October 11, 2015

Rethinking home ownership

In the March 5-11 issue of The Economist, there was an article entitled “The Perils of Property.” The author made the point that buying a home is the biggest single financial bet most Americans will ever make. As all too many Americans learned in the recent financial meltdown, buying a home can be a very risky bet.

Our government not only subsidizes home ownership through the home mortgage interest deduction, but it has created a variety of tools to enable lenders to make home mortgage loans to more people. Lawmakers have always believed that broad-based home ownership is an inherent societal benefit, because they believe it creates a greater stake in the well being of the community. Independent of whether owning a home is a good investment, American lawmakers want as many Americans as possible to own, rather than rent, their residences.

However, is this a good idea? For someone who has a limited amount of discretionary income or asset base, using most of one’s discretionary assets to acquire a home may be a very bad idea. If a person invests all of his or her savings in a home, the decision violates many principles of good financial management.

Don’t put all your eggs in one basket.

Buying a home with your savings is truly putting all your eggs in a single basket. It is worse than that. It is putting those savings in a highly illiquid asset that can only be bought or sold in its entirety. One risk management tool any of us can use with stocks and bonds is to cash in a portion of our investment to protect the rest of the investment. That option is not available for the purchase or sale of a home: it is an “all-or-nothing” proposition.

Don’t invest in an asset in which there are many independent factors that could significantly depress its value.

When we buy the stock of a public company, the Securities and Exchange Commission makes publicly traded companies describe a wide variety of risk factors. The most common thread among these risk factors is the existence of single points of failure. Companies have to disclose risks such as the dependence on a single product’s revenues, a single large customer, a single regulation, or a single patent or trademark. In cases in which companies disclose these risks, they are considered “single points of failure.”

Airplanes have redundancy built into every critical system because airlines and regulators demand systems that cannot fail because of a single defect. There are back-up engines, power systems, and controls.

Yet there are many single items that can cause the value of a home to drop significantly. My wife and I experienced this with the first home we bought 32 years ago. The federal government forced the state of Connecticut to allow trucks exceeding 80,000 pounds to use I-95, which was not far away from the home we had bought a few months before. The increased noise and vibrations from the larger trucks significantly depressed our home’s resale value. We lost every bit of our equity.

We invested in a cooperative conversion project in New York City a few years ago. We lost every penny of that investment because of tax law changes, and because New York City required every newly renovated or build housing unit to be 100% accessible to people with disabilities.

While we had successful real estate investments along the way, we learned the hard way that a single change in the law or some other factor outside our control can wipe out an investment in a home.

Don’t invest in something in which the other party has inside information and you do not.

The U.S. government, as well as every state, protects everyone who buys or sells a publicly traded security from the disadvantage caused by a party on the other side of the transaction who gains unfair advantage by having material inside information. However, there is no such protection in residential real estate transactions.

Buyers have the ability to get a home inspected and to do their own investigation about a home’s market value and the factors which affect it. However, if a seller knows that someone is considering an action that will affect the home’s value and the buyer does not, the buyer is out of luck. Similarly, if a buyer knows that a business is considering building on a piece of land and will pay premium prices and the seller does not, the buyer has a huge edge.

Don’t invest in something in which you have open-ended liability.

Homes are money pits (there was even a film by that name starring Tom Hanks some years ago), especially older homes that are often the ones available to first-time home buyers. My wife and I have had basement flooding, a leaky roof from the ice accumulation this past winter, and an underground oil line leak from a poorly insulated oil line. Although we had sufficient resources to correct all these problems, they resulted in huge, unbudgeted expenses, even after insurance claims were paid.

When my wife and I were about to sign the contract on building our current home in 1993, our attorney Tom Skidd, from Cummings & Lockwood, told us that, before we signed our contract to get the home built, he would bring over something we had to review. I expected to get a legal memorandum, or some educational materials on the legal risks of buying and owning a home, or an instructional videotape. Instead, he gave us a videotape of the old Cary Grant-Myrna Loy film Mr. Blandings Builds His Dream House, a wonderful movie that depicted not only the financial and technical problems of building and owning a home, but the relationship tensions a home buying or building process creates. He was and is a very wise person, and we avoided many pitfalls because of him.

The National Urban League and many of its affiliates, and Operation HOPE, a financial counseling firm, have done great work counseling first-time home buyers, and I am proud at what the Urban League has particularly accomplished under Marc Morial’s leadership in the last few years, since he reacted to the housing crisis with a far more expanded set of offerings than had been the case before that.

Final observations

The biggest single lesson from all this is that we need to rethink some long-held assumptions about the benefits of home ownership. Having a stable and engaged civil society and people committed to the betterment of their communities is critical to the effective functioning of representative democracy. Whether home ownership is the right way to achieve this goal needs to be re-examined.