Maybe Treating Housing as an Investment was a Colossal, Society-Shattering Mistake
I.
Alice is considering buying a house.
Alice lives in Littleton, Colorado. While she hasn’t decided whether she will buy or rent, she knows she wants a house, not an apartment or condo. In a stroke of great fortune, she finds two eerily identical but beautiful houses on the same block. The only difference: one is for sale, and one is available for rent.
While Alice is an incredible, unique person, her housing desires are exactly average. As such, she’s relieved to learn that both houses are exactly at the median price point. The house for sale costs $703,000 — the exact median house price in Littleton — and the house for rent costs $2,950 a month — the exact median rent price for a house in Littleton.1 She loves both houses. The only question: is it financially smarter to buy or rent?
Alice assumes she should buy, since she is the target demographic for getting a mortgage. She’s diligently worked a steady job for 10 years, gotten promoted, and accumulated a healthy pile of money into a savings account. Not an extravagant pile; she can’t all-cash-offer a new house. But enough for a responsible 20% down payment. She’s married and just gave birth to her darling child, Alice Jr. They’ll live wherever they move for the next 18 years, until Alice Jr. goes to college.
Even though Alice is the target demographic for buying a house, she tells her partner: we should do the math to be sure that it makes sense financially.
And by do the math, she means use the NY Times calculator for deciding to rent or buy. She plugs in the numbers: $703K total cost, 20% down payment, 30 year fixed rate mortgage at 7%, live there for 18 years, assume the stock market returns 7% annually, and assume the Fed gets its act together for 2% inflation.2
With those fixed, Alice notices wow, changes in housing prices make a huge difference. (For simplicity, assume home prices and rent rise or fall together, at the same rate.) A few scenarios:
Housing prices rise dramatically. President John Nimbyism wins in a landslide and decrees no new homes can be built, leading housing prices to rise 6% annually. After 18 years, the price of Alice’s house nearly triples. The whole process of buying (and at the end, selling) the house costs Alice ~$1.1M. By buying instead of renting, Alice saves $600K. Thanks to the money saved, Alice can afford to send Alice Jr. to future-Harvard, which has jacked up tuition to $150K a semester by then.
Housing prices rise moderately. Housing prices rise 4%. Alice’s home value doubles, but she’s only barely better off buying. Over 18 years, renting would have cost her a few tens of thousand dollars. She’s grateful she bought, but her life wouldn’t be much different had she rented.
Housing prices only keep pace with inflation. America realizes it totally forgot about a few million homes it built, greatly expanding supply. Housing prices rise only 2%. Alice is much, much worse off for buying. In total, buying costs ~$1.75M, where renting would have cost her ~$1.3M. Because her finances were tied up in the house while the home value has gone up so little, Alice has minimal savings. Her daughter receives some financial aid, but takes on hundreds of thousands of student loan debt to go to college.
Thinking through these scenarios, Alice feels awkward. Before buying a house, she was worried about housing affordability. She balked at rising rents. She has friends who commute 2 hours each day because they can’t afford housing near them. She hated how expensive homes were, how unlivable her city had become.
But now, if she buys a home, she needs housing prices to keep going up to make her decision financially sound. And not just go up, but outpace inflation and — almost certainly — wage growth. Otherwise, she's cost herself hundreds of thousands of dollars. For buying to be worth it, she needs the price of her home to double.
Alice wants to own a home. She wants to paint the walls a color she likes, to lay down new hardwood floors, to put in effort without feeling like she’s stupidly doing the landlord’s work for them. She wants a place that’s hers.
But she hates the idea that to do so, she needs to root for her home price to double. She hates that once she buys a home, she needs homes to become less affordable.
II.
I hear advice from the older generation that “buying a house is an investment”.
On one level, I get that. Buying a house is a better way to spend money than renting, because at the end, you have something. You have a whole frigging house.
On another level, I think that the idea that home prices should outpace inflation is insane and maybe has broken modern society.
When you invest in a company, you expect the stock price to rise because the company becomes more productive. It hires employees and buys resources to develop technology, improve processes, and eventually produce more widgets, services, or addictive digital videos. The company becomes worth more because it has generated, and can generate, more.
When you invest in a home, you expect the price to rise because *shrugs* it just does.
Some people say home prices rise because of “sweat equity”, i.e., the work homeowners do improving the house.
