Home Ownership & The American Dream
November 22, 2008
Part One: How Did We Get Here?
If there is anything as American as baseball and apple pie, it is probably the idea of owning your own home. Whatever their intentions, government has provided disproportionate incentives to lure people into purchasing homes, and in light of the financial and housing crisis, a lot of people are starting to question how we got to this point and whether home ownership is even something we should aspire to in the future.
Home ownership is typically pitched as a means to invest and build personal equity, and for whatever reason, it is marketed as one of the safest assets in existence. For investing purposes, however, homes may not be all they are cracked up to be. One takeaway from Jim Cramer’s book Real Money (I can’t say with confidence there were other valuable takeaways) is that for any given period in time, stocks have outperformed all other asset classes, including real estate.
So why take out huge mortgages to buy homes when we could just rent our housing and invest all of our money in the stock market? The answer: leverage. The Securities and Exchanges Commission regulates that a person cannot buy stocks using more than 50% of borrowed funds. In other words, if I have $10,000 in cash, I can, by law, purchase no more than $15,000 in stocks. Fair enough. But now consider what the same $10,000 can buy you in a housing investment. During the past few years, people could put down $10,000 to buy a $100,000, $200,000 or $300,000 home. In some cases, lenders didn’t even require a down payment at all. Imagine if a stockbroker let you buy $100,000 worth of stocks without putting down a dime!
Not only does the stock market provide historically better returns than real estate, but also is a liquid market with extremely low transaction costs. If I wanted to liquidate an entire stock portfolio on Monday morning, I could do it with no more than a few clicks of a mouse. The full trade (buying and selling) would cost me about ten bucks per stock (hedge funds, and other big investors have a more difficult time liquidating huge positions, but for individuals with less than $1 million invested, I highly doubt they would experience a problem). Real estate, on the other hand, is a very illiquid market. If I wanted to sell a house, I would have to pay a broker (or endure the cost of selling it myself), show the house to prospective buyers, and wait. A house could potentially sit on the market for months or more, especially given the supply of housing stock that exists on the market today.
When I opened a stock and option trading account in 2007, I had to fill out what seemed like endless paperwork. I had to document what I did for a living, what my annual income was, how I earned my income, etc. I had to sign page after page of legal jargon indicating that I fully understood the risks associated with trading leveraged products. When my application was initially denied, I called the broker and got a 15-minute lecture about the risks of trading leveraged products, before my account was finally opened.
This amazes me in light of the fact that in the housing market, lenders were literally giving money away, to the point where people didn’t even understand why they were getting money or at what terms. The story about what happened to Addie Polk in Akron, Ohio, is a quintessential example of how easy it was to borrow money and how aggressive predatory lenders were in pushing credit onto people who were completely unqualified for it.
I’m not suggesting that we ought to go out and apply hyper-leverage to stock investing; but the whole situation raises interesting questions about why we are so emotionally attached to homes. Presumably, since homes are real, physical assets, people feel more comfortable in the idea that they will be worth something at any given point in time. Stocks, on the other hand, are just pieces of paper (or electronic text), you can’t touch them or feel them. Granted, it is true that stocks often go into “bear market” periods; but housing, as we have seen, can suffer from the same phenomenon. Stocks are often considered risky because companies can fail, and short of a house burning to the ground, it will always hold some value. While it is true that some companies will fail, investing in an S&P 500 fund, for example, would be a reasonable long-term stock strategy. The entire economy would essentially have to fail for the S&P 500 index to approach zero.
In the end, home ownership isn’t all about investing and building equity. We seek out homes primarily for living. In the second part of this series, I question whether home ownership makes sense for individuals in today’s fast-paced world. What should be clear, at this point, is that whether or not a particular investment is objectively ‘risky’ or not, how we present risk to the public has a huge impact on their behavior.
See Also:
Part Two: How Desirable is Home Ownership?
Part Three: What the Academic Research Shows
Part Four: Costs and Benefits to Society
If there is anything as American as baseball and apple pie, it is probably the idea of owning your own home. Whatever their intentions, government has provided disproportionate incentives to lure people into purchasing homes, and in light of the financial and housing crisis, a lot of people are starting to question how we got to this point and whether home ownership is even something we should aspire to in the future.
Home ownership is typically pitched as a means to invest and build personal equity, and for whatever reason, it is marketed as one of the safest assets in existence. For investing purposes, however, homes may not be all they are cracked up to be. One takeaway from Jim Cramer’s book Real Money (I can’t say with confidence there were other valuable takeaways) is that for any given period in time, stocks have outperformed all other asset classes, including real estate.
