Homeownership sure seems like a bad investment


It’s said that homeownership is one of the markets that millennials are killing. Well color me a typical millennial, because I don’t own a house, and I can’t see why I would want to. Renting housing just seems like a better deal. I’m going to explain why I have this intuition, then I’ll actually do some research to see common rebuttals.

Similarities and differences

Let me start with some caveats and basics.  While homeownership and renting fulfill the same need, they are not directly comparable. At least around here, if you rent housing then you tend to get a smaller apartment, and if you buy housing, you tend to get a larger house. If you want to spend more money for more space, or less money for less space, that may make your decision for you.

The other main difference is that homeownership is kind of a two-for-one deal. If you rent housing, you’re pretty much paying money for living space, and that’s it. If you buy housing, you’re not just paying money for space, but also investing some of that money. If you don’t want to invest money (say you can’t afford to), then homeownership is a bad deal for you. If you do want to invest money, then you could buy a house, but it’s not like that’s your only option. You could just rent housing, and then invest the money you saved by not buying a house. Thus, the comparison I’m making is not between a house that you own, and a house that you rent. The comparison is between investing in a house, and investing in, say, an index fund.


One thing that’s not really different, is how you pay the money. Typically, “buying a house” does not mean paying a large sum of money upfront. Instead, a bank gives you the money to buy the house, and you pay the bank back over many years, plus interest. And if you fail to pay them, they take the house as collateral, not unlike what happens when you fail to pay rent. Eventually, if you pay off the debt, you get to live in the house rent-free (although you still have to pay property taxes and maintenance costs).  But it could take several decades to see that return on your investment.

Why homeownership seems intuitively bad

When I told my dad that I didn’t think owning a house was a good deal, he went off about how valuable it is to invest money early on, and have it pay off when you’re older. And I said, but that’s only an explanation of why it’s good to invest money, I already know that. There are plenty of ways to invest money, and I find it strange that buying a house is somehow considered the most essential or default option.

It seems that society at large places undue value on homeownership. Owning a house is considered part of the American dream. As a society, we in the US have decided that homeowners deserve tax breaks. And if millennials don’t buy houses, that couldn’t possibly be a rational response to their economic situation, there’s got to be something wrong with them.

There’s a very basic reason to reject this received wisdom: the efficient market hypothesis. The efficient market hypothesis says you can’t (on average) beat the market using only publicly available information. As long as housing is publicly bought and sold, it cannot be better than other kinds of investment.

Apart from that, there are several other factors that make homeownership look like a bad investment. First of all, you’re investing a lot of money in one big thing, when generally you would prefer to invest a little bit of money in many different things. That’s called diversifying your investment.

Why is a diversified investment good? Every investment comes with risk, and the higher tolerance you have for riskier investments, the greater your expected return. Thus, if you have some way to take a risky investment and make it less risky, then you’re basically tolerating a higher risk, which makes you a profit. One of the most common ways to reduce risk is by investing a little money in many different things. All the different investments will have their own risks, but as long as the risks are uncorrelated with each other, they tend to cancel each other out.

Index funds and mutual funds are basically portfolios of diversified investments. So, that seems more ideal. Except, well, someone has to manage those portfolios, and they probably pocket the profits. So… eh?

One thing that seems appealing about investing in a house is that, even if housing prices go way down, you still have a house to live in. But there are still plenty of risks. Maybe there appear serious maintenance problems that now you have to pay for in lieu of the landlord. Or maybe you have to move because you switched jobs. Or you lost income and can’t afford the house mortgage anymore. Or, if the idea is to hand off the house to your children, maybe your children move to a different city.

If you do end up moving out of the house, it sure seems less efficient than moving out of a rented apartment. You have to pay those real estate people.

I mean, it’s probably a good deal if you expect to live in the same place for a long time. So, good for older generations, and not millennials so much, who I understand to have less job stability.

In which I do some research

So that’s my intuition, but what do other people say? You could listen Adam Ruins Everything.  Adam is just a comedian with a research team, so he’s not the most reliable source, but then, maybe I’m not either.  Anyway, he gives a good TL;DR version of what I said.

I also found this Vox article by Timothy Lee, taking the opposing point of view–this being in response to economist Alex Tabarrok, who was agreeing with me. Tabarrok looked at the financial track record of housing, and argued that renting has become better than buying. Lee seems to quibble over the details, arguing that saved rent is like a dividend–I don’t know how to judge this point without digging into it.  Lee also brings up the thing I mentioned, that even if housing prices go down, you still have a place to live.  I agree that this is a form of hedging against certain kinds of risk (and recall how I said risk mitigation is profitable), but homeownership comes with plenty of its own risks too.

Finally, Lee argues for the benefit of a forced investment. Although maybe you could do better by renting, and investing the money you save, in practice people don’t do that, even if it would be better for them. Yeah, point taken. But instead of (or in addition to) homeownership, may I recommend an IRA? In the US, you can make a retirement account with special tax breaks, which accepts up to $5.5k contribution every year. Because it’s such a good deal I make the maximum contribution each year, which basically commits me to investing on a regular basis. And also, unlike investing in a house, if I’m in financial trouble I can temporarily drop the commitment, because I’m not actually required to keep it.

