Posted on Tuesday, November 2, 2010
A home is shelter first and foremost, but under normal circumstances it also is a proven, sound long-term
investment. Abnormal economic swings in recent years have distorted those perceptions and, for many
people, the reality as well. But a closer examination of the underlying fundamentals shows that owning a
home will continue to be a good long-term investment in the future – as long as the U.S. doesn’t tamper
with basic policies that promote responsible and sustainable home ownership.
Beyond offering shelter and investment opportunities, buying a home generates pride of ownership and
commitment to community, which come with achieving this key part of the American Dream. Combined,
these factors contribute to the quality of life in communities across the country – inspiring our nation to
be described as the “best housed nation on earth.”
The goal is sustainable home ownership, which contributes to the vitality of communities. People who
are not ready for the responsibility and challenges of home ownership should not pursue it, particularly if
they have short-term time horizons of only a few years, limited resources, or poor credit.
Home Ownership Rates
Over time, during most of the past 50 years, roughly two out of three households in the U.S. have been
home owners, while one-third have been renters. According to the U.S. Census Bureau, the home
ownership rate accelerated in the 1950s with strong household formation following World War II. By
1965 it rose to nearly 63 percent, and has hovered fairly close to the 66 percent range since 1979; it
currently resides at 66.9 percent (second quarter 2010), which appears to be a sustainable level based on
fundamentals that will be explained further.
The Modern Housing Era
By most accounts, the modern housing era began after World War II when the G.I. bill made the 30-year
fixed-rate mortgage widely available. In the 1930s and 1940s, it was far more common to pay cash or
finance a home with a 10-year mortgage and a 50 percent down payment; consequentially, home
ownership rates were much lower –only around 45 percent – before the housing market heated up in the
1950s with the Baby Boom.
The 30-year fixed-rate mortgage is the cornerstone of home financing, offering safe and stable payments.
Alternatives, including adjustable-rate loans and various hybrids, make sense for buyers who would be
comfortable with a worst-case higher payment adjustment or plan to sell before the first adjustment
period. However, preservation of the fixed-rate loan is critical to a stable housing finance system that has
worked well for over 60 years – any tampering with that model could have dire consequences for the
Favorable Tax Treatment and Economic Benefits
Congress has long recognized the intrinsic values of home ownership, and consequential economic and
social benefits, and has offered tax incentives for home owners since the inception of the Internal
Revenue Code with the Revenue Act of 1913. Most important is the mortgage-interest deduction, which
reduces the tax burden for home owners. The use of itemized deductions grew notably during the 1950s
and 1960s as home ownership increased.
Borrowers may increase the number of federal tax withholding allowances to increase their net pay,
which helps to make monthly mortgage payments more affordable. In addition, state and local property
taxes are deductible.
Today, home owners pay 80 to 90 percent of the income taxes in the U.S. and, among those who claim
the mortgage-interest deduction, nearly two-thirds are middle-income earners. In the mid-20th century,
the deduction became a key component in how the housing system works in the U.S., stabilizing
communities while helping owners to accumulate long-term wealth. That, in turn, has provided
confidence for consumers to spend and stimulate other economic activity.
Each home purchase generates nearly $60,000 in direct and indirect spending in the economy. Besides
the services directly tied to a home purchase, other sectors benefit from the demand for related goods and
services, including carpeting, furniture, appliances, window treatments, landscaping, home improvement,
etc. In total, housing and related economic activities account for more than 20 percent of gross domestic
product in a typical year.
Home owners have a stake in their community. Various studies* show they are more likely to vote and
are less likely to move. Long-term residents are more likely to volunteer and participate in civic
activities. In essence, many studies show home owners make better citizens – they have higher
educational achievement (as do their children), lower crime rates and help to maintain a community.
Some studies also show home owners are happier and healthier with higher life satisfaction, self-esteem
and perceived control over their lives.