So why take out huge mortgages to buy homes when we could just rent our housing and invest all of our money in the stock market? The answer: leverage. The Securities and Exchanges Commission regulates that a person cannot buy stocks using more than 50% of borrowed funds. In other words, if I have $10,000 in cash, I can, by law, purchase no more than $15,000 in stocks. Fair enough. But now consider what the same $10,000 can buy you in a housing investment. During the past few years, people could put down $10,000 to buy a $100,000, $200,000 or $300,000 home. In some cases, lenders didn’t even require a down payment at all. Imagine if a stockbroker let you buy $100,000 worth of stocks without putting down a dime!
Not only does the stock market provide historically better returns than real estate, but also is a liquid market with extremely low transaction costs. If I wanted to liquidate an entire stock portfolio on Monday morning, I could do it with no more than a few clicks of a mouse. The full trade (buying and selling) would cost me about ten bucks per stock (hedge funds, and other big investors have a more difficult time liquidating huge positions, but for individuals with less than $1 million invested, I highly doubt they would experience a problem). Real estate, on the other hand, is a very illiquid market. If I wanted to sell a house, I would have to pay a broker (or endure the cost of selling it myself), show the house to prospective buyers, and wait. A house could potentially sit on the market for months or more, especially given the supply of housing stock that exists on the market today.
When I opened a stock and option trading account in 2007, I had to fill out what seemed like endless paperwork. I had to document what I did for a living, what my annual income was, how I earned my income, etc. I had to sign page after page of legal jargon indicating that I fully understood the risks associated with trading leveraged products. When my application was initially denied, I called the broker and got a 15-minute lecture about the risks of trading leveraged products, before my account was finally opened.
This amazes me in light of the fact that in the housing market, lenders were literally giving money away, to the point where people didn’t even understand why they were getting money or at what terms. The story about what happened to Addie Polk in Akron, Ohio, is a quintessential example of how easy it was to borrow money and how aggressive predatory lenders were in pushing credit onto people who were completely unqualified for it.
I’m not suggesting that we ought to go out and apply hyper-leverage to stock investing; but the whole situation raises interesting questions about why we are so emotionally attached to homes. Presumably, since homes are real, physical assets, people feel more comfortable in the idea that they will be worth something at any given point in time. Stocks, on the other hand, are just pieces of paper (or electronic text), you can’t touch them or feel them. Granted, it is true that stocks often go into “bear market” periods; but housing, as we have seen, can suffer from the same phenomenon. Stocks are often considered risky because companies can fail, and short of a house burning to the ground, it will always hold some value. While it is true that some companies will fail, investing in an S&P 500 fund, for example, would be a reasonable long-term stock strategy. The entire economy would essentially have to fail for the S&P 500 index to approach zero.
In the end, home ownership isn’t all about investing and building equity. We seek out homes primarily for living. In the second part of this series, I question whether home ownership makes sense for individuals in today’s fast-paced world. What should be clear, at this point, is that whether or not a particular investment is objectively ‘risky’ or not, how we present risk to the public has a huge impact on their behavior.
See Also:
Part Two: How Desirable is Home Ownership?
Part Three: What the Academic Research Shows
Part Four: Costs and Benefits to Society
Great Blog, insightful, & well written. I’m looking forward to reading more from you.
Thanks,
Darrell
http://www.AlwaysMakingMoney.com
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This is an EXCELLENT article.
Suffice it to say, I think the desire to extend homeownership to those who don't need/want/should have it has been a disaster.
Renting is SO much better for many people, but from a standpoint of living though, buying a home has become almost the only way to get a place in a "decent" area. At least where I live, rental is either way too expensive for crappy construction, or cheap because it's in bad areas.
I hope the current housing crisis can lead to profitable, good but not expensive rental solutions.
No question about it -there are tons of benefits to renting, not the least of which is freedom to leave when your lease expires. And there are TONS of nice places to rent in the Cleveland area, which is a bonus. I've rented nigh unto 15 places since I turned 18, and the one thing I am NOT looking forward to in becoming a homeowner is the part where when the pipes burst, YOU have to get it fixed - you can't just call the landlord. Of course it works the other way too - if your landlord's a jackass and doesn't like to fix things.
I think most of the people who weren't sophisticated enough to understand adjustable rate mortgages might not be sophisticated enough to understand the stock market either. I hate using that term - sophisticated - but financial stuff is really complicated and even for smart, educated people it can be a real headache to puzzle out. Just speaking for myself, I've always done well enough by plain old frugality, with my money in the financial equivalent of a sock.