Anyway… I’m sure owning a house is a good deal in many situations. But maybe it’s just not a good deal for many millennials. And having tax breaks for homeowners relative to renters sure seems discriminatory.

Comments

  1. says

    Eh, it depends. Housing is seriously cheap where I live, so it’s not any sort of hardship to buy a house. We could have put our house on our credit card, but we chose to live very rural. For me, it’s worth it because I don’t care for people telling me what I can and can’t do in my living space. If I want to paint on the walls, I don’t want someone having the ability to tell me “no, you can’t do that.”

    If we still lived in SoCal, I’m pretty sure we’d still be renting.

  2. says

    @Caine,
    Yeah I think one of the biggest considerations is simply price range, which depends on geographical location.

  3. says

    Hobbies and security of tenure. If your hobbies take up a lot of space and they’re difficult to move, renting is a pain. There’s nothing worse than having set up your hobby and getting notice from the landlord. It’s happened too many times for myself and my friends, so we all bought something so we could settle down. The current house has been mine for 22 years and I have no intention of moving until I’m too ill to do anything useful with my hands.

  4. says

    Age was another factor, as was a desire to be removed from neighbours. I wanted a ‘retirement’ house. Neither one of us are retired, but I think security of housing is a bit more important when you get older.

    All that said, we’re still considering leaving the U.S., and if we do, we’ll be facing the housing issue again. I’d like it if you could arrange rentals the way you can in Mexico, where you can lease a house for 50 or 99 years for a set amount of money. That’s a system I like.

  5. Bruce H says

    I was once given three days to vacate a property because the landlord decided to use the house I was living in for a different purpose. I had no prior warning and my rent was fully paid. I could have fought him, making him go through formal eviction proceedings, but I decided it wasn’t worth it so I scrambled and moved a week later.

    When you own a home, that can’t happen.

  6. says

    I am neither US citizen, but I am seconding Lofty:
    ” If your hobbies take up a lot of space and they’re difficult to move, renting is a pain. “

  7. says

    Each individual has to run the numbers, but depending on where you live, you’re usually right.

    IIRC, home values were increasing much faster than the overall economy. One set of economists calls this a great opportunity, and another set calls this a bubble. The Global Financial Crisis seems to have weighed in heavily on the latter side.

    The problem with owning a home is the same problem as with owning any other asset: the price of any asset is determined by its growth in value, or at least its forecasted revenue stream. But predictions are hard, especially about the future.

    As your other commenters have noted, owning a home is beneficial if owning a home per se has utility. Just owning a home as an “investment” requires that you actually do the financial analysis. As you note, The illiquidity (hard to sell quickly) and non-transportability (if you move, you can take your portfolio, but you can’t take your home with you) of a home are important consideration. Also note that the tax breaks for an IRA are better, at least up front: you can deduct your entire IRA contribution from current year taxes, but you can deduct only your mortgage interest, not the principal.

  8. says

    Lofty @3,
    Our hobbies are board games and origami, which take up space, but are highly mobile.

    My mother’s hobby is hoarding… As I got older I became increasingly aware of how little value my parents are getting out of their extra space.

    BruceH @5,
    That strikes me as a case of renters not having enough protections, or the protections not being enforced. Renters’ rights are relatively strong in the SF Bay Area, and whenever there are unjustified evictions it tends to be a big scandal.

    Larry Hamelin @7,
    My partner had worked in home mortgages for a little while, and was telling me about financial practices before the recession. Basically banks gave out home loans too generously, because even if people couldn’t pay the loans off, they could always pay it off by selling the house–assuming that housing prices would continue to grow quickly. SMH. I think Vox is correct about homeownership hedging against some kinds of risks, but it sure doesn’t work if the risk includes losing the house.

  9. sonofrojblake says

    Some pushback:

    The efficient market hypothesis says you can’t (on average) beat the market using only publicly available information

    … and like most economic theories it is based on what economists think the world should be like, rather than what it demonstrably IS like. And it is dead wrong. See the movie “The Big Short” for how several unconnected small groups of people used publicly available information to become vastly rich when the financial crisis hit. What you can’t do is beat the market betting the same way everyone else is betting, but that is not the same at all.

    Your kids or spouse can’t live in your IRA. If I die, my mortgage is instantly paid off by the insurance and my wife and imminently arriving child will have somewhere to live rent free.

    What most of this successfully argues against is buying a second or subsequent house as a pure investment and then letting it out. But the advantages of home ownership where the economy encourages it, which it sounds like the US does, usually outweigh the disadvantages.

