Author Topic: House ownership as an inflation hedge and forced savings vehicle - NOT  (Read 3483 times)

milliemchi

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I know already that the house is not really an investment. It has been stated that the prices rise approximately with inflation, so it's more of an inflation hedge, as well as a type of forced savings. However...

1) I have also come across the rule of thumb that one should budget about 1% of the property value for ongoing maintenance. This would mean that real return would be 3% of average inflation - 1% ongoing maintenance = 2%. OK, so we're already behind.

2) With somewhat of an embarrassment at taking 12 years of home ownership to realize this, I have realized now that to keep property values, one needs to periodically upgrade, at the very least, bathrooms and the kitchen.  Working with numbers in our area, it would take an estimated $50-70K in today's money for a kitchen and 2 full bathrooms in our area. If upgrading every 30 years, one would need to set aside a couple of grand or such every year, in accessible money, or about 1%. Take 2%-1%... and we're now down to 1% real annual growth for property values - way behind inflation.

I know that the value of owning is in not paying rent, first and foremost, with the added benefit of having equity at the end of the 20-30 years to pay the mortgage. So, it's still obviously beneficial to own. But now, I don't understand the statements that owning property is an inflation hedge. Forced saving, perhaps, at today's interest rates, but if savings accounts and CDs pay 1.5% or more typically, even that claim does not hold.

Any comments?

maizeman

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I'd say that you cannot set aside the value of not paying rent when calculating the return on investment of owning property. Say you live in an area where the 1% rule* applies to real estate. That means you're starting out plus 12% per year from the money you're saving on rent. Now you're probably paying 3% interest on a mortgage for the value of the house, so let's drop that to 9% per year. Now drop off the maintenance costs you brought up above, another 1%: +8% return. Now the value of home upgrades every 30 years, another 1%: +7% annual return, just assuming the cost of housing keeps up with inflation.

That's a back of the napkin estimate, but it feels about right at a gut level. Having a house isn't a particularly great investment, but neither is it particularly worse than investing in the stock market (assuming you'd otherwise be renting another house of equivalent size and quality which doesn't seem to be the case for many people). 

As for the discussion about inflation hedges, you have to think about cash flow, not net worth, and break out of the assumption that the world of 2-3% inflation that we've seen the last couple of decades is the way the world will always be.  If you bought a house with a $1,000 buck a month mortgage in 1973, a decade later in 1983 you were still paying $1,000 bucks a month to have a place to live. Your buddy to rented the identical house across the street for $1,000 bucks a month was paying $2,243/month in rent a decade later.

Take 2%-1%... and we're now down to 1% real annual growth for property values - way behind inflation.

Not important to this conversation, but I think you may be mixing up "real" and "nominal." If inflation is 3% and something is growing at 2% less than inflation, its nominal growth is 1% and its real growth is -2%. It's confusing because you'd think real would mean actual dollars and it doesn't, it means inflation adjusted dollars.

*This states that the monthly rent on a building should be at least 1% of the total value of the property for it to make a good rental. May or may not apply depending on where you live.

Cranky

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Home ownership is a hedge against inflation if you stay put. (I can't speak to the value of selling, as I live in an area where property values haven't much increased.)

If you buy the home you can afford, you lock in your housing costs, though you do have to account for property taxes and basic maintenance. This is clearest over the long haul, as rents will continue to rise and your housing costs will remain stable. Over the life of your mortgage, your costs are stable and then fall sharply, while rents will steadily trend upwards.

I think it's a mistake to think of your residence as an investment, but it's useful to think of it as stabilizing your housing costs over a long period of time. When you think of it that way, then any upgrades you make are for your own benefit and entirely discretionary. But you need to be thinking about 20 - 30 years or more, not 5 years.

Ebrat

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I generally think of my house as a place to live, not an investment (paying for quality of life). But another consideration is leverage. Say you live in a house that's worth $100,000, but your equity is $50,000, and its price increases 2%. The value of the house goes up to $102,000, and your equity goes up to $52,000. That's a 4% increase in equity. At $25,000 equity, you're looking at an 8% increase in equity ($25,000 to $27,000). Your numbers are assuming you own the house outright. Of course, the other side of the equation is that you're paying interest on what you owe...

AlmstRtrd

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Housing is complicated when looked at in investing terms but, in general, there are certain hard assets that will do well (for example, housing and gold) when inflation is high and stocks are unable to keep up. The 1970s and 2000s are the most recent examples. When inflation is low - usually when politicians are not actively trying to debase the USD - stocks will knock the socks off everything else.

Just because these hard, "inflation" assets only have a low real, long-term rate of return doesn't mean that they can't kick in and mitigate portfolio drops when the USD is stressed.

A passive investor who can't deal with a bad decade is probably wise to deploy assets over a broader range of asset classes. The downside to that approach is that a balanced approach won't keep up during a raging stock bull as we had from from 1982 to 1999, and again from 2009 through the present.

Just my two cents worth, obviously.

trashmanz

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I know already that the house is not really an investment. It has been stated that the prices rise approximately with inflation, so it's more of an inflation hedge, as well as a type of forced savings. However...

