By Kevin Estes

The American Dream

“Home” has many connotations.

Home is where the heart is.

Home is a place of warmth, comfort, and affection.

There’s no place like home.

Home is a state of mind - a place of security and belonging.

It may or may not include a stereotypical:

• white picket fence,

• grill, and

• backyard with a dog and 1.94 children.

In many parts of the country, buying a home grants access to a great public school system.

Buying a home locks in a lifestyle. But is it an investment?

Survey Says: Yes

A poll I conducted recently on LinkedIn suggests most people do consider a home an investment:

• 52% “Yes”

• 18% “No”

• 31% “It depends”

The poll ran for a week (3/22-3/29/2024) and received 95 votes.

Heavy Government Support

The federal government really gets behind homeownership.

Special Tax Treatment

There are a host of special tax treatments for homeowners. They can:

• deduct property taxes up to the state and local tax maximum of $10,000

• deduct mortgage interest expense on the first $750,000 of debt, or up to $1 million if grandfathered

• exclude up to $250,000 (single) or $500,000 (married, filing jointly) gain on the sale of a home from income tax

• receive the lower capital gain tax treatment

• increase the tax basis with home improvements, which may lower future taxes

• treat depreciation as an expense if renting the home…

Buying Mortgages

The government creates a market for loans by buying them through two quasi-governmental agencies:

• Fannie Mae - Federal National Mortgage Association (FNMA)

• Freddie Mac - Federal Home Loan Corporation (FHLC)

Safety Net

Perhaps more telling than the regular structural support is what governmental agencies do in times of crisis.

Federal Reserve Targets Lower Interest Rates

One of the first responses in a recession is for the Federal Reserve to lower interest rates.

Lower interest rates encourage consumers and businesses to use debt to buy assets. That increases demand for big-ticket items and helps stabilize falling prices.

The federal funds rate has fallen after each recession since 1955:

The federal funds rate is how much big banks charge each other to lend overnight. It’s set by the market but influenced by the Federal Reserve, which uses open market operations to reach its target rate. Please see this page for more.

Great Recession

The U.S. Government Accountability Office (GAO) was tasked with tracking what the government spent in response to the Great Recession of 2007-2009.

Below are some of the GAO’s highlights:

Congress passed the American Recovery and Reinvestment Act of 2009, which included $800 billion to promote economic recovery.

In response to the 2008 housing crisis, the Treasury Department used Troubled Asset Relief Program (TARP) funding to establish 3 housing programs to help struggling homeowners avoid foreclosure and preserve homeownership.

In 2008, the federal government took control of Fannie Mae and Freddie Mac and has continued to maintain this role 13 years later… leaving taxpayers on the hook for any potential losses incurred by the two entities.

The Great Recession also led to the creation of the Consumer Financial Protection Bureau (CFPB). Here’s what that organization has to say about its founding:

In the wake of the financial crisis of 2007-2008, it became clear that the nation needed a financial regulator solely focused on looking out for consumers.

The housing finance bubble and Great Recession were fueled by reckless practices in the mortgage industry, which trapped millions of homeowners in mortgages they could not afford, and Congress created the CFPB to ensure that never happened again.

The CFPB officially opened its doors as an independent agency on July 21, 2011, with a simple message to American families and consumers: We’ve got your back.

What It Was Like

It’s hard for those who weren’t old enough to appreciated the magnitude of the housing crisis. It was a scary time.

People were “underwater” on their mortgages. A friend of mine essentially tossed his keys to his lender and walked away - trouncing his credit in the process.

I went to a closing for a few properties where the previous owners brought over $100,000 out of pocket. They owed that much more than the sale price.

Government support kept most financial institutions in business. It was a serious threat to the economy.

The sad thing is the home prices didn’t drop all that much. Based on quarterly economic data, the median home sales price fell 19%:

• from $257,400 in January 2007

• to $208,400 in January 2009

However, millions of people lost everything they had in their home due to leverage.

Fortunately, real estate recovered and now looks like a mere blip.

A Big Part of Net Worth

A reasonable response I often get goes:

But homes are the largest portion of net worth!

That’s true. However, it’s worth a deeper dive.

Real Estate is About 27% of Net Worth

According to the Federal Reserve, real estate was the largest component of net worth as of the fourth quarter in 2023:

• 27% real estate

• 24% corporate equities and mutual fund shares

• 19% pensions

Many pensions are invested in “corporate equities and mutual fund shares” so it’s likely more of consumers’ net worth is invested in stocks than real estate.

Why So Big

It’s still worth exploring why real estate represents such a large percentage of consumer net worth.

1. Home purchases typically require a 20% downpayment.

That cash adds immediate equity to the home.

2. A home is typically a household’s single largest asset.

Simply multiplying inflation by the biggest asset could result in the largest dollar gain.

3) Home purchases are often leveraged 5x.

Viewed another way, a 20% downpayment is 5:1 leverage.

Unfortunately - as many learned during the Great Recession - that lever works both ways. Fortunately, homes become less leveraged as mortgages are paid down.

Shrinks with Wealth

Real estate falls as a percentage at higher wealth levels.

It makes up:

• > 50% of net worth for those in the bottom half of wealth

• 38% of net worth for those in the 50-90%

• 24% of net worth for those in the 90-99%

• 16% of net worth for those in the 99-99.9%

• 9% of net worth for those in the top 0.1%

Pretend It’s an Investment

Let’s presume a home is an investment. What are some of its features?

Land in Limited Supply

With rare exceptions, land is fixed.

