RE: Shiller Weighs In

[ST]

Re: Shiller Weighs In

That's really what a home buyer is betting on today.

This is not to say that you shouldn't buy a house as you almost certainly agree.

Just as if I compute the value of my post secondary education and try to discount that salary earned in the future to NPV, taking into account salary lost by going to school, debt incurred on the loan/interest etc... there are other payoffs that need to be considered: enjoyment of learning, interest in a field, etc...

Even if taking a quantitative approach, the buyer buying his principal residence in most cases should be valuing the non-financial positives into the equation as well - which have some equivalent cash value - stability of residence, king of your own castle, etc.. other intangibles related to owning one's own home. Those are things that one should figure the value of as well - literally, if so inclined.

The investment may prove a good one when those things are considered. House as utility is safe way to think about it.

[EJ]

Re: Shiller Weighs In

This is not to say that you shouldn't buy a house as you almost certainly agree.

Just as if I compute the value of my post secondary education and try to discount that salary earned in the future to NPV, taking into account salary lost by going to school, debt incurred on the loan/interest etc... there are other payoffs that need to be considered: enjoyment of learning, interest in a field, etc...

Even if taking a quantitative approach, the buyer buying his principal residence in most cases should be valuing the non-financial positives into the equation as well - which have some equivalent cash value - stability of residence, king of your own castle, etc.. other intangibles related to owning one's own home. Those are things that one should figure the value of as well - literally, if so inclined.

The investment may prove a good one when those things are considered. House as utility is safe way to think about it.

I own a house because I consider the additional costs and responsibilities of owning versus renting to be more than worth it for the benefit of the liberty afforded me to do as I please on my property and with my property, within the zoning laws, of course. I have a studio where I can create metal sculpture, and perform other experiments. I cannot imagine having to ask anyone's permission.

[GRG55]

Re: Shiller Weighs In

shiller has said for many years that housing only tracks inflation. here's a link to an article about his work, published in the ny times magazine in march '06, describing his study of real estate in amsterdam going back to the early 1600's. some of the same houses are still around today! unfortunately the article no longer has the huge photo of stately homes, with price histories spanning roughly 400 years, along one of amsterdam's central canals.

It seems quite logical that housing does nothing more than track inflation over the longer term. It is not a productive asset.

This is one of the reasons that jurisdictions from California to Spain and beyond are in such difficulty today - too much capital tied up in property instead of capital goods and physical plant that generate jobs producing goods and services that someone will actually pay for.

Unfortunately we have been conditioned by the repeated cyclical excursions of local real estate market prices well beyond the long term inflation trend which encourages speculation, flipping, and the belief that homes are an "investment".

[EJ]

Re: Shiller Weighs In

shiller has said for many years that housing only tracks inflation. here's a link to an article about his work, published in the ny times magazine in march '06, describing his study of real estate in amsterdam going back to the early 1600's. some of the same houses are still around today! unfortunately the article no longer has the huge photo of stately homes, with price histories spanning roughly 400 years, along one of amsterdam's central canals.

I agree. Next time I see him I'll ask him why he no longer mentions this key point in editorials.

[Polish_Silver]

Shiller's book on house buying

I met Shiller on two occasions and appreciate the rigor of his housing market analysis and the way he talks to a mainstream audience about housing.

The only point I'd add to his comments is a simple conclusion that can be drawn from Shiller's research, and I sometimes wonder why he doesn't repeat it because from a residential real estate buyer's perspective it's the most important conclusion of his research: Unless you are a landlord, housing has never been an investment and never will be. .

He does say that in his book "Irrational Exuberance": A house is a place to live, not an investment.
Also the book makes a strong case that house prices only keep up with inflation. And that does not count all the taxes and maintenance costs!

He makes a meticulous study of the rent vs buy dilemma, and comes out barely in favor of buying, because of the reduced moral hazard. But I never heard such a hedged recommendation!

We were living in europe when I read his book. From news stories and talking with friends, I could see the bubble was nothing short of Humungus. I told my wife we should consider not buying during the bubble. Her reaction was "You'll never want to buy a house!" My response was some lame-ass thing like "let's wait until prices are reasonable".

