Monday, February 24, 2014

A roof over your head and a lead weight in the wallet

I'm approaching the age where according to certain traditional notions of American culture, I am supposed to be thinking about buying property sometime in the next decade or so, no doubt financed by a mortgage, to be sold if I and mine need to uproot ourselves.  It's a strange thought - not least since I'm still somehow getting over being allowed to drink alcohol.  Yet it is also strange to think about the idea and find that despite my culture's love affair with homeownership, the more I think of it the more I find it iffy.  This is shaping up as a rant, but whatever.

I can't help but feel, for example, that our cultural fetish for owning one's home is obsolete in an age when most people of my generation will switch employers every three to five years - if current trends continue, well into middle age.  All the arguments about putting down roots in the community by buying property seem moot when your ultimate outcome will be to flip that property right after getting properly settled down.  And as for roots, I don't see how my behavior might personally change in my community due to owning property - except, perhaps, for the inevitable politics over things like property taxes or HOAs.  Somehow, I don't view that as a change for the better.

The other thing I've heard over the years is that your home is a valuable investment that "encourages you to build up equity."  However, I've wrestled with more than a little bit of cognitive dissonance over this idea because I've been a relatively well-informed, if hands off, individual investor since the day I started drawing my own salary.  I balance risk between bonds and equities, make sure my portfolio is diversified to hedge against risk, avoid high costs, and save as much as I can as often as I can.  I simply am unable to square that approach with buying a house as an investment: not only do you make a huge outlay as a speculative bet on a very risky, illiquid, undiversified piece of real estate - why are you not buying a REIT, again? - but it's a leveraged investment as well, giving you the equivalent of costs equal to your interest rate.  As an index fund investor I'm leery of over 1%; mortgage interest rates seem to make this a fantastically bad idea.  And as for building up equity, well, my view is that savings are savings, and essentially paying a bank for the service of forcing you to save sounds iffy.*

The one wrinkle in this are the preferential tax treatments you can get.  The first is the mortgage interest rate tax deduction, which seems tailor made to simply make a portion of a person's opportunity cost of living in a property tax free if they take out an enormous amount of debt on it, but doesn't extend that same privilege to someone who rents.  I've expressed my frustration about this before, many times, but often the only response is to drink the kool aid, join in and buy a house, so you can take advantage of it, too!  In the long run, you'll be losing money if you don't!
Where have I heard that logic before?
For me this is only a bigger argument that the mortgage interest tax deduction needs to go.  Pushing an unsound investing strategy speculative property bet with a clearly discriminatory tax expenditure is just plain irresponsible, and doesn't change the fact that buying property as a young person with inevitably shaky job security is plainly stupid. 

The other one that strikes me as similarly plainly unfair is the capital gains adjusted basis, where the proceeds from the sale of a home have up to $75,000 in gains exempt from taxes.  What?  What other type of large investment receives this type of protection?  It seems to be wildly irresponsible on the part of the government to grant that protection to homes and not to any other type of investment.  Not only is it clearly discriminatory against people who lives in areas where most housing is held by others as investment property, it's a policy that inherently encourages speculation on the part of people with low levels of savings.  Historically housing has yielded about 0.4% above inflation, and is subject to vicious boom and bust cycles, and that is encouraged?

I've had the argument leveled at me that all of this tax support for ownership is to make housing affordable and to encourage the building of more homes.  Frankly, I find that idea to be nonsensical.  People who take advantage of this favorable tax treatment will invariably have no trouble finding housing in any case, even if it is not quite as big or as well-located as they like - else, if they were closer to the subsistence level, they would not be paying taxes at all.  Nor do I accept the argument that these things "clear" housing at the lower ends, since the property market builds both new multi-family and single-family dwellings according to demand (there was, for example, an imbalance during the financial crisis as retrenching families raised the demand for smaller units, catching developers off guard). 

No, the one conclusion I can draw is that most of what these tax supports tend to do is subsidize larger and more expensive homes.  Still worse, since the capital gains basis adjustment is post-sale, and the mortgage interest tax deduction is only open to the 30% of taxpayers who can gain by itemizing their deductions, the encouragement on marginal renters to buy is either limited to those living in very high cost areas (in which case these people hardly needed income support anyway) or premised on just how much a person thinks they can gain from their poorly diversified, speculative, illiquid, high cost asset.

* Clearly my circumstances are different from most in that I do know how to invest (thanks, Dad) and have the dedication to save on my own initiative, but even for those that don't have these advantages I fail to see how buying a house is at all better than taking a hundred-thousand dollar loan and plumping it all into a total stock market index fund, except as a cultural affectation.  In fact, the stock market is likely to do significantly better than speculative property in the long run...


  1. The capital gains exclusion is $250,000 every two years, I believe. For married "joint owners" it would be $500,000. I don't know of any equivalent tax break on other investments, so if your home does appreciate and you sell it and buy a new one (as often as every two years if you wish), that could be a substantial savings. It is offset by home purchase/home sale costs (now, there's a real racket!!) which you can mitigate somewhat by doing it yourself if allowed in your state.

    Another thing to consider is that at some point 30+ years down the road, the mortgage is paid off. Compare this to renting. From a retirement perspective, owning your home outright is, I think, a better deal than paying rent during your retirement years.

    An alternative to the fact that owning a home ties you down to a location would be to buy a home in a place that you would really like to work and or retire and then rent it out if your job does not take you there. This needs some modeling, but if you can 'recover' the home as your primary residence then you can get that $250,000 exclusion at some point.

    1. $75,000 is 15% of $500,000 - perhaps I didn't phrase it well, I meant it gives you a $75,000 boost on any profits.

      The whole point of my little rant there is that any way I look at it, the only reason to own a home given the reality of my life (moving around a lot) and sound investment principles (i.e., diversification) is sentimental in nature. I don't buy it.

      Some pretty astute calculations there suggest that if you don't expect to stay in the same place for more than 5 years, there is negligible financial advantage to owning a home and has a crappy ROI. It goes against every principle of good investing that I know of... and still sounds like a crap deal to me unless I'm retired. That counts doubly so if I am landlording, and triply so if I am an absentee landlord. It doesn't sound like a good deal.

      I'm not against owning a home in my later years - in fact, I would be saving for precisely that eventuality. Is there seriously a prohibition on buying a home in cash?