Updated: May 3, 2013 12:14PM
Originally published: July 8, 2002
Owning your own home is the centerpiece of the American Dream, and Americans are determined to own their piece of the dream even if it means devoting a record amount of their personal income to housing payments.
A decade ago, mortgage companies wouldn’t lend to a client who spent more than one-third of his income for housing. Today, however, lenders are making loans to would-be homebuyers who spend as much as half their income on housing.
Despite the growing portion of income devoted to housing, buying a home is more affordable now than in recent years, thanks to today’s low interest rates and low down-payment requirements. That’s difficult to believe when you consider that in the last 12 months, home prices have tallied double-digit increases. Los Angeles prices jumped 17.6 percent; Minneapolis, up 14.8 percent; the District of Columbia up 19.7 percent, and New York City up 20.9 percent. The Chicago market posted a gain of 7.5 percent.
Compare those performance figures to a dismal stock market over the same period, and suddenly you see why people think their homes are a far better investment than the stock market. After all, if you make a mistake and overpay for your home, you can at least live in your mistake!
Housing prices outperform the S&P
Statistics bear that out. The Federal Reserve just reported that U.S. household net worth actually increased in the first quarter of this year, as stronger real estate prices offset continuing losses in the stock market. Homeowners’ equity increased $85 billion, or 1.3 percent, to $6.7 trillion since year-end 2001, while the S&P 500 index is down more than 10 percent.
But housing is a market like any other, driven by market forces. And even though it hasn’t happened in recent memory, home prices in various locations across the country in the past have suffered big losses. Homeowners have seen their equity totally wiped out in places like Houston during the oil bust of the 1980s, and in Los Angeles during the early 1990s.
Sure, those are extreme situations. But those homebuyers never realized prices could fall as well as rise. Just as tech-stock investors a few years ago never believed that share prices would fall as far as they have.
That kind of optimism is seen at the top of every market--a belief that prices can only go higher. And when everyone is thinking and talking that way, it’s time to take a step back and look at the market forces at work.
Like any other market, housing is driven by liquidity. And right now there’s plenty of cheap mortgage money available to fund housing purchases. Plus, lenders have become very liberal about low down payments (margin). A decade ago, it seemed daring to put only 10 percent down on a home purchase. Today, the average first-time homebuyer is making only a 3 percent down payment!
But that kind of leverage works both ways. If prices fall just 3 percent, your equity is wiped out. You may not care about the market value of your home, as long as you can live in it and make the monthly mortgage payments. But if you’re forced to sell, the loss suddenly becomes real.
Like any market, the housing market could tank
Why could we see the housing market turn down? A booming economy could push interest rates higher, pricing some buyers out of the market. Or a return to recession could result in job losses, and fewer buyers.
As with any market, supply and demand can turn quickly. But unlike the stock market, the housing market is not liquid. You can’t just call your broker, place a sell order, and get your cash next week. Houses can remain unsold for months, even as prices are lowered.
So, is this an argument against buying your dream house? Absolutely not. Like the stock market, housing has proved a wonderful investment over the long run.
This column is just a reminder that it’s easy to get carried away by emotion in any market--stocks or houses. The smart buyer doesn’t chase prices up, but instead waits until someone is desperate to sell. That’s when you get bargains. That time will come. It always does. In every market. Eventually.
And that’s The Savage Truth.
Terry Savage is a registered investment adviser and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail to firstname.lastname@example.org.