I’ve been trying to make time to post this for some time, but, lacking said time am going to post it anyway.
This story in the NYTimes states that, in the words of an off-blog tipster:
(Housing) Prices go up and down, but over long periods they stay essentially the same, adjusted for inflation. Which, frankly, makes sense to me — there is nothing particularly about a house that suggests its value should grow over the long term. It’s just building materials, and if the supply of same is sufficiently elastic, then the asset should pretty much keep up with inflation and nothing more.
As a commenter says here,
Buildings do not appreciate, unless they are made primarily of some material that is both prized and no longer available for some reason. They depreciate, at about 1.5% per year. They can never be worth more than the cost to recreate them today, less depreciation.
Further evidence that focusing on the intrinsic value of residential real estate? Proof that there is more to buying and selling houses than meets the eye?
A longer article about the long term housing market referencing Piet Eicholtz is here.
As an aside, I’d like to get paid to study the papers here. 🙂
Technorati Tags: economics, real-estate
As NOT exciting as the papers at that site seem … you keep reading and writing your synopses, and I’ll keep paying attention here!
Interesting …
The Dutch study is hard to argue with, and it tracks long-term data about old neighborhoods in eastern U.S. cities — over the very long term, housing is a poor investment, with prices just barely exceeding inflation. But I think there is an aspect of the Dutch study which is even more important and surprising, and which the press coverage doesn’t get to. I went back and looked at the data in the Dutch study. The study reports prices over more than three centuries. When you look at the change over time, you notice that the price curve — i.e., the overall growth in prices, which barely exceeds inflation over the entire period — is not at all smooth. That is, there are periods where prices are rising quite rapidly, and then there are periods where real prices are falling.
Now, I think this data suggests that everything that the real estate professionals tell you about the housing market is wrong. Real estate pros tell you that housing is a long-term investment. Well, maybe not — over the long-term, say, over 20+ years, price growth strongly reverts to the mean, which is inflation plus about 0.2 percent (not so great). Real estate pros tell you “not to try to time the market”. Well, the data suggest otherwise — the only way to get above-inflation returns is to buy at the beginning of a price updraft. Real estate pros tell you that housing prices never decline. That one is definitely wrong, if you trust the Dutch data (and there is a great deal of U.S. data on this now as well) showing a number of periods of real price destruction.
So here are three assertions, based on the Dutch data:
1) Housing is a potentially good short-term investment, but is not much of a long-term prospect;
2) Intelligent market-timing is key;
3) Sophisticated real estate investment involves determined contrarian behavior — i.e., when other folks are convinced that real estate is booming, SELL!
Submitted for your consideration. AC
You completely fail to mention the LAND the building is built on. Isn’t land “a material that is both prized and no longer available”? Thumbs down.
Exactly. Land in desirable areas is very limited as are rights to build on it. With population growth uneven across the US land in the most desirable areas will grow in value much faster than inflation and home prices will follow. Let’s compare Detroit and California ocean view property over any time period you wish. What a waste of study time.
Jeff and Frank — The Dutch study focused on a neighborhood in the center of Amsterdam — a city which grew and thrived during the 350 yr. period studied, and in which buildable land nearby became progressively more scarce. So the increasing scarcity in available land affected prices — but not by much. And in the U.S., where we are much more willing than in Europe to build out from the center, and to build entirely new communities, land scarcity is likely to be an even smaller factor over the long-term generally.
Remember also that the cost of land is reflected in general inflation — directly. So for land scarcity to drive up land prices *in excess of inflation*, there has to be some pressure on demand for a piece of land that exceeds demand for land generally.
Frank makes a good point that the same might not be true for “niche” properties such as beachfront in Calif. Demand here is growing and supply is truly limited. But this is a tiny slice of the market. Our market in C’ville is much more representative — you have relatively little population growth in the city, quite a bit in the surrounding counties, where land is not as scarce.