1) I have also come across the rule of thumb that one should budget about 1% of the property value for ongoing maintenance. This would mean that real return would be 3% of average inflation - 1% ongoing maintenance = 2%. OK, so we're already behind.

2) With somewhat of an embarrassment at taking 12 years of home ownership to realize this, I have realized now that to keep property values, one needs to periodically upgrade, at the very least, bathrooms and the kitchen.  Working with numbers in our area, it would take an estimated $50-70K in today's money for a kitchen and 2 full bathrooms in our area. If upgrading every 30 years, one would need to set aside a couple of grand or such every year, in accessible money, or about 1%. Take 2%-1%... and we're now down to 1% real annual growth for property values - way behind inflation.

I know that the value of owning is in not paying rent, first and foremost, with the added benefit of having equity at the end of the 20-30 years to pay the mortgage. So, it's still obviously beneficial to own. But now, I don't understand the statements that owning property is an inflation hedge. Forced saving, perhaps, at today's interest rates, but if savings accounts and CDs pay 1.5% or more typically, even that claim does not hold.

Any comments?

Well if you live in a HCOL area, 1,000 a year is really more likely closer to 0.1% of home value.

Viking Thor

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If owning housing was not a good deal financially, there would be no landlords.

When you own a home on average you make out much better than renting in the long run (key words are long run and on overage). Of course there are tons of assumptions and people can skew the numbers to support any case, but the industry of people making good money owning rentals is pretty good evidence that owning is financially better than renting.

dividendman

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I generally think of my house as a place to live, not an investment (paying for quality of life). But another consideration is leverage. Say you live in a house that's worth $100,000, but your equity is $50,000, and its price increases 2%. The value of the house goes up to $102,000, and your equity goes up to $52,000. That's a 4% increase in equity. At $25,000 equity, you're looking at an 8% increase in equity ($25,000 to $27,000). Your numbers are assuming you own the house outright. Of course, the other side of the equation is that you're paying interest on what you owe...

Leverage works both ways.

lostamonkey

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Home ownership is often better than renting if the following factors apply:
-You are staying in the home for an extended period of time
-The fundamentals are good. Namely the house is priced appropriately given rents and incomes in the area. Since the housing market is very inefficient, this is often not the case

There are two ways you make money for owning a primary residence:

1. Imputed rental income: The income is the difference between fair market rents for an equivalent property and costs of ownership for your property. These cost of ownership includes periodic maintenance and upgrades. This income generally increase over time since market rents increase while cost of ownership stay fairly consistent.

2. Capital Appreciation: Generally speaking house prices increase at the same rate as wages increase. Since most people leverage a lot to buy homes, these gains can be significant.
For example lets assume you bought a $500,000 property with 20% ($100K) down (let assume a interest-only mortgage for simplicity). If this property increases in value by 3%, you just made $15K or a 15% return on your money invested.
If the value of the property decreases, the effect of leverage makes your paper losses bigger. Another issues with capital appreciation is you don't actually see the cash until you sell. And if you want to stay in the area, and live a similar lifestyle you will have to pay a similar amount for a new property.

ClovisKid

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If owning housing was not a good deal financially, there would be no landlords.

When you own a home on average you make out much better than renting in the long run (key words are long run and on overage). Of course there are tons of assumptions and people can skew the numbers to support any case, but the industry of people making good money owning rentals is pretty good evidence that owning is financially better than renting.

There a three things, in my experience, that *could* make landlording as profitable or more profitable than the stock market:
1)  Leverage (with no margin calls)
2)  Tax benefits (which is mostly a timing game - deduct depreciation from current income and  then pay lower capital gains tax later... among others)
3)  Timing (same as with any investment

With equities, you still get #1 (with risk of margin calls) and #3, and the choice to keep mostly in long term capital gains for #2.  With landlording, you get a job and stress with it.  It's difficult or way less profitable to "set it and forget it" like an index fund.  One can, of course, hire a management company.  However, I'm pretty certain that you won't beat the stock market long term with the latter.

Overall, I view real estate as a lower risk investment with a lower return, and generally more work and stress.

Greystache

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #10 on: April 03, 2017, 10:33:23 AM »
As others have stated, it is an inflation hedge because your home's value increases over time, while mortgage costs are fixed. Once you pay off the loan, your only housing costs are utilities, taxes, insurance and maintenance.  I would also challenge the assumption of 1% per year for maintenance.  It is probably a good number for low cost of living areas, but in my neighborhood, most of the value of my home is due to the land and not the structure itself. In my particular example, I paid $200K (only 5% down) 23 years ago. For most of the time that I was paying off the loan, my housing costs were the same as or less than the cost of renting a similar house.  Now that my house is paid off, my house is worth $600K and my monthly housing costs are about $500/mo.  Rent for a similar house would be north of $2500/mo. and rising at a 7% per year according to a recent article in the hometown newspaper.

ChpBstrd

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #11 on: April 03, 2017, 11:34:12 AM »
In theory, the price of the physical structure rises as the inputs required to build a similar structure go up in price. So the price of labor, lumber, concrete, diesel fuel, paint, drywall, copper, etc. A potential buyer's best alternative to buying your existing house is to build a new one, so the prices of new and old houses are somewhat related, although in my market, older homes go for up to a 50% discount because they are usually so deteriorated.