Owner-occupied housing generally is better maintained than renter-occupied housing. Higher levels of
home ownership lead to more stable communities as home owners are imbedded in the same
neighborhood and community for longer periods. For example, nearly 30 percent of renters moved
during 2009, while only 5.2 percent of home owners moved.
The Housing Boom and Bust: Aberrations
Much has been made recently about changes in the housing market since the boom, but it is important to
keep in mind that the market behaved uncharacteristically during this period – notably between 2003 and
2006 – largely in response to risky mortgage instruments motivated by greed on Wall Street. In
examining the correction that has taken place and any adjustments that should be made, it’s important to
put the information into perspective.
For example, the home ownership rate spiked to over 69 percent in parts of 2004 and 2005, and much has
been made of the decline since – but it is a decline only to the long-term average. Marginal home buyers
in the middle part of the decade were encouraged to buy homes by mortgage brokers recommending risky
financial instruments with no down payments and low teaser interest rates. As a result, home ownership
rates peaked above sustainable levels. Many borrowers didn’t understand the terms of the loans, while
the mortgage companies assumed no responsibilities and sold the mortgages as highly rated securities to
The mortgage mess caught by surprise many other buyers who frequently didn’t understand the terms of
exotic alternative instruments or assumed they’d be able to refinance or sell their home when the time
came. A fundamental shift in the playing field had occurred, one that in hindsight should have never been
The assumption of rising home values became distorted, in some areas with expectations of double-digit
annual gains. Even though the national median-home price had never declined in the modern housing era,
people were ignoring the fact that median existing-home prices had declined in many metro areas during
the 1980s and 1990s, as was widely reported in quarterly news releases by the National Association of
Purveyors of toxic loans focused only on aggregate national price gains as justification for their models,
not factoring in what would happen as lending products that lacked common economic sense were widely
introduced and borrowers began facing loan adjustments that they would not be able to afford.
Something of a herd instinct kicked in during the housing boom in many areas, with easy money
increasing demand and more buyers chasing a shrinking supply of listings. Multiple bids above the
asking price became common in many markets, driving annual price appreciation to record levels relative
to inflation. Buyers frequently ignored the advice of their real estate agents to get a professional home
inspection, with many responding to “as-is” offers, and often paid little attention to brochures or cautions
about the risks of new lending instruments.
In the most pronounced bubble markets, where very high double-digit price increases persisted for several
years, a sharp correction became inevitable. Nationally, based on annual median existing-home prices
reported by NAR, that correction amounted to a 22.3 percent decline but was much deeper in some areas
– particularly those with the highest percentages of toxic loans, where today we find the highest levels of
Buyers who bought at the top of the market in areas that experienced the largest home-price gains might
take more than a decade to recover the equity that was lost. There were terrible personal losses for many
such buyers who had to move, lost their jobs, or found themselves unable to refinance. However, for the
vast majority of home owners, net gains are realized when they sell their homes, and one-third of homes
are owned free and clear. For people who have purchased in recent years and plan to hold onto their
homes for a normal period of home ownership, expectations of healthy gains are on even firmer ground
for a variety of reasons.
Today’s Lending Standards
It is true that lending standards are tighter today than they were prior to the boom and bust period and, to
some extent, this simply is the pendulum swinging in the opposite direction from the lax standards of the
boom period which permitted extreme mortgage products such as “liar loans.” Those loans featured no
down payment and no verification of income – terms that confounded European bankers who rhetorically
asked, in reference to their American counterparts, “What were you thinking?”
Even with tighter lending standards and higher credit-score requirements, borrowers today can
successfully find a mortgage if they don’t overstretch themselves and stay within their means – something
that is greatly facilitated by historically low mortgage-interest rates. As bank balance sheets improve, it is
expected that lending standards will gradually return to normal sound and balanced practices.
Home Prices Trends
Since 1968, when NAR began collecting data on the median price of existing single-family homes, in
most years, the typical home value has increased at a pace of 1 to 2 percentage points above the rate of
inflation. From 1968 through 2009, even with periods of double-digit inflation and several years of price
declines that began in 2007, the national average annual price gain was 5.5 percent.