With all due respect, this is a crock of shit. Yes, if a homeowner spends a bunch of time and money improving their house, the price of the house will rise more than the cost of the improvements. But a tasteful new countertop and shiny appliances don’t double the value of the house.
Moreover, houses are pretty much the only physical good that are expected to 1) appreciate in value, and 2) be used all the time. Oil paintings and Faberge eggs appreciate in value, but they’re put behind glass cases so that they remain in the exact same state they were in when purchased. Tellingly, they appreciate in value not because they’re useful but because they’re rare.
All other physical goods — cars, beds, furniture, appliances — lose value with time. Your car loses value the moment you drive it off the lot. You can’t sell a couch on Craigslist, charge double the retail price, and claim “It’s worth more because I put a lot of sweaty equity into this baby.” You use it, it takes wear-and-tear, and you resell it at a discount.
Meanwhile, housing gets tons of wear-and-tear. You move furniture around and it scuffs up your beautiful hardwood. A water pipe breaks and floods a room, and it takes months to fix the water damage. Your kid decides indoor baseball-hockey is gonna blow up and slapshots a baseball through a window. And yet, the price of your house goes up.
In this way, our expectations for housing are bizarre.
In other realms, we expect new versions of consumer goods to 1) do more than their old counterparts, 2) be cheaper relative to inflation, or 3) both. Cars can now instantly show where they are and find directions to anywhere. A fraction of a standard modern television screen has higher resolution than the best TVs 30 years ago. Despite those improvements, cars and televisions (and furniture, and apparel, and just durable goods in general) have all gotten much cheaper on an inflation-adjusted basis over the last 30 years.
Meanwhile, for housing, we expect that a 40-year old house with a bunch of renovations is somehow worth more than it was when it was built. We’d be surprised if it weren’t.
It’s worth more because, like oil paintings and Faberge eggs, it’s rare.
When my parents — lovingly but prematurely — gave me advice on buying a house, they said: choose based on the neighborhood. Was it up-and-coming? Would more people be moving there? Would the neighborhood go up in value over the next 10-20 years?
And that reveals the true nature of housing prices. It’s not about the house, it’s about the location. Housing prices rise where more people want to move, but not enough houses are built to accommodate them. Aggregate housing prices do not rise because everyone’s retiling their bathrooms. They rise because the new demand outstrips the supply.
The current regime of “housing as an investment” rests on the idea that rising housing prices are good, because they generate wealth. And sure, a homeowner whose house value is rising fast enough is getting wealthier.
But it’s a fake version of wealth generation. The majority of the higher value comes from demand outstripping supply. Little actual value is being created, only transferred. Those who own houses gain wealth at the expense of the people who don’t, either through higher prices when buying or renting.
Real wealth generation should create value. It should create more goods, more services, more capabilities to do things we couldn’t before. But there’s minimal new value reflected in the rising house prices. Sure, there’s your sweat equity. But most of the house value is just “more people want in, and there’s nowhere to put them.”
For that reason — and I don’t wanted to come off as a polemicist here, but I gotta be honest — it’s not crazy to compare “housing as an investment” to a pyramid scheme. A pyramid scheme transfers money from the latecomers to the earlier adopters, often behind the facade of an allegedly amazing product. And while, according the proponents of the pyramid scheme, that product is the real wealth generator, very little wealth is being created. Instead, it’s a little bit of value creation and a whole lot of wealth transfer.
Again, not a polemicist, but that does describe the housing market pretty well. Specifically, a generational pyramid scheme in which the older generation got in early because they had the crucial advantage of being born before everyone else. With limited housing supply but more demand, housing prices rise, and the younger generation has to pay more.
Worst of all, for this to work out for them, new buyers like Alice need later generations to buy their homes at even higher prices. Just like a pyramid scheme, the only way newer members break even is for even more people to pour their money into the same system.
III.
That all said, I sympathize with those who advocated for housing as an investment. They didn’t do it with malice; they didn’t intend for it to become a pyramid scheme. Quite the contrary — they thought (and still think!) it’s a good thing, that it helps people.
In the US, a majority of homes (66%) are occupied by their owners.3 Moreover, homeownership is the largest source of wealth for Americans, making up 26% of all US wealth.4 And the poorest homeowners have the greatest proportion of their wealth tied up in their homes.5
It’s easy to see how rising home prices might be a good thing. If most American families own homes, have a ton of wealth tied up in their homes, and the poorest homeowners have the most tied up in their homes, then rising home prices will help most Americans, increase the biggest source of wealth, and help the poorest homeowners most of all. That’s a political platform you can get behind.
