Home Value

Debate: A personal home is an investment

My take : I agree it is an investment, but not a good investment always. Let me explain.

If you are personally living in the home, you are consuming all your potential rental income. Consumption does not equal investment. If you save money on rent that you would have otherwise spent, then it is a great investment. But that is exactly the point. The catch is that you have to guarantee you would have otherwise spent that same amount of money or greater on rent. There is no other class of investment, where if you invest more your consumption automatically increases. If you move to a bigger house because it is an investment, you have not made a good investment as you have increased your own rent. In other words, the only way to propely account this is to create a You Inc. and lease the house to yourself and pay rent to yourself. You will see the new bigger house does really well as an investment off the back of the high expenses of the tenant, who is.. you guessed it, yourself.

This brings us to the second facet of investment consideration, that is price appreciation. People get home appreciation facts confused all the time. So here goes some much needed clarification.

Home values are based on both the structure and land values. Structural values appreciate only with the residential building cost index. Land values are what truly appreciate in high demand/growth areas, like the Dallas area in the last decade. Land prices are set by supply demand market dynamics. Structure pricing can also be driven up by demand to a degree but is shielded from the sometimes irrational returns land owners enjoy, as it is capped by the cost of demolition plus new construction cost (including the time value of construction time).

I do think that land can be a great investment in some areas, but market selection success is not a given. Particularly, if one does not have a choice in the area they buy their personal home due to jobs, kids, roots etc. Morevover, I do not think the structure itself is a great investment unless it is generating rental income. Something that only grows with labor and material inflation is not a great investment! (*Granted that inflation rate is often higher than the consumer inflation measured by CPI, since electronics, manufactured goods and apparel generally bring the average CPI down)

Further nuances

Demand is affected by the overall economic climate of course, including where people want to live and what people are able to pay. Current supply is just another word for existing inventory. Increases to supply are driven by demand, of course, and affected by zoning laws, land availability for new construction etc.

Interest rates do not significantly affect nominal home prices contrary to popular belief. The ability to borrow more and repay the same (as borrowing lesser previously) is only a perceived reality. In fact, the present value of the future payments increases when the rates drop. So, even at a lower nominal payment consumers are paying the same real value as before the rate drop. This happens with the dual accompanying forces of lower inflation adjustement to wages and lower expected market rate of return on investments. I added the word significantly as a qualifier, because the uninformed first time home-buyer might indeed borrow a larger amount at lower rates and bid a higher price on a home. But if land prices appreciate temporarily due to this activity, this will be normalized over time as the sustained lower rates will reduce nominal wealth creation and people’s expectations on what is affordable will re-adjust. If anything, people with existing mortgages might re-finance at lower rates and if they ever change houses later, their expectations would be based off the reference of their new lower nominal payment. (Nominal = dollar amount face value ; Real = Spending power usually calculated as Inflation adjusted value)

These two claims (building cost index, interest rates) are also borne out by data. For example, the median price of homes sold in 2008 pre-recession was around $240k while in 2019 pre-pandemic it was $320k. (It has been flat across 2020). But in fact, the building cost index for new residential construction did go from 90 to 120 in the same timeframe, representing a factor of 1.33. This would mean housing price increases are in line with the cost index. This also signifies that overall land in the US has not appreciated much beyond inflation. Between 1990 and 2000, the median home price went from 120k to 160k, which is also a factor of 1.33 in a much higher interest rate environment. It must be conceded that the price appreciation in the last decade in such a low rate environment is comparatively better than the same appreciation in the 90s when even treasury bonds were yielding high rates!

As aformentioned, in high growth areas like SFO, the land does actually appreciate and that is due to market forces playing out. The word “playing out” is important, as the future growth potential to a certain horizon is priced into homes in these markets similar to a growth stock (there is no free lunch). As time passes, if things keep looking up, the confidence time horizon moves forward and the prices go up even further.

In conclusion, a personal home can in some cases be an okay non-diversifed investment, but try to lease a less expensive home from yourself and actually invest the savings!