In effect, rapid price gains in many areas during the housing boom had borrowed from future
appreciation. However, in some areas home prices have overcorrected because homes in many markets
have been selling for less than the cost of replacement construction.
Net Wealth Accumulation
Home owners accumulate significantly more net household wealth than renters. The Federal Reserve
Survey of Consumer Finances shows this clearly over time. The most recent periodic study in 2007
showed the median net wealth of home owners was $234,200, which is 46 times that of renters’ median
net worth of $5,100. Although there has been a loss of household equity since the most recent survey, it
has stabilized this year and home owner equity today remains significantly larger than renter equity.
Long-term home ownership is a form of forced savings. With a fixed-rate mortgage, the costs become
more affordable over time in comparison with rent, which generally trends up.
Favorable Home Price-to-Income Ratio
The national price-to-income ratio is back in line with historic fundamentals, while mortgage rates have
fallen to historic lows and housing affordability is near a record high. In 2005, the typical family
purchased a home that cost 3.3 times their income, but the ratio declined to 2.4 times income by 2010,
which actually is below a longer term trend of about 2.6 times income from 1985 through 2001.
Record High Housing Affordability
The relationship between median family income, median home price and average mortgage-interest rate is
hovering at the most-favorable level dating back to the beginning of NAR’s Housing Affordability Index
in 1970. The index is relative, with 100 defined as the point where a median-income family can afford a
median-priced home with a 20 percent down payment and 25 percent of gross income devoted to
mortgage principal and interest. For first-time buyers with comparable income but making a small down
payment, affordability levels are roughly 80 percent of the index level.
Any housing affordability index over 100 is considered favorable. 2009 set a record high with the index
at 172, meaning the typical family had 172 percent of the income needed to purchase a median-priced
home. In 2010, NAR projects the index to remain around that level, meaning there’s never been a period
in American history when home buyers had more purchasing power than they do today.
Abnormally Low Housing Construction and Household Formation
There is a clear relationship between household formation and housing starts. The U.S. population is
growing by about 3 million people a year, which would normally result in 1.0 to 1.4 million additional
households being formed each year, but formation has been weak for the past few years and totaled only
398,000 in 2009. On the supply side, the U.S. loses about 300,000 old housing units per year through
obsolescence and demolition, which translates into a long-term underlying demand for roughly 1.5
million housing starts per year.
We clearly overbuilt from 2002 through 2006, but have fallen notably below historic averages since 2007.
In fact, construction activity in 2010 is only one third of the long-term average demand of about 1.5
million. The construction slowdown will help to support home values, which will become very clear
once the available housing supply eventually diminishes to more normal levels.
Ironically, if construction doesn't return to normal levels within a few years, we could be looking at future
housing shortages and abnormal pressure on home prices. In the meantime, household formation is
constrained with kids moving back home, never leaving home in the first place or doubling up with
roommates. Much of the slowdown in household formation is tied to weak confidence resulting from
insufficient job creation, which impacts both home sales and apartment rentals.
Understandable concerns have been raised about the level of “shadow inventory,” homes that are
delinquent in mortgage payments and ultimately may be repossessed and enter the market. There is much
confusion over this issue; for example, the number of foreclosure notices is three times as large as the
number of homes that are actually repossessed and placed on the market. Depending on the state,
anywhere between two and four notices are issued before a home can be repossessed.
The estimates for shadow inventory range from 1.7 to 12.5 million, in part due to the confusion between
notices and repossessions, but also due to assumptions regarding home value. For example, a projection
of net housing worth based on selling prices in 2009 would be exaggerated because 36 percent of sales
that year were distressed, typically sold at a 15 percent discount relative to traditional homes in good
condition. Just over 5 million out of the 75 million owner-occupied homes in the U.S. were sold in 2009;
most of the remaining 70 million properties are not distressed properties; they are in good condition with
higher overall values.
