Financial Sense   Home  l  Broadcast  l  WrapUp  l  Storm Watch  l  About Us  l  Contact Us

Yes, of course, owning a home is a good family
and financial investment, but...
by Bob Bronson
Bronson Capital Markets Research
September 22, 2004

...there are several popular misconceptions about the investment return of home ownership, especially as the result of underestimating the operating expenses -- which renters don't incur -- as well as overestimating the benefits from debt leverage and the income tax benefits from deducting mortgage interest and real estate taxes.

This analysis demonstrates that the true investment return from home ownership is much less than popularly believed, and in spite of the double-digit home price gains of recent years experienced by many American communities and subdivisions.

This analysis, coupled with our "Cow Trading Story" at the bottom of this report, points out the weak underlying base of reality upon which the housing price boom mentality rests. We fully expect reversion to the extreme will ultimately occur with pessimistic home equity expectations becoming dominant.

We expect the reversionary boom-to-bust process will start with the second economic recession during this K-Cycle Winter, which is being signaled by the incipient second downleg in this BAAC Supercycle stock bear market. The recession will caused primarily by an unexpectedly sharp cutback in consumer spending resulting from a negative feedback loop involving a tremendously negative wealth effect resulting from the emergence of The Great American Home-Equity Bust, the severity of which we've opined previously.

#1 It takes about 3.9% annual house price inflation for 30 years simply to "break even" -- see the first spreadsheet below. This does not include the closing costs of buying or selling, especially the additional 5% to 6% realtor commission paid as a seller. It takes either another 10 years of staying in the same house with with 3.9% annualized price increases to "break even" over 40 years, or an additional 0.4% price inflation (4.3% annualized) to "break even" over 30 years.

#2 It takes more than a dozen years simply to "break even" even with historically high house price inflation because of real estate taxes, insurance and maintenance (upkeep, repair, and replacement, and amortization thereof) expenses, in addition to the principal and interest mortgage payments.

The second and third spreadsheets below use the past 21-year history of a Denver area "median home sales prices index," but this 5.58% annualized rate is an overstatement of what Denver homeowners actually experienced. That price index includes new home sales, which are not comparable because new homes have grown larger in living space square footage by about 1.5% each year on average, while existing, or "same homes" have not been remodel expanded to that degree.

#3 Income tax benefits are over stated largely because for home properties valued at less than $131,000, the $9,500 standard income tax deduction for couples exceeds typical mortgage interest and real estate tax deductions, especially with low mortgage interest rates today -- see the third spreadsheet below illustrating only a first year income tax benefit.

Since the amount of mortgage interest decreases each year more than real estate taxes increase, only residential properties that exceed $233,000 today will experience 30 continuous years of income tax deductions -- see the fourth spreadsheet below.

For a $233,000 residential property rising in price to $1,187,080 over 30 years, thereby matching the annualized percentage price rise in the Denver median home price index referred to earlier, the cumulative income tax deductions benefits add only 0.2% to the annualized ROI - compare the fourth spreadsheet above to the previous third one above.

For the mortgage interest rate and real estate tax deduction benefits to add just one percentage point (1.0%) to the return on investment (ROI ), it takes a 35% marginal income tax bracket with a $1,000,000 property -- see the fifth spreadsheet below.

#4 Even with high debt leverage, or a small downpayment, the ROI is not increased nearly as much as the debt leverage suggests. The sixth spreadsheet below, compared to the second spreadsheet above for an apples-to-apples comparison, shows that a 10% downpayment, creating 10:1 debt leverage, only increases a 3.3% ROI to 9.9%, assuming the mortgage interest rate is 6%.

But the ROI would be only 8.9% if the interest rate is 8%, which has been about the average over the past 30 years. These results also assume staying in the same home at least 30 years, and they don't consider the significant whack of inevitable selling costs that will reduce even 30-year net gains a whopping 15% to 20%.

#5 Mortgage interest rates are important, of course, but the other home ownership expenses -- real estate taxes, insurance and maintenance expenses -- are even more important. For example, a 33% increase in interest rates from 6% to 8% drops the ROI 1.0% from 9.9% to 8.9% -- see the second spreadsheet again for an apples-to-apples comparison to the seventh spreadsheet below.

This 1.0% drop in ROI is less that the 1.3% drop in ROI that occurs if the other expenses are increased 33% -- see the eighth spreadsheet below, where the real estate taxes, insurance and maintenance have been increased 33% compared to the second spreadsheet above.

Assuming homeowners insurance runs about 0.5% (1/2%) of the value of a residential property, this analysis assumes maintenance expenses will average only 0.83% (5/6 of 1%) annually over 30 years, which is in many, if not most, cases, too optimistic.

For example, such a 0.83% expense factor suggests that owning a $200,000 home property results in only $1,667 of maintenance expenses per year, which does not reasonably include the long amortization of such large expenditures as inevitable roof and furnace replacements, etc.

We more than welcome feedback on this analysis and conclusions.

Sincerely,

Bronson Capital Markets Research

The Bull Trading Story

© 2004 Bob Bronson
Bio and Editorial Archive

Contact Information
Bob Bronson
Bronson Capital Markets Research
Email