. Ken Shuman, Head of Communications at Trulia said:

 “With home prices nearing a double dip and more foreclosures expected to flood the housing market over the next two years, the decision between renting and buying a home across most of the country has clearly moved in favor of buying.”

The premise of Professor Bridges article doesn’t apply to the current market. Even some in the academic world agree that now is the time to buy. Business School professors Eli Beracha of East Carolina University and Ken H. Johnson Ph.D. of Florida International University have done extensive research on which makes more sense financially: to rent or own a home. They published a sensational paper on this issue: Lessons from Over 30 Years of Buy versus Rent Decisions: Is the American Dream Always Wise?. In their paper, they explain:

“[F]undamental drivers now appear to be in place that favor homeownership over renting in the near term future… [This] finding might seem unwise to many given the recent crash in the real estate markets around the country. However, rent-to-price ratios now seem to be in place along with other fundamental drivers that favor ownership over renting.”

They conclude their research paper with this sentence:

“Conditions (historically low mortgage rates and relatively low rent-to-price ratios) now seem in place to favor future purchases.”

If Professor Bridges’ assumptions are incorrect, how much value can the conclusions hold?

Bottom Line

The best advice given in the Wall Street Journal article was in the last paragraph:

Owner-occupied homes will always be the basis for healthy and stable neighborhoods.”

And, in today’s market, a home is also a fabulous investment!!


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9 replies
  1. Dean Hartman
    Dean Hartman says:

    Is it worng to ask Professor Bridges what his net worth is?

    I mean, is he wealthy using his strategies?

    With most of the richest people in the world attaining and retaining their wealth via real estate….does the academic have any real world proof of his hypothesis?

    Reply
  2. Dewey Linville
    Dewey Linville says:

    Hello Dean,

    Disciplined saver/investor is a myth. Those folks have passed on to their reward.
    Forced savings wheather buying a home or deductions for 401K’s is the best hope for most people.
    The PHD’s (piled high and deeps) have to publish or perish. So take them with a grain of salt and continue to put out a clear straightfoward message that owning your nest is better than renting one.

    Dewey

    Reply
  3. Debbie Ferrero
    Debbie Ferrero says:

    I hate to sound like a conspiracy theorist, but I wonder if the Professor is putting his own personal wealth into purchasing rentals as many very wealthy people are doing. Putting out this claptrap gives justification ( for some weak winded people) for renting over purchasing so there will be a pool of renters to fill investors rentals.

    Reply
  4. SarahGray Lamm
    SarahGray Lamm says:

    I wondered how long it would be before you all responded to that one! Knowing you would make the case so articulately saved me the time and energy required to do so myself. Instead, I spent the day doing what I do best…negotiating for and advising my clients on how to get the best deal they will ever see in residential real estate! Thank you!

    Reply
  5. Jack
    Jack says:

    It is amazing how people take a simple back of the envelope calculation and so easily prove something right or wrong. So there are two choices we have before commenting on a detailed paper a professor writes – read the entire paper and then comment. Alternatively build our own detailed rent vs own model in a big spreadsheet that accounts for all the variables (and I did that). I guarantee that most people who talk about rent vs. own have never done that and the simplistic arguments they make shows their lack of understanding the subject. Which is why we are in this housing mess to start with.

    Specific points that this article raises
    1. “disciplined investor” – fair point – a house forces you to save. But you can overcome that by deducting a fixed amount into your 401k or straight into a savings account. But this argument still has some validity and the blog makes a reasonable argument here.

    2. 20% downpayment assumption. Well, this argument is useless and the author of this blog should know you can get leverage. So yes, a homeowner can attain more leverage by putting down just 5%. (but that increases mortgage costs, therefore reduces the return on the home) but similarly that person can get leverage on stocks (on margin or buy levered ETFs or high beta funds) and still achieve same returns as the 20% down payment scenario. Overall this argument against the article is extremely poor and useless.

    3. Normal ownership expenses- again a stupid argument from this blog. The professor uses some costs in his assumptions. Whatever it takes to maintain a home. You have to add that of course. This blog argues that you actually save money by owning than renting, so you save money rather than spend it. Well even if that is true (though not always) -this “saving” (or to be more correct, the difference in net free cashflows in renting vs. owning) is already accounted for in the computations on renting vs owning. In addition to your usual costs and benefits, you must include some assumptions on the cost of maintaining a house. that is an input into the model and must be a strictly non zero cost.

    So, while readers putting in comments can say whatever they want (rational or irrational) – the person who writes a blog has the bare minimum need to try and recreate the numbers and equations a little bit before commenting, and to follow the rationale. Or to take someones help before doing so.

    Reply
  6. Steve Harney
    Steve Harney says:

    @Jack
    The article was written by a professor and the KCM Crew realizes that. They didn’t read the entire paper (if one even exists) because they didn’t see any links to ANY papers that supported any of the points made in the article. As far as your points:

    1.) Thank you for the kind words. However, the credit goes to the Joint Center for Housing Studies at Harvard University. It was their study that was used to make this point. The study was linked in the article. I hope you had the time to read it.

    2.) 66% of people in this country own their own home. What percentage of Americans leverage their stock purchasers?

    3.) The best paper written on this issue was authored by two professors in the business schools of two different universities. Their paper explains this point in detail. Their research paper is linked in this blog post. I will suggest to you what you suggested to the KCM Crew: “read the entire paper and then comment”.

    Reply

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