Fed Economist: A Home is a Lousy Investment

Punch line: Before the housing bust, Americans tended to think their homes were their best and most important investments –- a view promoted by Washington policy makers who made home ownership a top priority.

Karen Pence, who runs the Federal Reserve’s household and real estate finance research group, argues that homes are actually a terrible investment.

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Excerpted from WSJ: Fed Economist: Housing Is a Lousy Investment, January 5, 2010

Putting aside the fact that home prices have fallen dramatically, Pence says several factors make homes a lousy investments:

  1. An indivisible asset.
    If you own stocks and bonds and suddenly need a little cash, you can sell some of your stocks or bonds but not all. With a home, on the other hand, “you can’t just slice off your bathroom and sell it on the market.”
  2. Undiversified.
    You can buy stocks or bonds in industries or countries all over the world. A home is a bet on one single neighborhood.
  3. High transaction costs
    When you buy or sell a home, you pay real estate agent fees, mortgage fees and moving costs.
  4. Asymmetrically liquid
    That means it’s easy to get money out when home prices are going up. (You just take out a bigger mortgage.) But it’s hard to take money out when prices are going down because refinancing becomes more difficult.Put another way, the leverage that you have in your house with a large mortgage means your investment does well in good times but could be lousy in bad times.
  5. Highly correlated to the job market.
    Home prices in a neighborhood tend to rise when the job market is improving in the area and fall when the job market is worsening. This means that your main financial asset provides the smallest cushion to you when you might need it most.

Ms. Pence has been a Washington renter for many years. Ironically, though, she says she’s considering buying a house herself. The reason: Her husband wants a dog and wants to start gardening. That means moving out of the apartment.

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