The Return on Equity Myth — Again

By Robert Freedman, Senior Editor, REALTOR® Magazine

Picture 1

Take out the pocket calculator again?

Paul Starobin in his piece “Should Owning a Home Still Define the American Dream?” in the Spring 2011 issue of The Next Economy (a special supplement of the National Journal) asks us to consider whether it’s time to remove home ownership from the pedestal it’s occupied since the 1920s.

His piece is part of a growing genre of articles and TV stories questioning home ownership in the wake of the housing meltdown, probably the most well-known of which is a September 2010 piece in Time magazine called “The Case Against Homeownership” by Barbara Kiviat. These pieces have done much to encourage action by members of Congress who are predisposed to remove the federal government from anything having to do with home ownership. For these members of Congress, taking such action is their right and indeed their responsibility. But these anti-home ownership pieces occasionally rely on arguments that have long been picked apart by critics and shown to be misleading if not outright incorrect.

In Starobin’s piece, he uses two such flawed arguments. In the first, he compares the return on equity of home ownership unfavorably to the return we would get if we bought a basket of stocks that track the Standard & Poor’s 500 index. Drawing on an analysis from an economist at the University of Pennsylvania’s Wharton School, Starobin says the S&P 500 has averaged an 8 percent average return since 1976, adjusted for inflation. Home prices, by contrast, he says, have gone up just 1 percent a year since 1975, when adjusted for bubbles and dips. Starobin then asks us to compare the return one might get on a $20,000 investment. Although Starobin doesn’t do the math, his point is that a $20,000 down payment on a house would generate a return of 1 percent a year while that same $20,000, invested in the S&P 500 basket, would generate an 8 percent return. “The financial gain from owning [a home] is likely to be modest,” Starobin quotes the Wharton economist as saying. “There are lots better ways to accumulate the same amount of expected wealth that do not start off with [paying] a 6 percent fee to the broker.”

But Starobin is making the wrong comparison, because for the home owner the return isn’t on the value of the down payment but on the value of the asset, the house. So, assuming the return is just 1 percent, as he suggests, that 1 percent is applied to the value of the house, not to the $20,000 down payment. If the $20,000 represents a 5 percent down payment on a $400,000 house, that 1 percent would generate a $4,000 annual return. The 8 percent return on the S&P basket, by contrast, would generate a return of just $1,600, a difference of $2,400. That’s a difference of 150 percent.

For the comparison between home ownership and an investment in the S&P basket to be meaningful, the stock index investor would have to be able to tally up her gain based on the value of the companies she invests in, not just the amount of investment she’s made in the companies’ stocks. There’s simply no comparison between a stock investment and an investment in one’s home, because stock investors only gain based on the amount they invest, not on the amount that the asset gains in value.

In the second questionable argument, Starobin perpetuates another common miscalculation, and that’s the amount of tax expenditure that would flow back into the U.S. Treasury if the mortgage interest deduction is eliminated. He uses an estimate by the Urban Institute that the flow to Treasury from nixing MID would be $99 billion. But analysts from all sides of the political spectrum routinely knock that number down and say the savings to the government would be far more modest, maybe $25 billion — and maybe quite a bit less than that, too. The difference stems from what economist James Follain, a senior fellow at the Nelson A. Rockefeller Institute of Government, calls a reshuffling of the portfolio: Many households, facing a curtailed or eliminated MID, would simply shift their tax strategy to lower their taxes in other ways.

Follain estimates the federal government would receive only a quarter of what the nonpartisan Congressional Budget Office (CBO) estimates it would receive through elimination of MID. “Others might debate that figure and say the government will get more than 25 percent of the CBO estimate, but there’s a consensus that there will be some asset reshuffling,” he has said.


Hudson Institute forum: is MID a sacred cow?

John Weicher, a fellow at the Hudson Institute and FHA commissioner during George W. Bush’s administration and assistant secretary of research and policy development at HUD during President George H.W. Bush’s administration, says the actual savings to government is maybe $21 billion, “and even that’s an overestimation,” he said at a forum on MID hosted by Hudson in February.

It’s appropriate for members of Congress to debate the role of the federal government in home ownership, and journalists that write about the financial side of home ownership do a service by putting the facts on the table, but they confuse the debate when they make comparisons and use figures that don’t tell the whole story.

