Sunday, September 16, 2007

Do Not Confuse Houses with Housing: Housing Myths Part 5

Why Housing Is NOT an Investment
Why Home Mortgages are BAD Debts

Previous: Homeowner Profits Ignore Huge Costs: Housing Myths Part 4

“You Have To Live Somewhere” and Getting Rich by Eating Twinkies

Some people try to close their eyes to the bad investment of a home mortgage by asserting that the bulk of the borrowing costs “don’t really count.”

The common “You have to live somewhere” argument confuses opportunity costs/benefits and confuses houses (durable goods) with housing (the use of the durable goods).

(UPDATE: Economists recognize the distinction between house (asset) and housing (consumption) by referring to housing as a "shelter" "service"--although government's misuse of this valid distinction in its statistics and policies is another matter; see the Bureau of Labor Statistics (BLS) Consumer Price Index's (CPI) Owner's Equivalent Rent (OER) controversy.)

Rental Opportunity Costs/Benefits Negate Each Other

If the house was an income-generating investment, you could offset your borrowing cost with rental income. Living there yourself instead of renting to others (“renting to yourself”) means that you save writing a rent check to a landlord only by foregoing the receipt of a rent from a potential tenant of your own.

Imagine if you rented a house from someone but you bought an identical house next door and collected rent from your new house next door; the rents would cancel each other and net zero (paying rent to a landlord, collecting rent from a tenant). Owning and occupying a single house has the same result, net zero (not paying rent, not collecting rent). Therefore, the entire cost of the house including purchase/interest/maintenace/etc. is still an extra cost and not defrayed by anything. In other words, your savings are “not paying rent” but your costs are “not collecting rent” so you have not avoided one cent of the additional cost of house price and mortgage interest and insurance and maintenance and taxes.

Housing Is Consumption, Not Investment

You do have to live somewhere. That is exactly why housing is consumption, not investment. Do not confuse the house with housing; housing is the use of the house (shelter service). Housing is the consumption of time in a place (the house). When you "rent to yourself," instead of selling the consumption to a renter, you are consuming your own inventory.

No Such Thing as a Free Lunch: You Cannot Have Your Cake and Eat It Too

“Renting to yourself” means that housing is consumption (not investment) because time is money and the value of living in your house yesterday is gone with yesterday, not saved for tomorrow. Further, only one person can use a particular space at any one time and even renting one of your house's rooms to someone or other "shared space" is a reduction in your own consumption of housing, a reduction in your use of your own house (zero-sum game). Do not double-count.

Get Rich by Eating Twinkies?

You constantly consume housing like you constantly consume food.

Buy and eat a Hostess cake without trying to claim that paying to eat the cake is making you wealthy. Likewise, pay to consume housing (time in space) without trying to claim that paying to sleep in a room is making you wealthy.

Borrowing for Consumption Is Bad Debt

A typical rule of thumb is that so-called “good debt” (actually, less bad) increases productivity or generates income more than it costs (e.g. a tractor increases crop yield). “Bad debt” is everything else. Most people would see danger in taking loans to pay rent yet borrowing for instantly-consumed housing via a mortgage is essentially the same type of debt.

A 30-year mortgage is (in principle) no better than taking a 30-year loan to borrow 3 decades of rent in advance.

Think about that. In the first year of a 30-year rent loan, you could invest 29 years of rent in the stock market (a stock asset instead of a real estate asset).

(In practice, the securitzed mortgage and tax subsidies make a mortgage loan cheaper than a rent loan, but the principle is the same.)

The marginal asset value of a house, over and above the consumption cost of housing, is a separate factor that you can treat as a distinct investment.

You can try to use the historically minimal real appreciation of real estate as an investment but the appreciation is often small potatoes compared to the consumption cost/value of the house-for-housing--and the appreciation often is largely cancelled by costs (taxes, insurance, inflation, and especially borrowing costs if leveraged).

Satisfy your housing consumption and then choose the best investment for your surplus money (real estate? stocks?).

Before you borrow a quarter-million or half-million dollars, know if you are borrowing for investment or consumption.

Next: Hidden Burden of Overbuying: Housing Myths Part 6


allen said...

a post like this makes me doubt your sanity. There is no argument here, only half truths dressed up in confused language.

Difference between owning & renting:
When you rent, you don't get ANY of the money back. When you own, you at least have the CHANCE to (and almost always get ahead, based on market average).

J at IHB and HFF said...


Hello. I am sorry if I was not as clear as I hoped but the article is fairly standard economics about opportunity costs and the time value of money and assets (time as consumption). Some scenarios leave the homebuyer ahead while other scenarios leave the renter with more money kept or earned (when you count all factors mentioned in the entire series of articles). Thank you.

Brent said...

this is a terrific series that more people really should have read. I bet a lot of folks now wish they had. It is refreshing to find such a clear explanation to cut through the propaganda of the banking, real estate, insurance and finance industries. thank you!

J at IHB and HFF said...

Brent, hello and thank you very much. I did and still do get flak from industry bulls but I started the series a few years ago (before the recession and stock crash) because at least some people might be willing to think and prepare.