So rather than trigger alarm bells, steadily rising home prices were applauded. They meant people were getting wealthier; they meant people were lifted out of poverty.
Honestly, if I were an adult 40 years ago, I would have thought this.
But from where we are now, home prices forever growing faster than wages and inflation seems… really bad.
The poorest homeowners may have the greatest proportion of their wealth tied up in their homes, but the bottom half of Americans (by income) are overwhelmingly less likely to own homes than the top half.6 As housing gets more and more expensive, that bottom half is less and less likely to ever own a home. Worse, more expensive homes drive up rents, meaning those who don’t own a home spend more on rent, and can’t even save up enough money to invest in anything, much less housing. Those forces together widen the chasm between homeowners and the renter underclass.
So if your goal is to lift up the poor with rising home prices, it’s a losing game.
Also, limiting upward mobility for a third of society is a problem.
Idealistically, people should have the opportunity to flourish. But with average home prices at exceeding half a million dollars, it takes a while to save enough to buy. Even a 30-something who has held down a good job, gotten promoted, and not eaten avocado toast or whatever may still be unable to afford a house. They see that they’re stuck, that housing will devour their income. From a humane standpoint, that’s not great.
But even from a pragmatic standpoint, this situation is a recipe for instability.
People with nothing invested in the current system have no reason to uphold it. Millennials and Gen Z love Bernie Sanders and AOC because they talk about throwing out the system. If that sounds destabilizing, remember that Bernie Sanders and AOC are still normal candidates following all the normal rules of our political system. They throw the word “revolution” about, but really, they just want people to vote for them the normal way. If housing gets drastically more unattainable and the renter class has even less invested in the system, they might support people who have more interest in guillotines than ballot boxes.
I don’t think there’s a clean way out. As much as I want housing to be affordable, plummeting housing prices wouldn’t be great for societal stability either. While the rich are more likely to own homes, tons of middle class and poor people also bought homes and planned their lives under the assumption that housing prices would go up. Tanking housing prices would destroy their trust in the system that they bet everything on.
By setting the expectation that housing prices rise like a stock portfolio, we’ve created an unwinnable situation.
Homeowners expect their home prices to rise. In some cases, slowing home prices will legitimately make their lives much harder.
Meanwhile, renters are desperate. They’re begging for housing prices not just to slow, but to fall.
And that’s what worries me most: whatever policy we pursue, I see no way both sides thrive. Treating housing as an investment has made it so that for one side to succeed, the other must pay.
Justifications for these numbers: both NerdWallet and Bankrate listed the average 30 year fixed mortgage rate is as 6.95%, so rounding to 7% for simplicity.
The SP 500 has risen 9.87% annually (not adjusted for inflation) since 1993, so I might be lowballing there. I err on the conservative side because lower stock appreciation makes it less crucial for housing prices to rise. I don’t want it to conclude “there’s a lot of pressure for housing prices to rise” if that’s only because of ambitious assumption about stock appreciation.
Sourced from “Homeownership rate in the United States from 1990 to 2022”, Statista.
Sourced from Figure 3, “Effects of Asset Valuations on U.S. Wealth Distribution”, Federal Reserve Bank of San Francisco.
Sourced from Box 7, Figure A, “Changes in U.S. Family Finances from 2016 to 2019: Evidence from the Survey of Consumer Finances”, Federal Reserve Bulletin.
The math fails to account for mortgage interest deduction on income taxes, and for increases in rent prices. Let's look at scenario 2 again. Alice, who can afford a $700k house, probably makes $100k+ per year and therefore her income is taxed by the federal government at the 24% marginal level. Her monthly payment on a 30-year loan principal of $562k at 7% is $3742. Over 18 years, she pays over $600k in mortgage interest. If this is deducted from her taxable income, she pays ~$150k less in taxes over those 18 years. This is a lot more than "a few tens of thousand dollars" over 18 years, rather it makes her save nearly $10k more per year. Her savings would increase even more if we account for higher earnings, increases in rent over 18 years, and state tax benefits.
I'd be more persuaded to read the rest of the article if the math added up, but unfortunately it's not realistic. You paint a worse picture for home ownership than it deserves.
Great post!