Homeownership and Financial Well-being

Adam, Stephen, and I have previously written on some of the downsides of homeownership from an urbanist perspective; owner-occupied units are biased toward being single family homes, and when owner-occupied units are condos, they carry many detrimental characteristics for redevelopment. Despite the negative outcomes of homeownership from a market urbanist perspective, the pervasive conventional wisdom remains that an owning a home is a path to financial well-being. Even including the government policies designed to improve homeownership as an investment, from the mortgage interest tax deduction, to subsidized home loans, to the capital gains tax break for homes, owning a home is still not the fool-proof investment that many people seem to believe it is.

A recent Times Dispatch article reveals this commonly held belief. The reporter quotes the CEO of the Richmond Association of Realtors without noting that her profession depends on the buying and selling of owner-occupied homes:

“Homeownership always trumps rental when it comes to the accumulation of equity and wealth over time,” Lafayette said.

Given that interest rates remain near historic lows, a monthly mortgage payment for many households makes more sense than paying rent, she said.

While it is true that paying down mortgage principal is a form of forced saving, this analysis does not take into account the opportunity cost of what else households could be doing with their home equity, such as investing it in the stock market in a tax-advantaged retirement account. For example, this New York Times rent vs. own calculator does not take into account an accurate opportunity cost of making a downpayment. In the default example, the owner pays a $34,400 downpayment, but the calculator does not take into consideration the renter’s potential return on investing $34,400 over the same time period in a tax-advantaged retirement account. While many people believe that putting this money into a home is a prudent and low-risk choice, in fact putting a large chunk of individual net worth into a single asset is much higher-risk than purchasing shares of, say, an index fund. Some homes will appreciate in value more quickly than the stock market, but placing a bet on a single home even appreciating more quickly than the rate of inflation is risky. Homes in cities with tight supply restrictions are in a better position to see rapid appreciation, but a homeowner in any city faces the risk that a regional downturn will impact both his job security and net worth simultaneously.

It is true that homeowners often increase their net worth more rapidly than non-homeowners, but correlation is not causation. Mortgage payments act as forced savings, and it seems that many Americans are not naturally disposed to saving a substantial piece of each paycheck without a commitment to paying a mortgage. However, many people having a propensity to save little does not indicate that “investing” in an owner-occupied home is a smarter move than renting financially. Personal finance writer Jim Collins explains the characteristics of owner-occupied homes that make them a poor investment, including their illiquidity and high transaction costs.

Of course there are many non-financial benefits that some people see in homeownership — caring for outdoor space, freedom to remodel as desired, and psychological benefits of greater community ties — all valid traits that lead people to want to live in owner-occupied homes. The decision to own or rent should be centered around these characteristics, though, not around the belief that homeownership is the road to financial stability.