The Myth of Homeownership Wealth Creation

AOTC: Homeownership is a decent savings account that grows with inflation, but it is not a wealth builder as many believe

Over the past several decades, politicians in Washington have considered increasing homeownership to be a civic duty. And the reasons seem obvious: It’s the American Dream. It’s the only way low-income families can build wealth. It’s just a good investment every middle-class household should have. Or so we’ve been told. The real story debunks the theory that housing is the best investment for everyone, and reveals that the desire of policymakers to preserve homeownership at all costs is completely backwards..

Government support for homeownership has a long tradition. Fannie Mae and the Federal Housing Administration were started in the 1930s to help low-income families buy homes. The Community Reinvestment Act was passed in the 1970s to promote homeownership in urban areas and for minorities. Congress has even gone so far as to establish homeownership goals that the Housing and Urban Development Department has to implement.

It is easy to see why policymakers have bought into the uncontested belief that homeownership is a good investment. Looking at the Case-Shiller housing price index over time, we can see that prices grew steadily until the 1990s and then took off like a rocket until the bubble burst in 2006.

Case Shiller Nominal HPI

When looking at housing this way, the “ownership society” lauded by President Bush in the early 2000s, sounds like a good idea. Especially when considering the social values associated with homeownership, like being a good neighbor and having a stake in nuturing a community. However, while owning a home is rarely a bad thing, it might not be the great investment our parents told us it would be.

When you adjust these numbers for inflation, housing prices stayed nearly flat from the end of World War II until the mid-1990s. Only once the so-called 1992 Government-Sponsored Enterprise (GSE) Safety and Soundness Act opened up the floodgates of federal subsidies, later to be caffeinated by the Federal Reserve’s loose monetary policy in the early 2000s, did prices double nationally. Of course, that price jump was a bubble and prices have fallen nearly back to levels last seen in the 1990s.

Case Shiller Real HPI

By this measure, there really was very little national investment gain in housing until excessive subsidies created the housing bubble. This is not to say housing was a bad investment in the last century. In the 50 years following World War II, real housing prices grew 3.53 percent. But compared to other possible investments during this period, it is a very small growth rate. Consider that during the same period, the Dow Jones stock index grew more than 2700 percent. Similarly, the S&P 500 and NASDAQ-which started later in the century-have grown substantially larger than housing. Since 1970, the indexes have grown 542 percent and 953 percent respectively.

Eventually real housing prices picked up, doubling from 1996 to 2006 on the back of the housing bubble. But in trying to boost investment values, policymakers and poorly incentivized bankers drove prices unsustainably high, and the peak of growth was short lived as home values have steadily fallen back towards the pre-bubble trend line, as can be seen in the below graph.

Of course, investment gains from housing are not the only measure of wealth. In fact, one feature of homeownership is the forced savings it creates as households build equity through their mortgage payments each year. And if you look at the growth in homeowner equity over the past several decades, there is another sharp climb up until the housing bubble (see below graph from Federal Reserve data).

Equity Growth

But once again these numbers are deceptive, since they just show an aggregate gain in equity (i.e., we’ve built a lot more houses). All of the subsidies-both from GSEs and tax deductions-for homeownership did nothing to improve the average equity position of low- to middle-income households. As the below chart shows, the percentage of equity that households have their homes has fallen from around 80 percent in the 1950s to 38.5 percent at the end of 2010.

Equity in Decline

This means that nationally, homeowners are putting less money down on their homes on average, and paying off less of the principle on the mortgages. So not only has the homeownership rate declined from the peak of the housing bubble to 64 percent, but also the amount of “ownership” in homes by residents has been reduced as well.

Of course, if you look at local levels the story might be different. Certain markets have been historical strong, like Houston. Others were weak for decades, saw incredible growth in a short time, but have since seen a decline, like Orlando. But on the national level, the story has been clear: homeownership as an investment has essentially just grown with inflation, and homeowner equity is on the decline.

This is not to say homeownership is a bad thing. And on an individual level, low- and middle-income families certainly were able to build equity during this period-which is a good mechanism for creating wealth. But a lesson from the evolving “foreclosure society” in the wake of the housing bubble is that what many thought was homeownership was simply a twisted form of renting. If the only means of getting a family in a home is to provide government subsidies that lower interest payments and down payments, then the homeownership is all a façade, and there is no equity growth.

To be sure, homeownership is a worthy and attainable goal, but not before a household has the means. A house is not a stock to be wielded as an investment, but rather it is a savings account that maintains its value with inflation.

Furthermore, evidence has surfaced that owning a home before you are ready is actually detrimental to wealth building. Beyond the foreclosure crisis and misplaced confidence in interest only loans, unemployed families that can not find a job or a buyer for their homes have been unable to move elsewhere in the country where there is work to be found. In fact, the rise in homeownership could have contributed as much as 2 percent to the unemployment rate.

All of this together is important history for policymakers today to understand because so many decisions are being made in the interest of homeownership.

We know Fannie Mae and Freddie Mac must go, but Congress is hesitant to do something that might lead to lower housing prices-even though prices need to fall a bit more to come inline with the historical trend. We know that the Fed must unwind its balance sheet that has tripled over the past three years, but Chairman Bernanke fears how that might impact interest rates. We know that the mortgage interest deduction is an ineffective tax policy that largely just subsidizes young, wealthy households, but no one wants to risk another drop in home values that might result from getting rid of it.

In short, because it is politically difficult, the Congressional debate over housing finance is missing a key point: Without the homeowner putting equity into their home, there is no actual wealth building. And if the government juices prices, then there is no investment gain either. Policymakers must break from conventional wisdom and rethink homeownership when it comes to public policies that ignore fiscal responsibility in pursuit of a failed goal. Homeownership is a good store of value, but not a wealth creation machine.