Housing as an Investment
There’s a powerful cultural narrative in the US that says when you buy a home, you’re not only securing a place to live, you’re making an investment.
When I say “investment” I mean a thing that you can put some money into, and get more money out of later, in real inflation adjusted terms, net of the expenses associated with having the thing in the first place. Houses — as in, physical structures that shelter human beings — are clearly not this kind of thing. Anyone who has had to maintain an older home knows this. Roofs collapse. Pipes corrode. Walls need to be painted. Like bicycles, laptops, and virtually all other durable goods, left to their own devices, houses are depreciating assets: they lose utilitarian value over time. However, we’ve done an incredibly good job of ignoring this as a society. How do we fool ourselves?
We tend to ignore inflation. If you bought a house for $100,000 in the year 2000, and sold it in 2016 for $140,000, even if you didn’t put a single penny into maintenance, taxes, or insurance, you just barely broke even in terms of real purchasing power, if we’re talking about the house purely as an investment.
We tend to ignore the ongoing expenses of homeownership. In practice, you can’t avoid spending money on maintenance, taxes and insurance, but few homeowners record every property expense, and calculate whether they’ve come out ahead upon selling a home. Especially if the building is older “naturally occurring affordable housing”, maintenance costs can easily end up being a few percent of the building’s value each year. Property taxes and home insurance are also substantial expenses, typically less salient to homeowners than the purchase and sale prices of the home.
We can think of inflation and property expenses as cancelling out a fair chunk of any increase in the nominal value of a home. With 2% inflation, and spending 3% of the home’s value every year on maintenance, property taxes, and insurance, a home’s value needs to increase about 5% every year in nominal terms just to cover its own costs. In other words, if you bought a house for $100,000 in the year 2000, and sold it for $200,000 in 2016, you didn’t quite break even — again, if we’re looking at the house purely as an investment.
We tend to notice the accrual of home equity. Ideally, as you pay off a mortgage, the fraction of its value that is covered by your equity rather than the bank’s debt increases! Even if you just break even after accounting for inflation and ongoing expenses, you’ll hopefully have a larger chunk of change on hand to put into buying your next home. Continuing with the example purchase above (grabbing a mortgage calculator off the internet) if we assume a 20% ($20,000) down payment and an $80,000, 4%, 30 year fixed rate loan, after 16 years of payments, the remaining loan amount is about $49,000. So assuming you sell the home at the “break even” price, including expenses, of $200,000, you end up with $151,000 after paying off the loan. This is $131,000 more than you started with, which feels totally awesome! You “invested” $20,000 and “earned” $131,000, more than a 650% increase!
Housing as Savings
But the activity described above isn’t investing, it’s saving. There’s nothing wrong with saving — most US households could stand to do a lot more of it! But it’s simpler and less risky to save by putting money in, say, a short term bond index fund that will just manage to keep up with inflation. In contrast, saving by putting money into your mortgage means you’re betting on an undiversified real estate portfolio whose value is tied to the local economy. This local economy probably also provides you with employment, and thus your income. Using a house as a piggy bank also means committing to constant, time consuming maintenance, unlike a CD ladder or a short term bond fund. Of course, the example above is optimistic. There’s no reason to expect that you will break even by owning a house. Why, after all, would we expect a house that’s slowly wearing out to increase in value fast enough to cover its own upkeep, taxes, and insurance? We certainly don’t expect that of other durable consumer goods like washing machines.
Unreasonable though it might be, imperfect accounting & cognitive biases mean that a lot of people believe they’re making an investment in housing, and earning a real return. This behavior would be completely insane for all but the most devout home maintenance hobbyist, except that this enormous depreciating asset also provides a valuable — some might even say necessary — service: housing.
Depending on the local housing market, available financing terms, your tax situation, how much you enjoy DIY projects, your aversion to being forced to move, or desire for the flexibility to relocate, owning a home may or may not be a better way to purchase housing services than renting a dwelling. A house itself is not an investment: it is a place to live. However, places to live often sit on top of something that can behave much more like an investment.
