Wednesday, November 23, 2011

Fester's financial advice, housing.

There seems to be this misconception out there that housing is a commodity that should rise in value over time and at least keep up with inflation on the average. This is not really the case. Housing is a consumer good, just like your car and television, and will decrease in value over time as it is being used more and more. I believe there is a case to be made that land is a commodity and will generally maintain or increase in value over time, but what sits on that land is going to get wore out, rot away, and otherwise lose value. It is hard to say that the roof on a house will lose value, the carpet will lose value, the appliances lose value, and yet the overall house should gain in value and somehow expect this to make sense in the long run.

The idea that housing “always rises in value” is based on faulty logic and a skewed perception of reality, mostly by people who live in cities. It is true that in many areas of the country if you look at a chart of housing values over the last 100 years or so, you will see a steady increase in value and this has skewed the perception of the people living in those areas and created an expectation that this is the norm, when in fact it was a fluke. Many things happened in that time that account for the rise in value of (some) housing. First, the population grew very quickly. Second, there was a mass migration from rural areas to urban areas. Third, the banking system was set up to be controlled by the central bank that allowed fractional reserve lending to become the norm. So what happened was that demand increased for housing in urban areas and at the same time it became easier to get loans from banks (and unlike other loans the interest could be deducted from a person's tax liabilities), creating a century long boom. I don't expect this to hold into the future. The increased demand for the land the houses sit on this made up for the all or some of the loss of value in the buildings sitting on the land in urban population centers. The recent boom was because low interest rates allowed consumers to borrow more money for lower monthly payments and this brought up the overall value of the housing as consumers realized that they could buy more expensive housing, sellers raised their prices respectively. I know there were some other factors, but this is the very basic story.

One thing to note is that housing has went down in value in many places, rural America, industrial cities that have lost large employers (Detroit, Cleveland, etc). So if you have this idea that housing should always increase in value, I would like you to knock that thought out your mind right now, as it is not a universal truth. You may be lucky enough to have purchased a house in a community that will still be a desirable place to live well into the future and so your housing might hold its value, but there are no guarantees and you should not hold any expectations of such, especially as the population stops increasing and the migration from rural farm towns to urban centers comes to an end (at this point there are not a lot of rural people left to migrate and technology is not replacing farm hands at nearly the same rate as it was over the last 100 years). My understanding is also that the US would be experiencing a negative growth in population if it were not for immigration (which the government seems to want to further restrict).

Does this mean that it is a bad idea to buy a home? No. The reality is that you need a place to live, and if your choice is to buy or to rent, then you have to consider your own needs and your lifestyle to determine which makes financial sense to you. If you plan on living in the same place for 10 or more years, it is likely to be better to buy. If you move around a lot, then renting is better. If your choice is to rent a cheap one bedroom apartment or buy a big four bedroom house, renting is likely the better option since you need to compare apples to apples when looking to buy. It may make sense to buy a condo that is similar to what you rent, but likely would not make sense to buy a house that is far more extravagant than what you would chose as a renter. Due to the market distortions created by government, buying is often the better choice, they artificially restrict new construction through zoning and other laws, they allow you to write off the interest on the mortgage from your taxes, and distort the market in other ways, but you should not count on these things from the government into the future, so just be aware it is a gamble. Buy a house for the same reason you buy a car, you need it for its utility, not for its investment potential. If you want an investment property, either learn the real estate trade, or buy a REIT, but don't buy the house you plan to live in and expect it to be anything other than a consumer good.

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