Take a few deep breaths.

Big improvement on hyperventilating, isn't it?

Well, what we're going to do for the next few minutes is take deep breaths about homeownership instead of hyperventilating about housing prices. The difference is important. Your house is where you live. It's more than a price.

Failing to make that distinction--- between your house as where you live and as a price--- is one of the reasons so many people are worried about a housing bubble, etc. It's also the reason some financial advisors (or sales people) are telling us that the return on home equity is zero and we should borrow against our equity to make it "productive."

That's junk economics.

Here are the four realities that make home ownership a good thing.

Home ownership is the key to building wealth. This is true all over the planet, not just in Boston and San Francisco. Peruvian economist Hernando de Soto found that owning a home was the single most important step toward maintaining a good standard of living and stability. In countries where home ownership is less common than the United States, the distribution of wealth tends to be more highly concentrated.

If you examine the Consumer Balance sheet in the Federal Reserve flow of funds figures, you'll find that individual homes always play a large role in consumer net worth. Similarly, if you examine the sources of wealth for most households in the Survey of Consumer Finance, you'll find that home equity is the single largest contributor to net worth for all but the wealthiest households.

The economic return of home ownership is high.   A home provides two kinds of return. First, it provides us with shelter services. If we didn't own the house, we would be renting it or other shelter. Over time the value of those shelter services is likely to rise, just as rents are likely to rise.

Second, a home may also appreciate in value. Add the two forms of return and you have the total return of home ownership.

Over the last 25 years homes across the country have appreciated at a compound annual rate just over 5 percent, rising 273 percent. Add 4 to 6 percent (of market value) as a shelter services return--- what economists call imputed income--- and you've got a total return of 9 to 11 percent, tax-free. That's in the same ballpark as the 13.5 percent pre-tax total return on common stocks during the same period.

And that's just the national average result. As everyone knows, residents of some areas did fabulously better than residents of other areas.

Mortgage financing isn't part of the economic return.   Note that I haven't mentioned mortgages. The economic return you get from owning a house is independent of whether it is financed. All the advice about what you should do with your home equity is about investment arbitrage and debt leverage. It assumes that you can earn a higher return on the money you borrow by investing it somewhere else. Whether your home is debt free or mortgaged, you will enjoy the economic return of the home--- shelter services and appreciation. Whether your alternative investment will earn more than your mortgage costs in interest and cash flow is uncertain.

The return on homeownership is tax free.   One of the reasons home ownership is such a good investment is that the return is not taxed. The shelter services we receive are not in cash, so they are never counted as part of our income. And price appreciation has been tax deferrable. Today, it is tax free for all but the most expensive homes.

As a consequence, I believe the long term return on conventional home ownership will continue to be among the best returns we can get--- if we are ordinary long term homeowners who enjoy the shelter services of a primary (or secondary) home.

Are there exceptions?

You bet. If you borrow as much as possible and throw away the service return by not living in your house, you've got a problem. Why? Because you're betting that future appreciation, alone, will pay your mortgages.   

On the web:

  For price indexes of different areas, check the Office of Federal Housing Enterprises Oversite website go to www.ofheo.gov/HPI.asp. Click on "House Price Index for the third quarter of 2005" for their most recent report in PDF format.

Sunday, September 4, 2005: What's Missing Is Reality Tuesday, September 6, 2005: If you follow author's advice, you could lose a bundle