Housing vs. Land
Sometimes, people do end up making real money from owning their home. I’m not talking about buying a fixer-upper, and pouring a lot of sweat equity into renovating it. I’m talking about a return on the asset itself — a return purely on the capital invested. The cultural narrative of housing-as-investment is deeply ingrained. Homeowners often seem unsurprised by their returns, which have nothing to do with the value of their housing, and everything to do with the value of their land.
This point was driven home to me while talking to Jens von Bergmann about the housing market in Vancouver, BC. Jens runs a great little data company called Mountain Math, and on their website you can see that more than 1/3 of all single family homes in Vancouver are worth less than 5% of the total property value — the remaining value being attributable solely to the land itself. Another visualization shows the relative value of the buildings and the land on a per dwelling unit basis. Everything is egregiously expensive (I’m sure a map of San Francisco would be similar) but all else being equal, the smaller the number of dwellings per unit of land, the larger the role land tends to play in the overall valuation.
This is why smaller older houses in hot real estate markets get torn down — nobody is going to pay $1 million for a $950,000 lot, and then live in a $50,000 house. We’re used to seeing the value of land and buildings combined, so we have little sense of how they relate to each other. A $50,000 single family home is often worn out, with so much maintenance required that the only economically sensible thing to do is start over… especially if you just paid 20x that much for the lot beneath it.
The new building that replaces a small, old, worn out house is expensive partly just because it is new, and has many more years of service ahead of it than the home it replaced. This fact is often overlooked in discussions of preserving “naturally occurring affordable housing.” When such housing is acquired by non-profits and housing authorities (as with the recent partnership between Google, the City of Boulder, and Element Properties), the first thing they usually do is pour a bunch of capital into it, in order to ensure that it remains serviceable for another few decades. At first this looks like a great deal — they bought some affordable housing, and kept it affordable! They “saved” it from the evil price gouging real estate market. But mostly what happened is they bought some expensive land, which happened to have a dilapidated building on it, and then paid to un-dilapidate the building. This is not always the most cost effective way to create social housing, but in a place like Boulder, where building new affordable housing can be a political nightmare (see also here, or how about this one) it can make sense in terms of the political economy. Unfortunately, it doesn’t increase housing supply at all.
The point is, when we buy “housing” we’re typically buying both some land and some building. The building is often only a small part of the overall property value, but it’s the part that provides the useful service of shelter. The building is also the part that someone has to work to design, construct, and maintain. If you put time and money into making it better (more insulation, triple glazed windows, adding a basement apartment, refinishing old hardwood floors, planting fruit or shade trees, building a patio, replacing the roof…) then you’ve done something useful. You’ve added real value to the property, and so it seems reasonable that you should be able to recoup at least some of that added value when you sell the house.
Land Speculation and Value Capture
On the other hand, if you buy a house and the land beneath it, and the value of the land increases, where did that value come from? What have you done to earn that return? What consequences flow from such an arrangement? If you invest in a business, you’re being compensated for taking on some risk (that the business will lose money, or fail), and you’re hopefully facilitating some useful economic activity in the world. Is the same true for land?
Land value comes mainly from two sources, neither of which are attributable to the landowner:
- local amenities, most of which are public: parks, schools, streets, nearby transit, easy access to employment and recreation, etc.
- property rights associated with the land: in a tight housing market, having permission to build a single family home vs. a fourplex, vs. a small apartment building will change the value of the lot. This is zoning. Like it or not, it has been a serious thing in the US since 1926, and the Euclid, OH vs. Amber Realty ruling.
These sources of value both flow from the public sphere. They aren’t attributable to the property owner. Adding new public amenities, or changing zoning to allow property owners to build something that generates a bigger cashflow creates a windfall profit for the property owner. Because of this, it’s common for cities to engage in what’s known as value capture when they make a substantial investment in new amenities, or grant new development rights.
