What is it that makes us all just a little crazy when it comes to houses? It’s no exaggeration to say that many (or most?) of us make house buying a central part of our vision for financial and personal success. We fantasize about our dream homes. We furtively check Zillow each month to see if our ‘Zestimate’ has inched upwards. We sneak into our neighbors’ open-houses, even when we’re not in the market (or maybe that’s just me…). And of course, there is an entire genre of reality TV shows designed to fulfil our desire to peer in, voyeur-like, on couples making life or death real estate decisions. We’re obsessed. And like many unhealthy relationships, our house dreams are often built on unrealistic expectations.
We expect those humble walls of timber and sheetrock to be our homes, our status symbols, our outperforming investments, our ATMs, and our retirement kitty – all at once. It’s a monstrously large responsibility for a single asset. No wonder they fall short. Poor houses… we ask too much!
If you really want to hear from a hardened curmudgeon on this topic, we recommend JL Collins’s blog post “Why your house is a terrible investment” or James Altucher’s hate letter to home ownership. Both of those posts are thought provoking, if a little hysterically one-sided. In truth, many people benefit financially from owning a home, but not necessarily for the reasons they expect.
The fact is that in most places, and over the very long term, home prices don’t increase much beyond the rate of inflation. The value they accrue to us individually is primarily related to the equity we build over time, and therein lies the trick. Being a homeowner imposes a form of monthly savings on us through principal repayment over time. Anything that takes money out of our weak little hands and steers it reliably into a form of savings will have a powerful positive impact on our net worth over time.
For most of our clients, home ownership makes good financial sense. They’re unlikely to move, have conservative investment profiles which limit the opportunity cost of not investing in other assets, and they enjoy access to low cost mortgages. But that profile doesn’t describe everyone. If you live in a place with high home prices, require geographic mobility in order to secure upward mobility, and have an aggressive long term investment profile, you might be better off renting. And what about the intangibles: security vs freedom, predictability vs flexibility? You can’t quantify everything. We’re here to help you integrate all of these considerations into a clear-minded decision that dovetails with your long term financial plan.
Finally, while we don’t think in speculative terms when it comes to housing, we all need something to discuss at cocktail parties. So, where are house prices heading next? Our view is that the next few years will see a softening of house prices (on average) across the US. Years of above trend-price appreciation fueled by low mortgage rates and our collective recovery from The Great Recession are now pushing home prices out of reach for an increasing proportion of new home buyers. So far, buyers haven’t been put off because mortgage rates remain low and animal spirits are alive and well. However, as and when mortgage rates increase, affordability will decline precipitously.
The next generation of home buyers is shouldering record amounts of student and auto loans, meaning for transactions to continue to happen, prices will eventually have to fall. We don’t forecast a large or immediate drop in home prices, but rather a decline in real terms over the next few years. Volumes (the number of home sales) are already falling and that is often a signal of a turning point for prices. Time will tell!
For more views and insight, see our 1Q 2019 letter. We describe how Paladin thinks about housing in the context of client portfolios, provide a framework for assessing whether or not to pay down your mortgage, and outline our latest views on markets in general. If you would like to obtain a copy, please contact us at firstname.lastname@example.org.