Also, you forgot depreciation of the roof. $7,000 for 25 years = $280/year just for that one component.

Bottom line, today's houses lack durability. A shingle roof might last 25-30 years, but tile, slate, or copper could last a lifetime. Wood burns, rots when wet, and is eaten by termites. Foundations are rarely dug deep enough to avoid settling. Interior surfaces are often more faddish than permanent. Poorly done add-ons are endemic. Overall, few stick houses could survive a tornado or seismic event.

I wonder if one could build a small house out of 100% permanently durable materials and not pay for insurance or depreciation. E.g. 100% insulated reinforced concrete walls on an oversized slab. Tile or stainless steel shingle roof with heavy anchored metal joists. Stained concrete floors and stainless steel counters. HVAC would still suck, but the rest of the building would last 500 years.

frugaliknowit

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #12 on: April 03, 2017, 01:03:47 PM »
I think home ownership is a way of diversifying your assets (assuming you would otherwise invest the money), but not NECESSARILY an inflation hedge (but likely IS...).  It is partly dependent on what happens in your particular market during your holding period.

Overall, the longer the hold, the more of an inflation hedge, everything else being equal.

BlueHouse

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #13 on: April 03, 2017, 01:16:25 PM »
If owning housing was not a good deal financially, there would be no landlords.

When you own a home on average you make out much better than renting in the long run (key words are long run and on overage). Of course there are tons of assumptions and people can skew the numbers to support any case, but the industry of people making good money owning rentals is pretty good evidence that owning is financially better than renting.
This is not a sound analytical conclusion.  What you've said here is the equivalent of saying "Being Fat is good for you, otherwise, more Americans would choose to be thin".   Or would make many more people jump off of bridges after their friends have done so. 

Not saying the conclusion is wrong, but how you got there doesn't hold any water.

Viking Thor

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #14 on: April 03, 2017, 05:24:45 PM »
I'm not going to get into a dragged out philosophical argument but the example you gave is different.

The fact that an entire industry can make money off renters is a good indicator of the economics of owning vs renting, and it's not just select people but the industry as a whole that is profitable.

PizzaSteve

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #15 on: April 03, 2017, 05:29:17 PM »
Like any modeling exercise, your assumptions drive the outcome.  It is reasonable to suggest that each person assess their own housing options based in their local market conditions and lifestyle choices and run the numbers under a variety of scenarios.

There are no one size fits all answers for such a large and important choice/necessity as housing.

Hargrove

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #16 on: April 03, 2017, 07:43:01 PM »
Quote
I'd say that you cannot set aside the value of not paying rent when calculating the return on investment of owning property.

That's pretty much it. You have to pay something for housing.

The expense is assumed. What expense in particular, and what of value in equity, and what of maintenance costs? Those answer the question of rent vs buy.

You either pay a (theoretically larger) number that decreases with inflation until eventually dropping to just property tax, or you pay a (theoretically smaller) number that increases with inflation.

Laura33

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #17 on: April 04, 2017, 07:08:23 AM »
The concept of real estate as an inflation hedge is because real estate is a hard asset.  Inflation is a concept that is tied to paper money, because governments can just print more money whenever they decide to, for whatever reason.  But when the government does this, it devalues the currency that has already been issued, so people holding paper assets now need to pay more of them to buy the same thing.

Ergo, when you are afraid of inflation devaluing the pieces of paper that you keep in your wallet and that your stocks/bank accounts are denominated in, you want to trade that money for something that the government can't just print more of.  Real estate has always been a significant go-to, because excepting certain locations, the old adage "they aren't making any more of it" holds true.  Gold/precious metals have also been used for this purpose, simply because they are comparatively scarce and hard to find. 

Note that these investments have their own risks.  E.g., except for some modern industrial applications, gold has zero inherent value and is worth so much only because we humans think it's pretty; similarly, if someone discovered a huge source of gold that quintupled the world supply, then you'd have the gold version of inflation, and the value of the gold already out there in circulation would crash.  They also remain subject to the laws of supply and demand; if you choose a home next to a toxic waste dump, the fact that they aren't making any more land still won't make people want to live on the land you own. 

So it's not that these investments are "better" or "worse," or "safer" or "riskier," or that you will make more money over time one way or the other.  It's more that they are subject to *different* risks than paper assets, and therefore RE/precious metals/etc. can be used to hedge against the risks posed by paper assets, and vice-versa. 

Tl;dr: there's no guarantee that, on average, property values will increase above the rate of inflation, especially once you include all expenses; OTOH, holding RE can provide awesome protection if you are worried about a massive inflationary spiral as some other countries have experienced. 

frugaliknowit

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Re: House ownership as an inflation hedge and forced savings vehicle - NOT
« Reply #18 on: April 04, 2017, 07:38:26 AM »
I would like to add that owning RE is A way of locking PART of your housing costs.  It is possible you will "lock down" a cost that will go lower.  For some people, this has value as it aids financial stability, especially in older age/retirement.