Tuesday, June 14, 2011

Homeownership--what can and can't be measured

This'll be the last post in the series on homeownership, wherein we'll delve into both valuations and the non-financial benefits of owning a house. While some people (myself often included) attempt to determine, generally, whether buying a home is a better financial strategy than renting, the issue is too complex for such broad conclusions. This is somewhat unfortunate, as I often like to settle and wrap up matters into neat little boxes and file them away. The rent vs buy question, however, is situation dependent. The good news is that determining the best route for a particular situation isn't that complicated.

After once criticizing a mutual acquaintance for buying a house at the top of the housing bubble, a good friend defended the buyer, saying that she couldn't know at the time what house prices were going to do. While house stock prices cannot be accurately predicted from one month to the next, we can use logical valuations to determine if these assets are under or overvalued. Unlike gold (which you shouldn't invest in), stocks and houses provide a non-speculative financial benefit. Stocks are pieces of a company's earnings and a house provides what Jonathan Clements calls "imputed rent." Just as stocks and bonds pay dividends, so does your house through this imputed rent. He explains:
Consider how much you might earn if you rented out your house. Conceivably, you could receive a sum each year equal to 7 or 8 percent of your home's current market price. That is an indication of how much value you get from your house, as you live there rent-free.
So, this gives us an anchor for home prices. Could we get 7 or 8 percent of our current home price if we rented it out? William Bernstein approaches a home purchase through a similar lens:
A good rule of thumb is to never, ever pay more than 15 years fair rental value for any residence. This computes out to a 6.7 percent (1/15th) gross rental dividend, or 3.7 percent after taxes, insurance, and maintenance, which is about what you might expect from a mixed portfolio of stocks and bonds. (Imputed rent does have one real advantage over the return from stocks and bonds, which is that it is tax-free).
He goes on to say that the figure he keeps in mind whenever he's looking at a house is 150 (the number of months in 12.5 years). After hearing a broker's pitch, ask them what the place would rent for. Times that figure by 150, and if the house costs more than that, walk away. To add one more "rule" to the equation, due to transaction costs, Clements says that if you're not staying put for at least 5 years then renting is the better move.

Of course, there are other important features of the equation that are more difficult to assess. One is the fact that with purchasing a home, you are tying your family to the fate of the local economy. As mentioned previously, if the local economy is suffering, you may lose your job and want to move to find better prospects. The trouble is that your house price is probably also declining and your place will be that much harder to sell. This aspect is often over-looked, as people generally don't realize how much the economies of the various regions of the US can decouple. For example, if you've been living in Nevada for the last year you're experiencing an unemployment rate of 12.5%. This is bad enough under any situation, but if you're like more than 63% of Nevadans with mortgages that are underwater, you're not going to be able to easily move to equally deserted places, such as North Dakota, which has an unemployment rate of just 3.3%. Doubting how much unemployment negatively affects people? See here and here.

Finally, the main (non-financial) benefit of owning your own plot of land, free and clear, is something that everyone easily understands. You can't get kicked out. You can change the place as you see fit. And there's more that I'll simply leave to this boglehead:
Your land is not only part of your "net worth," it is also part of your total worth as a being traveling on this planet we call earth. From the dawn of time, for all living creatures, the land has been our mother, our father, our sustainer, that from which we arose and that to which we will return. Land can provide us with food, water, shelter, clothing, a place to mate and a place to call home. It can satisfy our physical needs, our emotional needs and provide a spiritual connection to all that is.

Put more concretely... you can build and live on your land, grow crops and raise animals there and have the space to provide for those of your clan.

The land you own has far more value than any bank account, 401 K, mutual fund or electronic entry next to your name.

They say that value lies in the eye of the beholder, but in the case of land the value will be there long after the beholder is gone.

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