Somehow, in all my reading of other people's blogs, I missed Kevin Erdmann, aka, The Idiosyncratic Whisk. My loss. His most-recent post, "Housing policy--please do the opposite," is excellent. In responding to Robert Shiller's claim that houses are a lousy investment because, over time, they appreciate so little, Erdmann writes:
You don't buy bonds for capital gains. You buy them for income. Likewise, you don't buy a house for capital gains. You buy it for the rent.
Some people do buy bonds or houses as speculative activities, but of course speculation is a zero sum game. That doesn't have anything to do with whether they are good investments. How can Shiller make this statement? The question is, how much does the house cost, how much would rent be (corrected for homeowner expenses), and how does that compare to alternative investments?
In fact, the fact that home prices in the US have roughly tracked inflation suggests that thinking of a home as an inflation-adjusted bond is a pretty good first step for looking at aggregate home values. There is no way that 30 year TIPS bonds are paying a higher return now than the average rental home is. This has nothing to do with what home prices will do in the next 10 years.
This reminds me of my thinking when my wife and I bought our house in coastal California in 1986. The Tax Reform Act of 1986 was being debated and it was clear that the mortgage interest deduction would stay. But our marginal tax rate would be lower, which would mean that the value of our mortgage interest deduction and the value of our property tax deduction would be lower. My wife and I used every liquid dollar we had, plus gifts from her mom and my dad, to put just a 10% down payment on the house and handle closing costs. Our net worth at the time, including IRAs, was well under $50K, probably close to $20K. If the value of the house fell, we could easily have negative net worth. I was nervous. But here's how I thought about it: "We're on an escalator. We just don't know if it's an up escalator or a down escalator. If it's up, we get a nice capital gain. If it's down, we still have a house that we can live in for a long time."
Erdmann's post is chock-full of other insights also. One is about the mortgage interest deduction, which, at one point, but only at one point, he mistakenly calls the mortgage tax credit.
Here's the part on the mortgage interest deduction that I found most interesting:
Normally, there would be a fear that ending the mortgage deduction would lead to a drop in home prices that was steep enough to cause an economic dislocation. But, real estate credit has been too hobbled for the mortgage interest deduction to lead to higher prices. Home prices are low enough to be profitable for investors, and at least until very recently, cash buyers have been dominant, so if the mortgage deduction was ended now, cash and institutional investors would keep prices from declining significantly.
This could suggest a "grand bargain" a la the Tax Reform Act of 1986: Eliminate the mortgage interest deduction and make it revenue-neutral by cutting all marginal tax rates by one percentage point or by whatever fraction of a percentage point would make it revenue-neutral in a static sense. The big losers from the loss of the mortgage interest deduction, as Erdmann notes, are the upper-income people. So maybe cut their marginal tax rates by double the amount that the government cuts marginal tax rates for others. So, for example, if someone at the 15% bracket gets a cut to 14.5%, someone in the 39.6% bracket gets a cut to 38.6%.
I guess, looking at the above, you could call this a "medium bargain."