Your home is not an investment. (Or, “Today, we are all Lehman Brothers.”)
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Zillow.com, which tracks home prices nationally, released a report today which concluded that 22% of all homes in America are “underwater”—that is, the homes’ owners owe more on their mortgages than they can sell their homes for.
I could go on and on about what trouble those homeowners are in. Even if they keep up with their mortgage payments, they basically can’t move without negotiating a short sale, putting up thousands of dollars at closing to make up the shortfall, or going into foreclosure.
A ways back, when I was a real estate reporter with the Florida Times-Union in Jacksonville, I remember talking to a homebuilder who made the case that a home was the best investment someone could make.
“In no other investment can people leverage their returns at such a low cost,” he said. (This was several years ago. I’m paraphrasing.)
“Just look at the math!”
Someone buys a $200,000 home with $20,000 down and a $180,000 loan. If the home price goes up 10% and the homeowner sells it for $220,000, he makes $40,000 on the deal. In other words, his return is 100%, even though the market’s return was only a tenth of that.
Sound familiar? It was nearly the same strategy Lehman Brothers used to generate its market beating returns for years.
According to a Bloomberg story written when Lehman went under, Lehman’s ratio of total assets to shareholder equity was 31. To put that in easier terms, it’s as if Lehman had bought a house and only put 3% down. (It’s just the inverse: 1 divided by 31)
Just a 3% drop in its investments completely wiped out Lehman’s equity.
According to Zillow, since last year, home prices have dropped 14%. That means, the average homeowner who put up to 14% down at this time last year has had more than a negative 100% return on his home “investment”. Even if the homebuyer was extremely frugal and put 30% down, his results would still be pretty terrible:
Let’s say he bought a $500,000 home and put $150,000 down. His home is now worth $430,000 after the 14% drop.
Unfortunately, the size of his mortgage didn’t change. But his equity dropped to $80,000. In other words, despite the 14% drop in home prices, his investment’s loss is 47%! (We’re not including monthly payments made between the purchase and the drop.)
That’s the kind of change we didn’t even bother to calculate in 2005, when a large drop in home prices wasn’t on the radar. Home buying is great as a forced savings vehicle. It also has tax benefits, and I’m sure it makes people happy to have a plot of land that can be called theirs. But an investment? To me, the leverage involved makes it one of the riskiest investments you can make.
And no—As a real estate reporter in 2006, I did not foresee that one day the American dream would put 22% of Americans in over their heads.
— Joe Light
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I think the title of your article should have been “Your Home is Not a Piggy Bank”.
I suspect that most of the 22% of people who are under-water on their homes refinanced them and took some equity out. There are definitely some unlucky people who bought at the market peak, but many have hosed themselves and it’s a shame.
As for a home, I think it can be one of the best long-term investments, when purchased wisely. Leverage is only one of about a dozen reasons that can make a home a great invesment. Tax benefits, inflation and usefulness as a dwelling come to mind.
Real Estate is risky, like any investment. But, it has value as a real asset, unlike our curency and the securities on our exchanges.
Thanks for visiting and for the comment.
If we were back in 2007, when home prices were only down a few percentage points, I’d agree with you that it was the no-money or low-money down people who were going underwater. But a 14% drop in the last year (22% since the peak) catches a much wider swath of homebuyers. And that’s just the average drop—drops in places like Miami and Las Vegas have been much steeper.
I didn’t address the average long-term appreciation rate of real estate here, but I believe Yale prof Robert Shiller has measured that it about keeps pace with inflation. I agree that a home has lots of benefits, which you mention. But in my mind, an “investment” is something you buy with a reasonable expectation that it will earn you money. It doesn’t look like homes fit that bill.