[vinoveri]

Re: Shiller Weighs In

If only the racket were confined to the poorly publicized fact that owning a home is not an investment but an inflation hedge that is more economical than renting but only if you stay in the home for the full duration of the mortgage.

Perhaps an even bigger scandal of home ownership in the U.S. is the amortization schedule of a 30-year fixed-rate mortgage, by far the most popular home mortgage product in the U.S.

Ask your average homeowner with 360 payments to make how much home equity they'll have after 180 payments in 15 years and they will usually tell you half. Most are surprised when you tell them they will own 29%.

This pretty good Investopedia article offers a typical example:

In our example of a $100,000, 30-year mortgage, the amortization schedule consists of 360 payments. The partial amortization schedule shown below demonstrates how the balance between principal and interest payments reverses over time as later payments consist primarily of principal.

Payment	Principal	Interest	Principal Balance
1	$99.55	$500.00	$99,900.45
12	$105.16	$494.39	$98,772.00
180	$243.09	$356.46	$71,048.96
360	$597.00	$2.99	$0

As the chart shows, each of the required payments is $599.55, but the amount dedicated toward principal and interest varies from payment to payment. Because of the inverse relationship between principal and interest paid, at the start of your mortgage the rate at which you gain equity in your home is much slower. This demonstrates the value of making extra principal payments if the mortgage permits pre-payment. Each extra payment results in a larger repaid portion of the principal, and reduces the interest due on each future payment, moving the homeowner toward the ultimate goal: paying off the mortgage.

The average home owner in the U.S. stays in a home for six years. The average home owner with a 30-year mortgage may think he or she will have a 20% equity stake after six year rather than the 8% they will actually have. They look at the low interest rate and think they're getting a good deal rather than the amortization schedule that determines how much equity they are actually buying at that rate.

Not surprisingly, this arrangement works out well for the banks.

Small nit: In ZIRP with 30 yr mortgages of 3% available belive those numbers work out to be ~39% and ~14% respectively. Front loading effect less pronounced with lower rates.

[Polish_Silver]

Houses depreciate less than anything!

Why would the chef publicly piss in his soup. Home equity is the closest thing to magic that the average sheeple experiences in his or her finances. It's important that mystery not be revealed for what it is. Consumers get clobbered on every purchase they make - from televisions to cars. Walk out the door and it plummets in value. From my early 20s I was told buying a house was the best investment I could make - from my well-meaning sheeple friends and family. They never made the inflation connection either, nor could they see through FIRE's prestidigitation on home buying in general. The 'Tulip has blown away much of that fog for me, along with a few others, noticeably Hudson. And yes, everyone I have known that was in the income property (RE) game had to be a working landlord, preferrably providing most of the ongoing repairs, with hands on tenant management an absolute necessity. Breaking even over time was the name of the game, with rollover (to another property of equal or geater value) tax deferred equity the game-winning, rinse-and-repeat goal.

Agreed that it's hard to make money renting out a house. Only savvy people bring it off.
Some get lucky that prices rise while they own the property.

But houses do depreciate much more slowly than almost any other item. Many don't appreciate how quickly a car depreciates. (having said that, cars depreciate more slowly now than 30 years ago. Cars of today really are much more durable, and the higher prices of used cars reflect that.)

[Polish_Silver]

Building equity: inflation, not amortization

Not surprisingly, this arrangement works out well for the banks.

Until the recent bubble, the nominal house price would have gone up 20% or so during the first 5 years of the mortgage. So, even after subtracting closing costs, the buyer would have come out ahead. The lack of amortization is offset by the inflation. You build equity much faster than you pay down the mortgage.

[Polish_Silver]

Re: Shiller Weighs In

I agree. Next time I see him I'll ask him why he no longer mentions this key point in editorials.

An equally good question is "why do people think houses rise in value?." Shiller takes up this question too, and says it is partly the inflation trick. (Confusion of nominal prices (inflation) with purchasing power).
But I think another reason is that they confuse higher prices with faster rate of increase. My wife says it is good to buy a house in an expensive area because "they always go up". Well, they cannot rise faster than the incomes of the people buying them, or they could not pay the mortgages. The property went up at some time in the past, because of its prime location, but after that is reflected in the price, it has the same inflation price rise as the slum on the south side. In fact, choice neighborhoods do go down in price, and the poorer ones sometimes rise the quickest. That happened in East Palo Alto, when an Ikea opened and some older houses were demolished to put in posh apartments.

