Why Robert Shiller Is Wrong On Home Ownership

by: Jussi Askola


Robert Shiller recently published a very bearish article on home investments.

The data provided by Shiller is incomplete and misleading.

The financial benefits of owning your home are superior than presented in his article.

I recently wrote an article entitled "Why Robert Shiller is Wrong on Farmland" as a response to his recent article published on The New York Times under the title "Why land and homes actually tend to be disappointing investments." Having recently written several articles on farmland investments, I first decided to defend that asset class from what seemed to me to be a misleading and erroneous presentation. To my surprise, after reading the article again, I noticed that his analysis of home investments was just as unsophisticated as the one that touched farmland. It is very bearish and uses incomplete data to mislead readers into thinking that renting makes more sense than buying.

He fails to account for certain aspects of home investment returns and comes to economic conclusions without supporting data. The article created lots of controversy (see comments section) and it seems like the following paragraph generated the most response:

Over the century from 1915 to 2015, though, the real value of American farmland (deflated by the Consumer Price Index) increased only 3.1 times, according to the Department of Agriculture. That comes to an average increase of only 1.1 percent a year - and with a growing population, that's barely enough to keep per capita real land value unchanged. According to my own data (relying on the S&P/Case-Shiller U.S. National Home Price Index, which I helped create), real home prices rose even more slowly over the same period - a total increase of 1.8 times, which comes to an average of only 0.6 percent a year."

As a result of this article and the stated 0.6% per year, many potential home buyers might be misled into thinking that owning a home provides no financial benefits. Shiller does not provide any additional explanation to the total financial returns of homes and concludes that they are bad investments.

Three elements cause this misconception among the readers: Shiller does not mention nominal returns; he forgets to account for the rent savings or the potential cash return that could be earned by renting the home; and finally he does not consider the first criteria of real estate investment: location, location, location.

First off, as I did with my farmland article, let's remark that it is rare for any individual investor to talk about real returns. The 0.6% mentioned by Shiller is a real return which means after inflation. Between 1915 and 2015, the U.S. experienced inflation at an average rate of 3.21% per year. The nominal capital appreciation per year would hence have been 3.81% per year according to Shiller's data. Since it is uncommon for the average home buyer to discuss real returns when assessing historic returns, I think that this already leads to many misunderstandings. When you hear investors assess the performance of the S&P500, it is rare to hear them talk about real returns after inflation, so let's not do that with home investments. There is a big difference between 3.8% and 0.6%.

Secondly, he does not even mention that value appreciation is only one component of the total return generated by home investments. A major component of home investment returns comes from the rent cost savings. By living in your house, you save substantial cost and also benefit from additional non-monetary benefits. Alternatively, you could have rented your home to a tenant who would have provided you a monthly payment. Historically, cash yields on basic single family houses have, depending on the property type and location, often ranged between 5-10%. When combining both cash return plus value appreciation together, single family houses have during long time periods achieved very satisfactory returns with consistent and predictable cash flow that are very competitive with other asset classes.

Thirdly, let's not forget that homes are one of the most financeable assets in the world with better than average conditions. You rarely buy it outright; you buy it with a mortgage. Often your mortgage ends up being about as high as if you would pay rent. However, there is a huge difference between paying down your mortgage and building equity in your house and just paying a rent. The rent is 100% lost, but the mortgage payment is partly the principal getting paid down which builds wealth.

Warren Buffett commented as follows on single family home investments in 2012:

If I had a way of buying a couple hundred thousand single family homes and had a way of managing them, I would load up on them. I would take 30 year mortgages at very low rates. It is a very attractive asset class now.

If I knew where I was going to live the next 5 or 10 years, I would buy a home and finance it with a 30-year mortgage instead of buying equities. It is a terrific deal. Literally, if I was an investor that was the handy type and I could buy a couple of them at distressed prices and find tenants, and again take a 30-year mortgage, it is a leveraged way of owning a cheap productive asset. I think that is probably the most attractive investment that you can make.

Buffett remarks that if he were a younger investor he would be investing in single family homes, a move that makes sense when looking at census data indicating that from 2004-2010 homeowner households declined by 805,000, while the number of renters increased by 3.9 million in that same period. That's a lot of demand for rental property. He did say that in 2012 when homes were cheaper and yields higher. Note however that if Buffett believes that homes are a "very attractive" asset class one day, they are unlikely to be horrible the next day. The asset class itself did not change since 2012; people still need to live somewhere and will rent houses. The prices have gone up, but so have rents. The cap rates have gone down, but so have interest rates.

Lastly, the most important criteria for success in real estate is forgotten: location, location location. The 3.8% nominal appreciation that he mentions is certainly very impacted by the large long-term decline in home prices in many towns and cities that have suffered economically during the past century. The results of a property bought in a flourishing city with growing demographics and positive long term prospects would be very different. The appreciation of a house in an infill location of an attractive neighborhood in San Francisco will be significantly higher than an average house in Cleveland. I think that this is quite clear, and using a mean appreciation rate is hence not appropriate to come to conclusions.

Real life example of how home ownership creates substantial wealth:

Despite the fact that Germany has one the most successful European economies and that its income per capita is above average, the net wealth of German households is one of smallest in Europe. Germans are some of the poorest people in Europe, even poorer than those in the troubled nations of Spain, Greece and Italy according to a study from the European Center Bank.

The study found that the composition of net wealth is mostly driven by real assets including home ownership. Countries with low home ownership rates are, not surprisingly, often among the poorest and this is one of the main reasons why Germans are so poor. They don't buy, they rent.

Final thoughts

There is no doubt that Robert Shiller is a great economist. But this does not change the fact that his article misses the whole concept of real estate investment. He fails to account for many components of the total return and only bases his conclusion on the mean real appreciation of houses.

The 0.6% return that he mentions obviously doesn't tell the whole story to the readers. By accounting for the rent savings, the built-in equity, and the superior value appreciation from a desirable location, returns in excess of 10% could as well have been calculated. The European case study is a pretty strong argument in favor of home ownership.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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