Robert Freedman

Robert Freedman is director of multimedia communications for the NATIONAL ASSOCIATION OF REALTORS®. He can be reached at

More Posts

  1. I’m glad you’re on board with intelligent discussion – an almost oxymoron when it comes to our legislative processes of late. And I’m glad you’re taking a careful look at everyone’s math, because, of course, that matters. I’m wondering if you agree with NAR’s position that the MID be untouched given that even the most conservative estimates bring $20 billion back into the treasury. I’d say that’s a good chunk of money that might be worth contributing to our shared national debt. I’d also suggest that when we’re comparing homeownership value to stock value we might factor in the fact that you get to live in your home and derive value from that which cannot be derived from a stock portfolio.

  2. Of course a leveraged investment is going to have a higher Beta than a non-leveraged investment. This variable needs to be controlled for in both of the calculations above.

    If you are going to use leverage (ie: a mortgage) and value the house on the asset, then you need to use the $20,000 investment in the S&P levered as well. Therefore, you need to use the $20,000 invested in options that lever the S&P basket of stocks to the same ratio as your mortgaged asset (the house).

  3. Exactly, you cannot live in your investment portfolio. Living in a home can offer you so many wonderful memories that money cannot buy. I still believe that home-ownership should be part of the American dream.

  4. Carmen, thanks for your comment. You make a good point that, with home ownership, owners get something they certainly can’t get with other investments, and that’s a place to live, one that they can change to suit their needs and lifestyle. Of course, financial considerations are secondary when it comes to owning a home, but sometimes it makes sense to talk about that aspect of it, such as we did in this blog post. On the issue of MID, NAR polled a representative sample of its membership last year and the vast majority of them favored keeping the MID as it is, even though the poll gave respondents a choice between that and giving up some MID benefit to help with the deficit. A separate poll by Harris Interactive found that 75 percent of owners and two-thirds of renters also said MID is vital. These poll results certainly validate Realtors’ longstanding support of MID as one of the integral ways Congress has historically shown its support for home ownership as not just an individual good but as a social good as well. If you want to see those poll results you just go to and search “MID vital.” Thanks again for your comment.
    Rob Freedman

  5. Dan

    I agree! We should be promoting home ownership and the MID does serve a very important function. Trying to compare a home purchase to that of a stock portfolio is absurd. I also question whether the S&P has truly earned an average 8% return when adjusted for inflation. Have you checked that figure? I would have thought that it has earned an average of 8% before adjusting for inflation but I could be wrong. Housing on the other hand has definately earned at least a 1% return after being indexed for inflation. As stated above you also have the benefit of living in the investment which means that you help control inflation when it comes to living expenses. When someone rents and inflation is high the monthly payment goes up up up but when you have a fixed rate mortgage on a property the payment usually is a much more stable payment. It will increase due to taxes going up and insurance going up but the amount is much less than what it can go up for a rented property. Plus of course as was stated in the article most people are earning that 1% or more on leveraged dollars which is much less often the case with investments in the S&P.
    Studies also show that there is lower crime rates and many other good social benefits to areas with high home ownership rates. Not to mention the benefits of getting to know your neighbors. When people own they usually stay put longer than when they rent which gives communities a better chance at getting to know each other and bond with each other for the common good of the community.

  6. Karl

    You missed the biggest refutation of this “Equity Myth.” The biggest component of real estate returns (commercial or residential) is “income” not equity appreciation. People miss this when thinking about homes because they ignore the value of living in a home. This is easiest to see when one takes a mortgage out of the equation. In this case, the income is the difference between the “imputed” rental value and the taxes, insurance and maintenance/depreciation. This will probably run about 6% or so in most places. Thus, the 1% return is really like 7%. My guess is that less than 2% of our policy makers in Washington and pundits actually understand this basic, fundamental issue.

    When you add leverage, this alters the equation somewhat but the basic source of underlying value is the same because you are applying a large percentage of that “imputed rent” towards paying the debt, which will eventually enable you to capture a larger percentage of the “imputed rent.”

    The math, performed correctly, shows that owning a home (assuming you stay there for a while and the house really suits your needs) is the best investment that an average person can make. The last few years have skewed this perception but in the long run but when you have the ability to reduce, capture and control one of the largest, if not the largest, living expense, this has tremendous and stable value.

  7. Bill Saunders

    Excellent post. “The American Dream” is such a multifaceted concept. To many it is having a great portfolio and driving the biggest car on the block. Home ownership is just that… “owning a place of your own.” Chris’s comment above says a lot. I think where we fell off the wagon was when we began to view our residences as stocks to be traded. None of my stocks can keep the cold out or the rain off my head.