Although NAR estimates shadow inventory at 2.5 million, the fact is foreclosures have been entering the
market at a steady pace since peaking in the middle of 2008. With stable home prices, it’s expected we’ll
work through the mess created by toxic loans over the next couple of years. Unless there is an unusual
change to the pattern that’s persisted for nearly two years, the market is expected to continue to steadily
absorb these properties.
Demographically, there is pent-up demand for new households well into the future. In recent decades the
market was driven by the Baby Boom generation, the 75.8 million people living today born between 1946
and 1964. Their children’s generation, sometimes referred to as the Echo Boom generation, is essentially
the same size, with 75 million people born between 1982 and 1995. Considering that the median age of a
first-time buyer is 30 to 32 in most years, this younger generation is just entering the peak years for
buying a first home and will fuel demand in future decades.
Opportunity for Buyers
In hindsight, the current period is likely to be viewed as a golden opportunity to buy a home. Mortgage
interest rates are at record lows, home prices have declined and actually overcorrected in many areas,
inventory is plentiful, and sellers are motivated. With a growing population and housing construction
below long-term fundamental demands, it is inevitable that supply will eventually come back in line with
At the same time, the 2009 NAR Profile of Home Buyers and Sellers shows the typical buyer plans to stay
in their home for 10 years. With that kind of a long-term view, it is likely that most buyers will see a
return to normal price-appreciation patterns that will allow them to build equity. Although many
comparisons of home-equity change focus exclusively on price, equity also is accumulated by gradually
paying down the mortgage principal.
Home buyers also benefit from the power of leverage. Buyers typically use their own money to cover
only a small portion of the purchase price, but the gain they realize is based on the total value of the
property. Ironically, when home ownership is compared with other forms of investment, this benefit of
leverage often is ignored, along with the fact that an individual has to live somewhere at some cost –
similarly, an imputed rent value generally is not considered.
Typical Seller Equity
The typical home seller has been in their home for seven years, and in the current period generally is
seeing only a modest gain from when they purchased. However, the longer a person owns, the better the
investment. In a 10-year comparison, which includes the entire boom-bust cycle, sellers who purchased
10 years ago are seeing an average net gain nationally of 25 percent. In dollar terms for the national
median existing-home price, that works out to an increase of $34,500 (the 1999 median was $138,000,
while the 2009 median was $172,500; home prices have been relatively stable in 2010).
Certainly, any seller would be happier with the higher price they could have received a few years ago, but
this underscores the long-term value of home ownership, even in a period that is atypical. More
importantly, the lessons learned from the housing bust have virtually eliminated risky mortgage products.
The loans being made today are safe and sound, with some safeguards in place and others being
developed to prevent future abuses or confusion over loan terms. The caution is to not overreact, with a
clear understanding of the cause and effect relationships in the boom and bust cycle.
Home ownership continues to be a sound investment over the long term, providing shelter and a higher
quality of life where most owners feel safe and secure. It is the primary means for most households to
accumulate wealth, providing resources for a more comfortable retirement. In times of need, the
accumulated equity in a home offers financial flexibility – it can be tapped for major expenses such as
college education, major medical bills, or adding to the home to accommodate a growing family. It
should never be used for simple consumption.
In a normal market, most families accumulate enough equity to trade up to a larger home in three to five
years, although that is longer in the current environment and conditions vary widely around the country.
When approaching retirement after a long period of home ownership, most owners have accumulated
large amounts of equity which permit them to trade down to a smaller and easier to maintain home,
generally with an all-cash transaction. Most renters could never dream of such options; a mortgage might
last 30 years, but renting is forever.
In short, achieving sustainable home ownership truly is the greatest part of the American Dream.
*See Social Benefits of Home Ownership and Stable Housing, National Association of REALTORS®,
August 2010, for a detailed analysis and references to specific studies NAR