What History Says About Buying a Home as an Investment

A decade ago, buying a home was viewed as an almost sure-thing investment. The collapse of the housing bubble then proved that real estate could be a heart-breaking and ruinous investment. Which view is more accurate?

An examination of historical home price data paints a picture that is between those two extremes. For most people, buying a home is neither a ticket to instant riches nor a financial disaster, but rather a slow-but-steady way to build wealth.

Long-term return

According to the S&P Case-Shiller National Home Price Index, over the past 40 years home prices have gained an average of 4.84 percent annually. That is hardly the kind of get-rich-quick number that comes to mind when people promote buying a home as an investment, but it is a reasonably solid return.

By way of perspective, inflation increased by an average of 3.82 percent a year over the same period, so real estate has at least kept home buyers ahead of inflation over the long run. Also, a 4.84 percent return sounds surprisingly attractive in today's low-yield environment, when Treasury bonds are yielding less than 3 percent, and savings accounts less than 1 percent.

Up-and-down cycles

While the long-term pace of housing prices has been solid if not spectacular, looking at up-and-down cycles in prices gives you a feel for what is the best and the worst situation historically.

In this regard, home prices are much more stable than the stock market. Over the past 40 years, there have been only two downturns that lasted a year or more. The first of these was very mild - from the peak to the bottom, home prices fell by just 3.11 percent during a downturn back in 1990/1991. Far more damaging, of course, was the collapse of the housing bubble. From the peak in mid-2006 to the bottom in 2012, home prices fell by a cumulative total of 27.40 percent.

The flip side of these declines is what happened when home prices were rising. In the upward phase of the cycle before the 1990/1991 decline, home prices averaged gains of 7.5 percent a year. Following that decline, home prices then gained an average of 6.04 percent annually on their way back up and rising to the mid-2006 peak, though in the latter stages of that upward phase year-over-year returns topped 14 percent. Finally, since bottoming out in February of 2012, home prices have been rising at an annual pace of 7.76 percent.

Perhaps the biggest hazard these up-and-down cycles pose is not so much the downturns themselves as the prospect of dead money - extended periods with little or no gains. For example, during the entire decade of the 1990s, home prices averaged annual gains of 2.67 percent - less than inflation over the same time period. And, home prices have still not recovered to the peak level of the housing boom, some eight-and-a-half years later.

In short, owning a home can be a rewarding investment, but only if you recognize that real estate operates on a very long-term schedule. In the meantime, extended periods of dead money can frustrate those who don't have the time to be patient.

Regional differences

Any discussion of real estate as an investment is complicated by the fact that price movements vary so radically from one area to another. For example, while prices nationally have gained a cumulative total of 67.35 percent so far in the 21st century, the corresponding figures for major metropolitan areas range from a low of -2.97 percent for Detroit to a high of 126.84 percent for Los Angeles.

These regional differences point to the fact that while long-term average returns on real estate nationally are fairly modest, there are opportunities for much richer gains in select markets. Of course, alongside the strong markets there will be those that underperform, so these regional differences bring risk as well as potential reward.

Other complications

There are other complications to viewing buying a home as an investment. Homes are not very liquid assets, so you cannot always sell them as readily as you might like. There are also considerable expenses involved in buying and selling a home, and these transactions costs would eat into the return you might earn from price changes. Significantly though, the negative impact of these complications is lessened the longer you hold onto a home. So, if you think of buying a home as securing a residence first and as a means of building wealth second, you might find that you are able to accomplish both goals over the long run. On the other hand, if you go into it intending to flip the house for a quick profit, you might find you have accomplished neither goal.

There are some investments that you hope to trade in and out of for a quick profit, while others you buy and hold for the long-term. The illiquid nature and long cycles of residential real estate suggest it is much better suited to the buy-and-hold approach than quick turnover. History suggests that buying a home can be rewarding over the long-term, especially if you are careful about where and when you buy.

Get Home Mortgage Loan offers customized for you today.