Can Owning a Home Still Build Wealth?

"Possibly the only thing worse than a world in which homeownership doesn't work as a wealth-building tool is a world in which it does work as a wealth-building tool."

That statement summarizes the argument made recently by Daniel Hertz, senior fellow at City Observatory who contends that housing can't be both affordable and a good investment.  This observation runs contrary to conventional wisdom that homeownership is the most reliable pathway to household wealth.  Well perhaps it is, Hertz says, just not for everyone.  And this pits two pillars of American housing policy directly against each other.

Hertz say that promoting homeownership as an investment strategy is risky. No financial advisor would advise going into debt as well as putting a substantial portion, if not all, of one's savings into a single financial instrument except when it comes to buying a house. And, to boot, this is an investment that, as many learned only a decade ago, is not without risk.

And that risk, he says, falls most heavily on low-income minority buyers.  They get worse mortgage terms and their neighborhoods are more likely to see low or even falling home values, increasing the racial wealth gap.  But putting that aside, Hertz paints a picture of what a sure-fire housing investment would look like. 

For starters, it would look like San Francisco.   For housing to be a good investment, prices would have to appreciate faster than inflation.  He picks what he sees as a reasonable rate of price growth, one 2.5 percent higher than inflation, and applies it to a $200,000 home purchased 10 years ago.  If sold today, the owner would pocket a profit of about $56,000.  In the iconic California city - which he points out also has a lot of other things to offer, like a booming economy and ocean views - rents have been growing, net of inflation, by about 2.5 percent for the last 60 years and home prices at about the same rate since 1980.  The result is a profit of just over 25 percent.

But that scenario ignores compound interest, "and the longer this consistent wealth-building goes on, the more out of hand housing prices get."  For example, as represented on Zillow's home price index, San Francisco was at about $315,000 in 2015 dollars in 1980 and today it is over $750,000.  Of course, this ignores a few stumbles along the way; those prices did fall back in both 2008 and in the dot.com recession of 2000.  People who needed to sell during either of these periods may have suffered enormous losses.

This sort of wealth building depends on a perpetual stream of new buyers willing to pay homeowners an escalating amount of money for their homes and a massive transfer of wealth from the younger generations to the older ones.  Of course the former has to assume, or at least hope for a subsequent generation willing and able to do the same for them at the end of the road.  That new generation of course, must have a sizeable contingent who are already well-to-do and able to live where what Hertz calls a "Ponzi scheme" will work.  We assume neither Detroit nor Cleveland need apply.

Those two opposing drivers, wealth building and housing affordability, largely result in U.S. housing policy acting "as though doesn't really care that much about affordability after all."  While funds for low-income housing subsidies languish, there are well funded ones promoting homeownership - like the mortgage interest deduction and capital gains exemptions - that are mostly aimed at the upper middle- and upper-class households.  

In those markets where there is a lot of affordable housing, it has come about, Hertz says, because of "filtering."  That is, that market-rate housing falls in value relative to the rest of the market as the structures age or the neighborhood loses social status - often because of racial changes.  Thus, low-income affordability, when it does exist, is because housing in that sector has proven a terrible investment, and its owners, while having an affordable roof over their head, are not building any wealth.