It’s the classic example of what economists call “inelastic supply” - higher prices can’t materially increase acreage!

All else equal, rising water levels would reduce the supply of land. Continued “greenfield” housing development gobbles up farmland, further driving up land values.

Land tends to at least hold its value. Accounting practices acknowledge the value of land. It can’t be depreciated!

However, land is generally much less valuable than the structure resting on it.

Location?

There’s an old saying:

The three most important things in buying real estate are location, location, and location.

However, chasing the hot dot can burn people.

The tech hub of America - the Bay Area - of 100 years ago was Detroit.

According to Business Insider, the population of Detroit spiked:

• from just over 285,000 in 1900

• to over 1.5 million by 1930.

Since then, the area’s fallen on hard times. Property values have plummeted.

Outrageous Fees

Here’s what home expenses might look like:

• 2-5% front-end load

• 1-3% annual expenses

• 6%+ back-end load

The 2-5% of front-end expenses are for things like:

• home inspection

• credit check

• title search

• origination

• underwriting

• mortgage points

The 1-3% ongoing expenses are for:

• property taxes

• homeowners insurance

• maintenance

• repair

A broadly diversified stock portfolio might earn that much in dividends each year.

The 6% (or more) back-end expenses include:

• prepping it for sale

• staging

• closing costs

• real estate commissions

All of this ignores the costs of interest and relocation! For more, check out: Investing in or Betting on Real Estate?

Real Estate Performance

It’s surprisingly difficult to compare the growth of real estate with that of investments like stocks.

Home Growth

Houses have literally gotten bigger!

According to the U.S. Census, the median square footage of a new single family home completed grew over 50%:

• from 1,525 square feet in 1973

• to 2,299 square feet in 2002.

Higher Price Per Square Foot

Fortunately, house values have grown faster than square footage:

• Median House Square Footage grew 1.5x

  • from 1,525 in 1973 to 2,299 in 2022

• Median House Sales Price grew 12x

  • from $35,200 to $429,000

(It’s imprecise, as two different data sources were needed.)

That led to an 8x increase in median sales price per square foot:

• from $23 per square foot

• to $187 per square foot

(Just) Beat Inflation

According to the Federal Reserve, inflation caused the price of goods and services to grow about 7x:

• from 44 in 1973

• to 293 in 2022

This is based on the Consumer Price Index for All Urban Consumers (CPI-U). Also, Shelter (housing cost) is a component of CPI-U.

Less Growth Than S&P 500

Over the same time period, the S&P 500 index price grew about 39x:

• from about $98 at the end of 1973

• to about $3,840 at the end of 2022

The index chosen didn’t make much of a difference. I reviewed the historical prices for the Dow Jones Industrial Average (DJIA) and it wasn’t materially different.

Overall from 1973 to 2022, the estimated growth was:

• 8x for the U.S. house price per square foot (excluding costs)

• 39x for the S&P 500 index price (excluding dividends)

Applying those growth rates, the median home in 1973 worth $35,200:

• grew to about $284,569 in 2022 on price per square foot alone

• might have grown to nearly $1.4 million with the S&P 500 index

Potential Growth Rates

For those 49 years, the price growth rates may have been:

• 4.4% in U.S. house price per square foot

• 7.8% in S&P 500 index price (excluding dividends)

However, the difference is likely substantially bigger. As mentioned above, a home might have annual expenses of 2% a year for:

• transaction costs,

• repair and maintenance,

• property taxes, and the like

However, the S&P 500 has paid dividends over the same stretch with very few holding costs. Those dividends may have been reinvested and improved the annual returns.

Others’ Incentives

Stacked Against Homebuyers

Essentially everyone but the buyer has a vested interest in the home selling for more:

• The seller gets a higher sale price.

• The realtors split a bigger commission.

• The bank earns more interest on the loan while they own it.

Remember Fannie Mae and Freddie Mac? Many conforming loans are sold soon closing.

Banks get their cut and move on. It may be helpful to think of lenders as loan marketing and processing businesses.

Fancy Expensive

It’s important to watch out for creative new mortgage offerings.

One example I saw recently - an All In One Mortgage - would likely have cost the borrower dearly over the life of the loan.

For more, check out:
Could an All In One Mortgage Cost an Extra $270,000?

Friends and Family

I hate to say it but it’s important to consider the motives of friends and family members as well.

They have a vested interest in having someone they know have a big, beautiful home. It could become a community gathering place and might even become a place for them to stay if needed!

When we were getting ready to purchase our home “space for people when they come visit” was definitely on the list. The first holiday season we owned our house, we hosted six of my wife’s family members!

It may be helpful to divide the annual cost of the additional space by the number of visits. It might be cheaper to spring for a hotel room whenever they visit!

Long-Term Impact of Undercharging for Rent

Taking it one step further, children who rent a home to their parents often charge less than market return. The financial impact of undercharging for rent can be significant.

Over 20 years with a 7% annual return:

• $200 a month may grow to nearly $108,000

• $500 a month may grow to over $269,000

• $1,000 a month may grow to over $538,000

For more, check out Charge Market Rent and Raise Rent on Parents?

Investment or Not?

Both! I consider a home an investment in a lifestyle.

When factoring in growth in square footage and annual expenses, house prices seem to have approximately tracked inflation over nearly 50 years.

Nonetheless, the decision of whether to consider a home an investment is a deeply personal one. What matters is what you think.

I hope this helps!

If you’re interested in a review of your specific situation…

Disclaimer

In addition to the usual disclaimers, neither this post nor these images include any financial, tax, or legal advice.