Who wants to buy a house?

In the last decade, no investment has been re-scrutinized as much as home ownership. A house as a badge of arrival into the American middle class is no longer an obvious or automatic decision.

Homeownership in the US peaked in the 2000s housing bubble at around 69%. Since then, it has tailed off to just below 63%, about the same as the 1960s. The average size of the single-family home continues to swell. Americans still desire nice homes, but they are no longer convinced that ownership is necessary.

Why do people buy houses?

“I can’t think of another investment that benefits from such a legislative tail-wind.”— Paul MeloanThe tax code is stacked with incentives to get people to buy a home, and to borrow money to do it. The law gives a tax deduction for mortgage interest payments. Many commentators believe this feature only benefits people who are already wealthy and artificially inflates real estate values. Nevertheless, these incentives are wildly popular. Property taxes are also often deductible. The cherry on top is that when you sell your primary residence up to $500,000 in capital gain may be tax exempt. I can’t think of another investment that benefits from such a legislative tail-wind.

Residential housing suffers from other financial drawbacks.

The primary strike against home ownership is that it is expensive to buy and sell. Real Estate transactional costs are astronomical compared to other investments. I could sell $1 million worth of stock or mutual funds for a client for transactional costs cheaper than a pizza. Selling a $1 million home would likely involve a commission to a broker of at least 5%. Local taxes and fees are another toll-booth along this highway. These taxes typically exact anywhere from 1-3% of the transactional value from the buyers or sellers.

Demographic changes also argue against home ownership. Does anyone still work for the same employer forever any more? Persons change careers, jobs and location much more frequently than their parents or grandparents ever did. Some now see home ownership as a burden as much as an opportunity. Millennials are graduating from college with more student debt than any generation before them. Coming by the money for a down payment is not at the top of their to-do list any time soon.

Finally, I think more people recognize that periods of rapidly escalating home prices have been the exception through history and not the rule. The New York Times published a very useful interactive model that considers multiple factors, and can help make a reasonable comparison between buying and renting.

So who should buy and who should rent?

The bottom line is that owning a home can have financial advantages for some people. Those with stable long-term prospects in a given location should strongly consider the financial advantages. These advantages need to be weighed against the considerable financial costs and risks.