For example, a city might use public money to build a new light rail line, and upzone the neighborhoods within easy walking distance of stations, in order to maximize public benefit from and the cost effectiveness of the new transit infrastructure. Without some kind of value capture mechanism, these changes would result in huge windfall profits to the property owners in the upzoned neighborhoods. With value capture, the increased land values can be used to pay for the construction of the light rail line. This forces developers to work for their profits by providing the useful service of designing, building, and potentially managing new housing and commercial spaces. There are lots of different ways to do value capture — the details aren’t important here — what’s important is that it’s seen by many as more equitable to use increases in land value, which flows from the public realm, for the public’s benefit.
In contrast, back in the late 19th and early 20th centuries when new development often took the form of streetcar suburbs, it was common for rail magnates like Southern California’s Henry Huntington to quietly buy up all the land adjacent to a planned streetcar line, build the line, and profit handsomely from the increased land prices. This kind of private value capture (or land speculation) was largely how the streetcars got financed.
At some level, both of these arrangements seems reasonable — or at least self consistent. If the public invests in infrastructure, then why not capture the increased value for the public? If a private entity invests in infrastructure, why shouldn’t that private entity capture the value that flows from its investment? What seems to upset people is when value created by a public investment is captured by a private entity. As with the bank bailouts nearly a decade ago, this can amount to socializing losses, and privatizing profits.
It’s common to talk about value capture in the context of a big public investment like light rail, with increased residential density benefiting profit motivated developers. It’s rarely pointed out that private homeowners accrue exactly the same kind of unearned financial gains when land values increase. This is the only way that anyone makes a real return on an investment in housing, and the returns in a hot market can be substantial. Mountain Math looked at this in Vancouver, and found that in 2015 land value appreciation beneath just the single family homes in Vancouver was about $25 billion (CDN) while the total after-tax income of the entire city was only about $18 billion (CDN). Closer to home, according to Boulder County property records, the Picklebric Co-op’s old neighbor, Steve Meier, bought his house at 755 13th St. for $1,025,000 in 2012 (coincidentally, the same year Picklebric was founded). Looking at various real estate websites like Zillow, in 2016 the property appears to be worth around $1,400,000 — nearly $100,000/year! Assuming the home was bought with 20% down, that’s a ~200% nominal profit in 4 years. For doing what?
As Daniel Kay Hertz has eloquently noted at City Observatory, this kind of real estate appreciation is fundamentally at odds with housing being affordable, which means it is also fundamentally at odds with communities being economically diverse and inclusive. Given our rich and colorful history of racist housing policies — both explicit and implicit — this economic exclusion also seriously compromises the ability of our communities to be racially diverse and inclusive.
Cities like San Francisco and Boulder and Seattle, that are filled with homeowners who think of themselves as progressive, seem inclined to try and get around this incompatibility by subsidizing affordable housing. So long as rising land values dominate housing costs, this is a losing battle. Housing has a relatively well defined minimum cost — the cost of financing, building and maintaining a minimal amount of living space for human beings — but land values have no real upper limit. If we want housing to be affordable, if we want our communities to be economically and racially inclusive, if we want to reduce the time, energy, and money consumed by long car commutes, then we have to somehow mitigate high land costs, and ensure that mostly what we’re paying for when we buy housing is a place to live, not the land beneath it.
There are several ways to do this, but there’s an intrinsic trade-off. If we want to take land out of the equation entirely, then homeowners must be willing to give up on the idea that their housing is an investment, and start seeing it as simply a place to live. This is exactly what Community Land Trusts do, but with a very limited scope. It’s also what a Henry George style single land value tax would do. Poetically, George developed these ideas after living through San Francisco’s early boomtimes. This would represent an unfathomably large shift in the US mentality around real estate and private property, affecting tens of trillions of dollars worth of existing assets.
Alternatively, we can spread the cost of land out over a larger amount of housing — increasing supply to the point where the speculative appreciation of land is no longer a major driver of housing costs. Unfortunately, this is a very hard thing to do in the US. Why? Because we have local control of zoning.