On Brett Arends on House Prices

I know I shouldn’t be doing this. I talked about home prices yesterday, and I’ve singled out the Wall Street Journal’s Brett Arends way too many times already. (This will be his sixth mention in this blog. See also one, two, three, four, and five.) I don’t want to give the impression he is exceptionally bad. He’s merely typically bad, but writes often and on topics I like to talk about.

But Arends ran this column yesterday sharing his thoughts on house prices and, well, fish gotta swim and birds gotta fly.

He starts out by mentioning the previous day’s release of the Case-Shiller home price indexes for March. This update, which was, let’s face it, more or less as expected, was “startling” to Arends because of “What the latest data show about the long-term of the real estate market.”

Apparently, this last set of numbers was the missing piece needed to allow Arends to make the observation that since the late 1980s and early 1990s, house prices have only beaten inflation by one or two percentage points a year.

Well, golly.

As it turns out, house prices have roughly tracked inflation over very long periods, at least since the 1890s, never mind the 1990s. I made a nice chart of this in a post a few months ago. I got the data (and the entire idea) from the work of an obscure economist named Robert Shiller, known in certain circles for co-inventing a useful index of home prices. This little-known professor detailed the longer history of home prices in the second edition (2005) of his bestseller Irrational Exuberance, a book widely purchased, if not widely read.

Arends draws from this insight that house prices hug the inflation rate to conclude that “You can often do better on long-term inflation protected government bonds.” And then, as if somebody reading over his shoulder pointed out that owning a house has certain other benefits besides price appreciation, he launched into a defense of ignoring the fact that you can live in a house but not in a bond.

Conventional wisdom long held that home ownership was a route to wealth, and the imputed rent — in other words, the right to live in your home — was just part of the value you got from it. Under that widespread view, the recent housing bust was simply a temporary, though deep, pothole.

I would be the first person to confirm that conventional wisdom did indeed once hold that home ownership was a route to wealth. With the smallest provocation, I can be induced to supply citations showing various mainstream gurus telling their followers to invest in a house. But I am not so convinced that this was a view widely held for all that long. Circumstantial evidence suggests it really kicked in around the mid-1990s, when the recent bubble began. (And, possibly not coincidentally, when the tax laws were changed to favor capital gains on houses.)

But big picture, I would hope it is quite obvious that ultimately the only economic benefit of a house is that it can be lived in. It is a stark illustration of just how crazy things got during the bubble that so many people, apparently including a columnist at the Wall Street Journal, lost sight of that fact.

[Photo: W. Marsh]

Housing, Media, Robert Shiller | Frank Curmudgeon | May 28, 2009 9:00 am

30 Comments

By Steve, May 28, 2009 @ 12:08 pm

I don’t understand why a house is viewed as anything but a perpetuity of lodging. Back in 2007 I had a debate with my coworker about why you would spend more on a mortgage than it costs to rent an equivalent place, and all he would say is “You have to think of it as an INVESTMENT!” Yes, an investment – in a place to live! There are a few other aspects (e.g. you can paint the living room whatever color you want, which does have some monetary value), but it’s all based on that underlying value of “a place to live.”
By maxwellthedog, May 28, 2009 @ 2:41 pm

Actually, there is one aspect of homeownership that has “created wealth” historically. For most people, a house is one of the few real, non-depreciating (ok, very slowly depreciating) assets that they could buy. It has a value that is often a significant multiple of an annual’s year’s pay. And most importantly, you could borrow nominal dollars at a highly advantageous (subsidized) interest rate against it. And because this debt was collateralized by the place where you live, most people did everything they could to avoid defaulting on this obligation.

In a sense, this ended up being a “forced” savings scheme. (So it got people to do something they should have been doing all along.) That is not wealth creation per se, but to the average homeowner who probably could not save a lot beyond monthly expenses, when they went to sell their house, it seemed like found money.

And if you add on top of this the fact that they owned a real asset levered with nominal dollars, then your return is a lot higher than the “inflation-plus” calculation you site.

Of course, likely none of this will hold true for those of us who bought in the past 10-15 years…
By Rick Francis, May 28, 2009 @ 3:02 pm

@Steve,

Comparing renting to owning isn’t simple because there are a lot of extra costs for owning as well as extra tax deductions. That’s too complex to address in a comment!

However, if those differences were gone it would make sense to spend somewhat more to own than the current rate to rent the same home if you believe that the rates of rent will grow higher in the future.

Since inflation tends to be slightly positive in the US (I believe the long term average is ~3.5%/year) it should be a good assumption that rent will increase at that rate.

If you plan to live in the same area for a long time, and the current property values are not far more than current rental rates then locking in your housing expenses makes a lot of sense.

Of course it is really risky to fix your housing expenses at a level you can’t currently afford!

-Rick Francis
By Dave C., May 28, 2009 @ 3:29 pm

I’ve always been a little perturbed by the people who say, “buying a home is the most important investment you will make in your life”. I wished they would say “buying a home is the most important housing decision you will make in you and your spouse/children’s life”.
By Matt, May 28, 2009 @ 9:36 pm

There was a recent Gallup poll about what Americans view as the best long-term investment:

http://www.gallup.com/poll/118300/Savings-Accounts-Real-Estate-Seen-Best-Investments.aspx

Savings Accounts 34%
Real Estate 33%
Stocks/ Mutual Funds 15%
Bonds 12%

Real estate was around 50% in 2002.
By IndependentOperator, May 29, 2009 @ 12:34 am

I think it’s incredible that so many people bought into the constant appreciation line. Why would I sell you a widget for $1 that was going to be worth $1.50 tomorrow? If the asset is appreciating faster than inflation and the cost of capital (as well as alternative investments), why would I sell it to you for the “present value”. Or, more accurately, why wouldn’t the present value reflect the higher appreciation rate? Doesn’t the very fact that it is appreciating so fast and consistently imply that there is a considerable amount of downside risk there?
By Frank Curmudgeon, May 29, 2009 @ 11:36 am

Matt: Thanks for the awesome link.

IO: Get with the program. You would sell me the $1 widget going to $1.50 so you could borrow more money and buy the $2 thing going to $3. Duh.
By Andy lapointe, June 3, 2009 @ 9:46 am

I have a garage and basement full of purchased crap that I never needed when I rented. Throw in lanscaping and gardening costs, taxes and the numerous other expenses that you have as a homeowner and I don’t see a strictly financial benefit to owning a house. If one was financially savvy and concerned only with money, he would rent, invest the difference and retire early. I can attest that my spending on furniture and household goods exploded when I purchased.
By Alfonso, June 4, 2009 @ 3:59 pm

Sorry – where did this guy say living in a house wasn’t the economic benefit?
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