Is a house an investment?
Short answer
No.
Long answer
Common wisdom stipulates that a house is a good investment, and indeed I’ve had a couple of conversations lately where people have espoused this view.
For a while, however, I’ve been feeling that there are holes in this argument, particularly that since people are always in need of accommodation, and since houses don’t really have a changing utility (a roof over your head is not really making you more efficient over time, it just keeps you from dying of exposure), it would seem that over the long term their prices can’t outgrow the economy.
When I recently stumbled on this article by Joseph Gyourku, I decided to try to run my own numbers on South Africa. Unfortunately, finding decent data series of inflation and housing prices for SA proved to be a challenge beyond my capacity, and so I turned to Sweden, where SCB kindly obliged.
I decided to look on the time series of small houses in Stockholm and in all of Sweden over the years 1986 to 2008, and to use time series adjusted by the consumer price index KPI and the OMX30 Stockholm stock market index.
KPI-adjusted prices
What do I mean by adjusting by KPI? I mean that I divide the housing price index with the KPI index (after rebasing them both on 1986). The reason for doing this is that whenever you wish to compare the past with the present, you must always take the time value of money into account.
We are all familiar with older people lamenting the fact that milk is so expensive. “When I was young, a bottle of milk cost just 1 kr”, they will tell you. What they don’t remember is that their salary was only 1000 kr per month.
So in order to be honest in our comparison of a bottle of milk then and a bottle of milk now, we must look at how expensive it is in terms of our salary. If a bottle of milk cost 20 minutes of work then, but 30 minutes of work now, then it has gotten 50 % more expensive. On the other hand, if it cost 20 minutes of work then, but 15 minutes now, then it has gotten 25 % cheaper.
To this end, SCB (and similar agencies in other countries) create inflation measures where they track the cost of a basket of goods. SCB’s such measure is called KPI, and so, in order to compare prices, we can divide by KPI and get an inflation adjusted price.
When we divide the housing index with KPI and plot it, we get the following graph
Using 1986 as the baseline with the index grounded at 100, this graph shows the percentage of the 1986 cost that the house held at different times. As can be seen, by 2008, the housing index in Stockholm was about 300, meaning that a house bought in Stockholm in 1986 was about three times more expensive in 2008, after inflation has been accounted for. This sounds quite impressive, but it actually is only a return of 5 % per year above inflation.
In the country at large, the prices are always trailing those of Stockholm (as could be expected), and we end at about 232, giving a return of 3.9 % per year.
Note also the importance of timing the market; buying a house in 1990, just four years after 1986, would mean you had missed out on almost a third of the price increase, and shame indeed on those who bought in ‘90 and sold in ‘95.
Alright, so we see that a house has mostly been beating inflation, which at least means that the value of the money hasn’t eroded, as might sometimes be the case in a savings account. It seems that a house is a sound investment. Or is it? We will now turn to an even more pertinent question: how does a house fare as an investment when compared with the stock market?
OMX30-adjusted prices
Let’s assume that instead of buying a house, we put our money into a broad stock market index fund. In the case of the Stockholm stock exchange, we’d go for the OMX30, which is the stock market in phrases such as “the stock market rose 5 % this morning on news that…”
By dividing the housing price index with the OMX30 index, we can see how large our excess return would be over the OMX30. If a house is indeed a good investment, it should outperform this very simple stock market strategy. The results?
Look at that. We see that during those tender years around 1990, when house prices shot up, and then crashed down again, they were still a lot better than having your money in the stock market. The OMX30, however, came on strong beginning in 1990, and from 1993 and all the way through 2007, the money would have made a better return in the OMX30 than in a house. In 2002, when the IT bubble burst, the stock market took a strong hit, but still outperformed the houses. Only in 2008 did the house’s value surpass that of the OMX30 again, when we entered another stock market crash.
Other factors
Another thing to consider when buying a house is that unless you’re sitting on top of a huge pile of cash, you’re looking at taking out a sizeable loan, and then you will pay interest on this. That interest represents an opportunity cost, since not only are you paying it out as a cost, but you could have otherwise invested that money, and made a positive return. There are also other costs involved in house ownership, such as property taxes and maintenance fees.
Conclusions
From the data above, we can see that a house is likely to give a return that stays ahead of inflation, but still severely underperforms the stock market during long periods. A house is also a much less liquid investment, and much harder to manage. Because of the price of houses, it will also in general represent by far the largest amount of money a person handles, making for a very unbalanced and ill diversified portfolio.
In other words, my conclusion is that a house is not an investment.
That’s not to say that buying a house is a bad idea; but it must be looked at as what it is: a purchase of an asset. The point of buying a house should rather be that you wish to own the house, because you sincerely want to live in it for a long time. If that’s the case, then go ahead. Just don’t expect to make a killing off flipping your accommodation.
Personally, I feel that a very good case can be made for renting, as long as the surplus money freed up compared to owning is put towards an investment account, and not squandered on booze and floozies.