Housing -- Good or Bad Investment for the Little Guy?

With housing prices falling sharply in some areas of the country and stagnant on most others, many people are beginning to wonder if that traditional symbol of achieving the American dream -- home ownership -- is a wise investment. The Washington Post business section on this gray and gloomy Sunday in the nation's capital weighs in with a front page story from which casual readers will draw that incorrect conclusion. It is based on an incorrect assumption: that stocks have provided higher returns than housing over the long-term.

The story is accompanied by a chart from the National Association of Realtors comparing investments of $48,700 in either the median home or a Standard & Poor's 500 index fund in 1978. According to the chart, over the next 30 years that home would have appreciated 347 percent to $218,000. The basket of stocks, on the other hand, would grown a stunning 1,438 percent to $749,000.

That's an average annual return of 5.3 percent for the house, barely ahead of inflation, compared to nearly 10 percent for stocks, according to the chart. Slam dunk for stocks, right?

Alas, the author and the Post editors left out the critical factor in evaluating any investment: how much capital is actually invested to earn those returns. A typical homeowner in 1978 (and we're rapidly returning to those days of typicality as the financial finagling in home mortgage markets gets swept away) put 20 percent down on a home and took out a mortgage for the rest. So for that $48,700 house, the actual amount invested was $9,740; with closing costs, it can be rounded to a neat $10,000.

Let's forget for a moment that this homeowner over the years also got a substantial subsidy from the federal government for the interest paid on his mortgage. Let's also forget about the taxes paid on the dividends and capital gains earned from the stocks. (These factors are mentioned near the end of the story, just like the debt-to-equity issue, but neither are factored into the front-page chart calculation).

If we only look at the return of the house compared to the initial investment, we get a percentage increase of 1,690 percent. That's 200 percent more than the return from stocks.

It's testimony to the power of leverage, and homeownership remains one of the few areas in life where average people get to exert its almost magical powers. (You can buy stocks on margin, too, but few individual investors do since most invest through mutual funds.)

Of course, leverage has an equally powerful effect on the downside. When home prices plunge, equity in a home can quickly be wiped out. That's what happened to families that bought overpriced homes at the peak of the bubble with highly leveraged or no-equity loans.

But that's a relatively small sliver of the market. For most people, homeownership remains their number one source of household savings, and will remain so for the foreseeable future. It's almost shocking that a major American newspaper could so fundamentally misrepresent these basic realities of household finance.

Posted by gooznews at April 27, 2008 12:58 PM