[Polish_Silver]

Re: Shiller Weighs In

Aaron,

I think buying now could turn out very well for you. The house can be a very effective inflation hedge-- the payments will be a breeze 10 years from now. Also, it acts like a mandatory savings account. Ok, the return is not great, but many people really waste money. So paying down a mortgage is far from the worst way to use your income.

The first place we bought did wonders for our balance sheet, and the second has certainly not been bad.

[don]

Re: Shiller Weighs In

An important corollary to the above is the role of magical thinking. Not understanding the historical trending of housing to inflation makes people enormously vulnerable to bubbles. Remember all those 'educated people' that floated ever higher on their can't-stop equity climb. The cocktail chatter, the smug neighbors, the proliferation of expensive autos up and down the block. Without a grounded understanding of housing prices they were easily unmoored by FIRE. How many still long for the bubble's return, convinced it was the new normal, or in sheeple-ese, "what my house is really worth".

[NCR85]

Re: Shiller's book on house buying

The average home owner in the U.S. stays in a home for six years. The average home owner with a 30-year mortgage may think he or she will have a 20% equity stake after six year rather than the 8% they will actually have. They look at the low interest rate and think they're getting a good deal rather than the amortization schedule that determines how much equity they are actually buying at that rate.

Not surprisingly, this arrangement works out well for the banks.

By the sound of it, the real estate sector is already functioning almost as if the loans were extended on a zero-amortization basis. The actual amount of amortization taking place is negligible as percentage of the total. You sometimes find people crying outrage about zero-amortization loans, but when you think about it, they were never more than a formal and cosmetic difference from the status quo.

[flintlock]

Re: Shiller's book on house buying

The old way of thinking, that housing is a good investment and will generally rise over time, will only hold up in the long run if economic growth rises with it. We saw unprecedented growth since WWII. Highly unlikely to see the same growth rate the next 60+ years. Not only does the population need to grow to maintain the demand for growth in new housing, but the ability to pay for it must be there. Fewer and fewer good jobs probably means that at least the larger homes will become poor "investments".
But I still think buying a home can be a decent financial move, if you buy at the right price, the right area, buy quality, and keep the house size reasonable.

I have to add that it is not necessarily the value of the bricks and mortar in homes that has appreciated, but rather the value of the land these homes sits on that appreciated the most. A quick look at some of the "best" in town neighborhoods will often show a 50 year old fixer upper valued at far more than a brand new, larger home in the suburbs. Obviously, some of the best locations were built out long ago, and that can contribute hugely to a home's rise in value as well.

The county I live in has grown in population almost 7x since 1980. Its no wonder the home values have appreciated a lot since then. Demand outstripping supply would probably account for a lot of that rise, even without the liar loans, overstated appraisals, etc. New construction has really taken off again here and I have a theory on that.
Its not as much demand for housing overall that is sparking this, but rather a somewhat affluent, younger, very mobile, corporate, buyer. While some real bargains are out there in existing homes, many are bypassing these "used" homes for nice sparkling new ones. Why not. When you are only staying in a home 3 to 5 years and interest rates are so low, the price difference is not really that big an issue. Many had rather pay a few hundred bucks more a month and skip the repairs and hassles that come with buying an existing home. When they get transferred to a different city in 3 years, their company will buy them out anyway. This little mini housing boom will end soon enough and we may see another glut of macmansions rotting away.

[don]

Re: Shiller's book on house buying

As EJ has written, if housing is fundamental to our economy, an 18-wheeler on the FIRE expressway, than inflation is the Cummins under the hood.

[Polish_Silver]

inflation and house prices

As EJ has written, if housing is fundamental to our economy, an 18-wheeler on the FIRE expressway, than inflation is the Cummins under the hood.

I kind of agree, but without inflation, mortgage rates in general would be a lot lower, making
homes more affordable.

Right now the mortage rates are below inflation, and I think that is a relatively rare situation,
due to our financial system and government manipulation of interest rates.

I wonder if you could short the dollar by going long real estate?