In any event, and this is the major point, prices for land behave much in the same way as prices for buildings — there are short-term booms and busts, and long-term returns that balance out to a rate just slightly over inflation. So a piece of land becomes much more valuable if a highway is built next to it. But then after that adjustment its value stagnates for a period while the value of other investments keeps going up. The trick to making a killing in land — as any speculator in that asset will tell you — is to time the market. Buy just before the highway goes in. Sell quickly thereafter.
My point is that the same is true for houses. My point is NOT that there is no money to be made in houses. But *if one looks at a house as an investment, rather than as something to live in* the typical advice re: buy-and-hold may be off base.
Some additional information: in 2004, the Federal Reserve did a study of residential land prices in the U.S.
Key finding: In nominal terms, land prices have increased by a factor of 10.4 since 1970; after
accounting for inflation, land prices have increased by a factor of 2.6. So over a 35 year period, real land prices rose by an average of 2.75% per annum. Again, not bad, but not particularly stirring either, compared, say, to stocks.
So the old adage about real estate ownership being a good long term investment may not be true. Even so, when rent payments or mortgage payments cost basically the same, it is better to own and get 2.5% return versus nothing for renting.
Correct?
Hi Charles. You ask whether a 2.5% real return is better than getting no return for renting. The answer, I think, is “it depends.” When you buy, you commit resources — a down payment, ongoing maintenance expenses — to an asset yielding real returns of perhaps 2.5%. That creates an opportunity cost, b/c the money that you’ve committed to purchasing and maintaining that asset could have been committed to another asset yielding a higher return — more than 5% real returns, for example, for a diversified stock portfolio. So by that reckoning the opportunity cost of owning a house is something like 2.5% per annum. Of course, it’s probably not quite that, b/c there is a tax advantage to housing, but the value of that advantage is shrinking as the alternative minimum tax continues to move down the income scale.
Again, I’m not saying that housing is a bad investment. I’m saying a couple of things:
1) Housing over the long-term is a low-risk but low-reward investment — kind of like a T-bill;
2) The long-term data shows that housing and land prices are quite “bumpy” — i.e., they jerk up and down over the relative short term. The shape of the price curve suggests that real money in housing investment is in market timing. Now, this is not to recommend that short-term housing investment is a good idea for ordinary folks. We’ve seen this recently, and it’s turned very sour. Houses are costly assets to sell — there are high transaction taxes and fees. Prices can also turn quickly, leaving sellers holding a highly leveraged asset that is not producing enough cash flow to cover the debt. We’re also seeing that on a very large scale.
“1) Housing over the long-term is a low-risk but low-reward investment — kind of like a T-bill;”
I couldn’t agree more. I do think that for the vast majority of people, buying a home is a smarter financial decision that renting. Especially since those are really the only two choices we have if we want a roof over our heads.
People buying real estate for investment (income) purposes, that is another matter entirely.
Good stuff Jim!
Thank you everybody for the excellent comments and contributions to the discussion. I apologize for being negligent and not jumping in sooner.
All of the arguments lead me to two conclusions:
1) Buy land. It’s a finite resource and as such, is likely to increase in value as its availability is restricted by growth.
2) When buying a house, condo, townhouse, etc. – focus more on the intrinsic long-term value. Will you be happy in that house? It’s likely to increase in value, but how do you value the growth chart on the kitchen doorjamb that marks your kids’ growth over the beginnings of their lifetimes?
That can be an invaluable investment.
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If you can forecast the big demographic trends like “the flight to suburbia” or “New Yorkers retiring to Florida” or the (possible) “return to the city and new urbanism…” then I guess things do make sense: Over 100 years it’s going to be impossible to predict, but over, say, twenty to fifty years you might do a good job of realizing that the Charlottesville downtown area is becoming an increasingly desirable place to be.
But then again, if you can forecast those huge demographic trends, you can probably make more money on Wall Street or Madison Avenue…