    Put it this way: I know people who invested in a house early, i.e. immediately after university. I know others who rented for a small or large amount of time before buying, and some who never bought at all. Is it a coincidence that were I to draw a graph crudely comparing quality of lifestyle (including size and desirability of location where they live as well as general financial security), it would be a fairly linear graph with the earliest investor at the top of the quality axis and the renters at the bottom? Admittedly, if you’d drawn the same graph two or three years after graduation, the renters would be ahead – home ownership is HARD, especially at first, and the benefits only accrue later. I’m trying really hard here not to fall into the trap of sterotyping millenials as not wanting to get involved in things that will only pay off years later, but it’s so easy

  10. Bruce H says

    Siggy, I live in Texas, where property rights are sacrosanct. Renters have little protection or recourse in situations like that. Had I chosen to fight, I would still have lost eventually. At best, I could have gotten three months at great cost to me and with great difficulty. At worst, I could have faced county constables putting all of my stuff on the street in addition to a legal eviction on my record. In such situations, it’s usually better to cut losses and move. Since I was living alone, that was easier.

  11. says

    BruceH @10,
    Yeah I didn’t mean to advise any particular course of action, I was just observing. Another valid reason to get a house is for the tax breaks. It’s just that I think that either the tax breaks shouldn’t exist, or there should be comparable tax breaks for renters. It doesn’t make sense to subsidize one lifestyle over another.

    sonofrojblake @9,
    I’m not sure how far I would trust the efficient market hypothesis in extreme or unusual situations but… wait, the movie you’re citing isn’t even a documentary? Anyways, it doesn’t seem relevant here.

    Your kids or spouse can’t live in your IRA. If I die, my mortgage is instantly paid off by the insurance and my wife and imminently arriving child will have somewhere to live rent free.

    This argument… I mean… it really doesn’t seem to be an argument. I was comparing homeownership to renting+investing, and you seem to be comparing homeownership to being homeless? If you can buy a house and pay off the mortgage with a life insurance payout, then you could also rent an apartment, and then buy a house with the life insurance payout.

    I know others who rented for a small or large amount of time before buying, and some who never bought at all. Is it a coincidence that were I to draw a graph crudely comparing quality of lifestyle (including size and desirability of location where they live as well as general financial security), it would be a fairly linear graph with the earliest investor at the top of the quality axis and the renters at the bottom?

    Given that houses are often in a higher price range (in a given location), no it does not seem like a coincidence that people who can afford to own houses are better off. Not at all.

  12. Onamission5 says

    For us, buying was a better plan overall because the money we were sinking into an ever shrinking and thus more expensive rental market wasn’t earning us anything and never would, and we didn’t have liquid funds to invest elsewhere.

    It was pretty frustrating never being able to afford quite enough space for the whole family and having rental after rental either be sold out from under us or have the rent jacked up year after year until we had to move into something even smaller just to afford housing. As renters without extra money to invest in other things we found ourselves having to move, whether voluntarily or not (left one rental because the LL forbade us from doing anything about the roach infestation which involved use of “chemicals”), about every 1-3 years. As homeowners we’ve been able to settle into one location for four years, a record! And while our insurance rates are a bit higher due to our two large dogs, we didn’t have to pay hundreds in non refundable deposits, and our mortgage is about the same as the current “fair market” rent on our last place, which was half the size.

    Which, now that I’ve written it all down, is more a set of arguments against living in rapidly gentrifying areas while working class than an argument against renting, I think.

    Carry on!

  13. says

    @onamission,
    Yeah one of the problems with renting is that if land values go up, then rent can increase and you can get priced out. It can happen to homeowners too, if property taxes go up. But I’m pretty sure the effect on rent should be much greater than the effect on property taxes. ‘Cause when you invest in land, that’s basically a bet that the land values will go up faster than market rates. If land values went down instead, I think you’d prefer to have rented.

    In California, property tax increases are restricted by the infamous prop 13. And there’s rent control too, although it doesn’t apply to all rental properties.

  14. coragyps says

    A big snag for renters out here in the West Texas Desert is the crazy fluctuation in the labor market here. When the price of oil went from $30 to $65 a barrel, rents doubled from one month to the next for some people. That might be fine if you had a good oilfield job, but McDonalds and the public schools didn’t increase wages much at all. And that problem is a predatory landlord problem , but it still forced some folks to move away.

  15. sennkestra says

    I find that an alternative way to look at it is that the benefit of owning is not in the creation of future wealth (i.e. it’s not a great investment asset, at least not for people like me), but it does give you opportunities to increase the sort of…life enjoyment value of the money you are spending.

    For example, if you have the option of spending 2k on rent or 2k on a mortgage, owning a house might not be cheaper overall after maintanence. But the advantage is that you can make sure that you 100% enjoy that house you have to pay for – if you want a different style of stovetop, you can install it. If the bathroom is an ugly color you can paint it yourself. You can mount whatever coathooks or toolhooks or bookcases you want on the walls. IMO, I’m willing to potentially pay more to have a space that I can enjoy 100% instead of a rental space that I can’t modify to suit my needs and that therefore will maybe meet only 50% of my preferred housing preferences.

    (Unfortunately, local conditions can still outweigh that benefit – while that advantage would be enough for me in some markets, the bay area is such that paying like 100% as much is not worth maybe a 50% increase in enjoyability, so housing investment would have to be something that goes hand in hand with geographic relocation for me.)

Leave a Reply

Your email address will not be published. Required fields are marked *