By Joseph Gyourko
Sunday, November 15, 2009
Even as we wade through the wreckage of the housing collapse, Americans remain a staunchly house-proud people. And our government is apparently determined to encourage us: This month, President Obama signed into law an extension and expansion of the popular homebuyer tax credit, which had been scheduled to expire at the end of November. But before you rush out to claim your extra cash, take a moment to make sure you're not in the housing market for the wrong reasons. We've found that several of our most cherished beliefs about the value of a home don't hold true:1. Housing is a great long-term investment.
Historically, the value of owner-occupied homes has risen at a fairly low rate, one that pales in comparison with the performance of stocks and bonds. Between 1975 and 2008, the price for houses of comparable quality and size appreciated an average of about 1 percent per year after inflation. You would have earned well over 2 percent per year after inflation had you invested in Treasury bills over the same period. And you would have earned even more on riskier investments: After inflation, Moody's corporate bond index rose an average of 6 percent per year between 1975 and 2008, while the S&P 500 stock index rose an average of 8 percent per year. Most of the return from owning your home comes not in financial gains but in the benefits you enjoy by living there.2. The homebuyer tax credit makes buying a house more affordable.
Not necessarily. Just because you got an $8,000 tax credit toward the purchase of a home doesn't mean that you actually saved $8,000. In areas where there is strong demand for housing and the supply of new housing is limited -- including the Washington metro region -- tax credits may result in the bidding up of home prices. In other words, the program has probably led to higher prices in these areas than we would be seeing without it. This means that some of the benefit of the tax credit is being passed on from homebuyers to home sellers.3. Homeownership is good for society because owners make better citizens.
This is the rationale behind the government's many efforts to subsidize and expand homeownership, and there is an appealing logic to the argument. Since homeowners have a financial stake in their communities, one might expect them to be more responsible and involved citizens. But there's no overwhelming evidence that higher homeownership rates make for better societies. Austria, Germany and Denmark all have ownership rates in the low 40 percent range, meaning that just over two-fifths of all housing units are occupied by their owners. This is well below the 68 percent ownership rate in the United States, but those countries don't appear to be suffering a shortage of civic-mindedness. At the other end of the spectrum, Spain's ownership rate tops 80 percent, but no one seriously claims that this makes Spaniards better citizens than Americans.4. It's safe to buy a house with a very low down payment.
Because the Federal Housing Administration insures mortgages backed by down payments as low as 3.5 percent, you might think that buying a house with a low down payment is relatively safe. But in the case of a 3.5 percent down payment, a borrower winds up carrying $96.50 of mortgage debt for every $3.50 of home equity. And the less equity you have in your home, the greater the chance that a fall in prices will leave you owing more than the house is worth, a condition often described as being "upside down" or "underwater." In this example, housing prices only need to fall by 4 percent to leave a buyer underwater.
To put this in perspective, Lehman Brothers, Bear Stearns and other investment banks were using similar ratios of debt-to-equity to finance their investments before the financial crisis. Of course, buying your house with little money down is less risky than engaging in the complex trades that Lehman and Bear Stearns were making. Still, negative equity sometimes leads to mortgage defaults, and when buyers default, they lose not just their down payments but also closing costs and the value of any improvements they've made to their homes.
Even if buyers don't default, they may not be able to afford to move, because they have to pay off their old home loans to get new ones. My research suggests that households with negative home equity are half as likely to move as similar households with positive home equity. As a result, our borrowing binge during the recent boom will probably leave many people locked into their current homes. One of the great virtues of American society has long been our willingness to relocate and follow opportunity. But now, many families are going to be stuck in declining parts of the country, unable to take advantage of better labor market conditions elsewhere.5. Owning a home is cheaper than renting one because you save on rent.
Most real estate agents will tell you this, but the argument doesn't survive scrutiny. It's true that if you own, you don't have to write a check to a landlord. However, you have to cover all the costs of maintaining the house. It is the same house with the same operating costs, whether you pay them directly or whether you pay rent to cover them. By covering these costs as the owner-occupier, what you spend (including your mortgage payment) comes very close to what you would have spent if you rented your house.
Many of us own because it is a way to commit to saving by building equity over time, but we should not expect to make large profits. Housing is an expensive durable good, and durable goods are costly to maintain. The main reason to own is because you really like your home, not because you think it makes you money. It doesn't.
Joseph Gyourko is the chairman of the real estate department and the director of the Zell/Lurie Real Estate Center at the University of Pennsylvania's Wharton School.