Is Your Home A Good Investment? – As assets, homes provide only modest annual returns in the long run

As assets, homes provide only modest annual returns in the long run

Home prices have fallen 32.2 percent since peaking in the second quarter of 2006, according to the Case-Shiller index (Posted: 05/27/2009 08:24:38 AM PDT)!

There’s the usual talk about what the latest Case-Shiller house price data mean for the next short term move in the real estate market. Has housing bottomed? If not, has the rate of decline slowed? And when will we see an upturn?

Human nature likes the short term. Which is why so little attention is paid to something that is probably more important, if less urgent: What the latest data show about the long-term of the real estate market.

And it’s startling.

We have just been through the biggest boom in real estate in American history. The subsequent bust surely hasn’t finished.Yet look at the numbers. Since 1987, when the Case-Shiller index of 10 major cities begins, it’s risen from an index value of 63 to 151. Annual return: Just 4.1% a year. During that period, according to the Bureau of Labor Statistics, consumer prices rose by 3% a year. Net result: Home prices produced a real return of just 1.15% a year over inflation over that time.

Critics may point out that the analysis is unfair — after all, it starts counting near the peak of the 1980s housing boom. Fair enough. Look at the performance since, say, early 1994, when home prices were near a historic trough. Surely someone who bought then has made a bundle.

Not necessarily. Since then the ten-city index has risen from a value of 76 to 151. Annual return: 4.7%. Inflation over that period: 2.5%. That’s still only a real return of 2.2% a year above inflation.

You can often do better on long-term inflation protected government bonds.

And real estate often costs 2% or more a year in property taxes, condo fees, maintenance, insurance and the like.

Conventional wisdom long held that home ownership was a route to wealth, and the imputed rent — in other words, the right to live in your home — was just part of the value you got from it. Under that widespread view, the recent housing bust was simply a temporary, though deep, pothole.

Yet for very many people, even over the past 15 or 20 years, the imputed rent may have been all, or nearly all, the real value they actually got from their home.

Yes, it’s only recent data. And it’s only ten cities. But there’s some reason to suspect these numbers may, if anything, flatter real estate performance. After all, it’s hard to look at the data and figure the bust is now over. And if they fall further, those long-term return figures will fall too.

Prices weren’t just down 19% over the past year. They fell 2% just between February and March. And it’s not the worst-hit markets that worry me the most — Phoenix is down 53% from its peak, Miami 47%. That smells of capitulation. It’s the other markets. New York and Boston are only down 20%. Denver’s only down 14%.

Overall the ten- and 20-city Case-Shiller indices are merely back to mid-2003 levels. After the biggest boom and bust on record, history suggests things don’t stop getting worse until they’ve gotten a lot worse than that.

We don’t recommend you try to time the housing market but, if you’re in the market for a new home, it helps to pay attention to its cyclical nature. When times are hard, prices drop and the market becomes more attractive. When more people get in, prices naturally rise. While there are still deals to be had, this map shows that some of the regions that were hit hardest by the housing crisis in 2007 and 2008 have begun to bounce back in early 2009 with increased sales numbers. With sale prices of homes plummeting as much as 50% in some regions, more people have been jumping into the market with hopes of getting a great deal, especially with 30 year fixed rates falling below 5% for the first time in recent memory.

The metropolitan areas that are highlighted are those with the highest percentage of change in median sales prices, for better or worse. The highest percentage increases in home sales are in areas where prices have dropped the most over the past year, which is an encouraging sign as bargain hunters see new opportunities. Further, the decrease in prices and attractive housing credits have finally made it possible for many first-time homebuyers to afford a home in the once red-hot areas like Orange County, Phoenix, and Las Vegas. While there are only six states that have experienced increases in sales volume in the past year, most of those positive changes have been drastic. Arizona has seen a 50% jump, California over 80% and Nevada an impressive 117% increase from 2008. Depending on where you live, the housing market may be in either a boom or bust cycle.

Let us know in the comments how real estate is looking in your hometown, whether it is on the map or not.