Buying a home is probably the biggest financial decision most people will make in their entire lives, and it’s one that I think a lot of people rush into because there’s a lot of social pressure to buy a home. People associate home-ownership with success, and it’s considered a stage of adulthood.
Obviously, there are a ton of articles out there on renting vs. buying. From what I've seen, they usually focus comparing the all-in costs of home-ownership monthly rent. However, here are some reasons that I don’t often see talked about.
Portfolio Concentration
Houses are very expensive. Chances are your home is going to be the most expensive thing that you ever buy. That means that your home is going to be a big chunk of your overall net worth. Even worse, people usually borrow to buy a home, which means their overall exposure to the value of their portfolio’s exposure to the home’s value is greater than their initial investment.
For most people with a net worth of less than a million dollars, their homes are their biggest assets. For wealthier people, though, stocks or businesses former a much bigger portion of their net worth while homes are a significantly smaller piece. This difference has had an enormous impact for economic inequality over the past decade.
In 2008, both the stock market and the housing market crashed, so almost everyone across the wealth spectrum got a lot poorer. However, by 2011 the stock market had fully recovered, and it’s been in a massive upward trend ever since. The same is not true about the housing market. This article from CNBC is a bit old (2017), but it says the at that time, only about a third of the housing market had recovered from the crisis and that the market wasn’t expected to make a full recovery until 2025.
A lot of people also don’t own their homes outright (around 40% in 2019). During the Great Recession, foreclosure rates spiked as people weren’t able to make payments on their mortgages or homes went underwater and people walked out on their mortgages. As a result, these people weren’t able to participate in the recovery since their assets had been wiped out. This article from Harvard Business Review, says that “race between the stock market and the housing market” dominated changes in wealth inequality over the last 70 years.
Specific Risk
It’s not just the overall housing market that you have to worry about, though. When you buy a house, you are invested in one single home, so you have none of the benefits of diversification and are exposed to a lot of unsystematic risk. There is a ton of things that can affect the value of your home. A flight path could change so planes start flying overhead, a school in your area could shut down, a cellphone tower could go up. All these things could significantly impact the value of your home. It’s kind of ridiculous to think that you could lose a big chunk of your net worth because a cell phone tower built nearby but that’s the reality of home-ownership.
If you actually wanted exposure to the housing market, there are better ways of doing so. You could, for example, buy REITs, which operate portfolios of real estate assets. These provide get the benefits of diversification even with small investments.
Risk Correlation
People might not see it this way, but buying a home is essentially an investment in the local economy. The economic strength of your community a big determining factor in your home’s price. High salaries in Manhattan or San Francisco might mean that a tiny condo in one of these cities is more expensive than a mansion in the Midwest. Chances are you probably work in the local economy as well.
As you would expect, unemployment and home prices are inversely correlated within counties. High unemployment in a county also generally means lower home price increases. In the 2008 financial crisis, counties with the worst drops in house prices also had the steepest increases in unemployment.
This is bad for the same reason it’s bad to own a lot of stock in the company you work for: if the company goes bankrupt, not only will you lose your salary, you’ll also lose your retirement. If the city you work in starts to decline the same will happen. This happened all over the Midwest in the latter half of the 20th century, with Detroit being a particularly notable case.
A more recent example would be Alberta, where a significant percentage of people work in the oil and gas industry. Home prices are still down over 6% from their peak in October 2014, just before the price of oil dropped in 2015. At the same time, there were massive layoffs (group layoffs increased 134% from 2015 to 2014).
You’re better off keeping your retirement savings as unrelated to your income as possible, and while a well-diversified stock portfolio is still going to have some correlation with your income because the health of the economy and the labor market are interconnected. However, the strength of the correlation is probably going to be weaker.
tl;dr: There are a lot of risks to home ownership that people don't always think about and you should treat your home as you would a (large) investment in a local business.
Submitted January 04, 2020 at 11:05PM by RentForever2020 https://ift.tt/35uGv8J
