By Robert Freedman, Senior Editor, REALTOR® Magazine
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.