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Your daily guide to the Transitional Economy as the FIRE Economy recedes and the TECI Economy takes over


Fooled by Inflation: Housing is not an Investment

The myth of the long-term investment value of a home is discussed in my book. Here is a summary.

Consider this classic chart created by economist Professor Robert Shiller in the second edition of his book Irrational Exuberance. The chart shows the median price of a US home with my comments in red.

Inflation-adjusted US housing prices
Click to enlarge

My friend Sean O'Toole in a recent post on his blog notes the key message of the chart.

If you bought a home in 1955 at the end of the post-war housing boom and sold it 40 years later you lost money in real terms!

Not until 1998 did you break even on your 1955 home purchase, not counting the money you spent on mortgage interest, taxes, and maintenance over 40 years. Sure, the alternative cost of rent -- paying someone else's mortgage -- was higher, so you can argue that buying was better than renting, but that does not mean that your home purchase represented a real investment that produced a return net of inflation and other costs.

The Facts

The $22,000 median price for a home in 1955 prices that Robert Shiller does not include interest expense. If you bought the home in 1955 for $22,000 with 20% down ($2000) and financed the rest ($20,000) with a 4.5% fixed rate 30 year mortgage you spent $46,731 for the home over 30 years, including $15,831 in interest. Inflation over those 30 years reduced the real cost of that mortgage by approximately half, so the purchase price plus interest cost you about $30,000 in 1955 dollars in total by 1995 when you finally paid off the mortgage.

Here's the shocker. When you sold the home 40 years later in 1995 for the median price of $130,000 you received $21,000 in 1955 dollars for a home that cost you $30,000! That's an "investment"?

By comparison, $22,000 invested in the S&P 500 in 1955 returned over $250,000 1955 dollars in 1998, more than ten times the $21,000 that an "investment" in a home produced.

Inflation-adjusted relative price and total return of the S&P 500
Inflation-adjusted S&P500

Add it all up and the fact is that buying a home is more economical than renting for 40 years, but compared to the returns on money in the S&P 500 over the same period, a home purchase cannot qualify as an "investment."

Moral of the Story

The moral is that buying a home is economical housing compared to renting, most of the time. Buy the home that you need and no more, and put the rest of your savings into a portfolio of stocks and bonds that will appreciate in real terms.