The Gamble of Home Ownership
I
No one is more aware than I of the happiness that home ownership can bring. As a member of a large family, I lived for twenty years in the home owned by my father; and no investment ever paid any family more handsome dividends than we received in contentment and comfort. As a result of this experience, I began my adult life thoroughly prejudiced in favor of owning a home.
I now have a family of my own. We live in a modest but attractive suburban house. But we do not own it. We rent it. Many of my friends whose income and net worth are smaller or no larger than mine own houses of a similar character. They seem somewhat scandalized by my persistent refusal to buy a house. In fact, they are so anxious to initiate me into the joys of home ownership that many of them have confidentially offered to sell me their houses, subject to large mortgages already on them. Such universal willingness — for a small cash consideration — to part with the joys that home ownership is supposed to bring somehow gives me pause.
My reason for not buying a house is simply that I do not feel I have sufficient means to pay a really substantial part of the purchase price on the sort of house I should be willing to live in for the rest of my life and still have sufficient remaining assets of a liquid character to meet all possible family contingencies. Only under such circumstances is home ownership an investment that brings happiness and freedom from care. Under any other conditions it is merely a speculation in real estate that is all too likely to bring only worry and grief.
In the days when I was a boy in the house of my father, people really owned their homes. To-day, because of the ready availability of the modern, streamlined mortgage, most people are lucky if they own even the bathroom faucets.
There has been too much sentiment involved in home buying in the past generation, and not enough simple arithmetic and economics. I maintain that the purchase of a home should be regarded as a hard, businesslike proposition, just like any other investment. What room is there for sentiment in the assumption of liability for $10,000 or $20,000 worth of illiquid physical assets? For most people the purchase of a home represents the biggest financial transaction of their lives. If it is not to end in disaster, it should be appraised coldly and sanely.
I realize that this is an extremely unorthodox point of view. Home and hearth are usually spoken of only with reverence. Criticism of home ownership is likely to brand you as the worst sort of iconoclast. It is almost as reprehensible as an attack upon the Deity or a denial of the sincerity of mother love. This probably accounts for the striking absence of realistic discussions of the subject. There are many good reasons for owning a home. Most of them are sentimental reasons, and they have been well publicized. The purpose of this discussion is to point out some of the strictly economic phases, which have not been nearly so well publicized.
Any financial counselor or sound business man will advise an individual whose net worth is $2000 that he would be extremely unwise to buy $10,000 worth of common stocks on a 20 per cent margin. In fact, public indignation at this sort of financial hara-kiri has resulted in regulations by the Securities and Exchange Commission requiring at least a 45 per cent margin for the purchase of listed securities. This properly protects a man from his own folly. But that same man with $2000 is urged — nay, exhorted — to ‘ invest ' it on a 20 per cent margin in a $10,000 home.
At this point the average reader will say that the comparison of these two transactions is not a fair one; that one is a speculation for profit whereas the other is an investment in comfort and security with no thought of profit. I grant all that; but purposes and intentions do not alter the economics of the case. An unsound financial transaction is still unsound regardless of the purposes for which it is perpetrated.
II
As soon as an individual, contrary to all sound business and financial principles, has entered into a real-estate transaction of the type just described, he is immediately hailed as a pillar of the community. He is a home owner — a taxpayer. He acquires an aura of increased respectability, and in the eyes of his fellow citizens takes on a more substantial stature than before. Why he is any more of a taxpayer than the man who rents the same house is something no one has ever been able to explain to me. Why he is a more substantial fellow, now that he is trading on a thin equity in real estate, than he was before, when his assets were liquid and he had no debts, is something else I have never been able to understand. Adversity is the test of the substantial citizen. And I will wager that in hard times such a home owner will be on the relief rolls much sooner than if he had rented a home and kept a liquid reserve for emergencies.
I am aware that no one is supposed to be willing to die in defense of a boarding house. And I suppose that this derogatory remark applies to rent payers as well. But I submit that neither is anyone willing to die in defense of a home that is about to be taken away from him by the sheriff. If my observations have been correct, insolvent home owners have been one of the greatest causes of social unrest in recent years. A dispossessed home owner nurses a greater grievance against society than does the rent payer whose adversities have forced him into a less expensive establishment. It is a dangerous and unsound state of affairs when a large proportion of our property owners can become, during a period of adversity, the chief disgruntled element of a community. There were more than half a million home mortgage foreclosures in the United States during the years 1932 and 1933, and another half million in the three following years.
The same general conditions that would have shown the weakness of the stock speculation our hypothetical individual was advised against also reveal the unsoundness of his real-estate transaction. The values of all forms of property usually decline or advance together, under the influence of alternating cycles of prosperity and depression. When the trend of values is down, the shoestring home owner encounters the same difficulties as the shoestring stock speculator. He can’t protect his position, and is usually forced out when prices are lowest.
My observation has been that the purchase of a home almost invariably results in a final loss, whether taken or untaken. Of the scores of people whose experience has come to my personal attention over a long period of years, only one man I have known ever made profit on the sale of his home, and retained it by virtue of the fact that he did not reinvest the proceeds in a new home.
The reason for this condition of affairs becomes fairly obvious on further consideration. In the first place, the average home owner usually buys his house when times are good, for the simple reason that that is when he is most likely to have the necessary funds. Unfortunately, that is also the time when real-estate prices are likely to be the highest. A comparison of the rate of residential building for 1928 and 1932 shows clearly that the bulk of home building takes place when the real-estate market is high. The relative activity in the real-estate market in good times as compared with bad shows the same evidence with regard to purchases of houses already built.
Even if the home owner is one of those who buy when prices are low, and the value of his property subsequently increases, he rarely takes advantage of the situation by selling and realizing a profit, because of sentimental attachment for his home. Of those less sentimental, who seize the opportunity for profitable resale, the great majority promptly reinvest their money in new homes — often larger and with a heavier load of debt — and thus expose themselves again to future losses.
The pressure to sell, on the other hand, almost always comes during times of economic stress, when prices are most likely to be considerably lower than at the time of original purchase. Real estate, moreover, is a notoriously illiquid form of property, and the need for immediate sale usually requires an offering at sacrifice prices.
All of this, of course, applies only to the man who resells his property. What of the man who buys and has no later need or wish to sell? His probable ultimate loss comes through the usual tendency of residential neighborhoods to deteriorate, rather than improve, as they grow older.
III
Now I am not arguing that the probabilities of loss on residential property make the ownership of a home an unsatisfactory investment for those persons who are in a position to assume such risk of loss. The man who buys a home he can well afford and who lives in it happily for twenty or twenty-five years can afford to give it away at the end of that time. It will owe him nothing. But I firmly believe that it is an economic crime to entice people to expose virtually their entire net worth to losses they cannot afford, through purchase of a home on a thin equity that they cannot protect in times of adversity.
What are the reasons that so many people who buy homes come to regret it? Again, I will draw only on my personal knowledge and observations. A number of people I know, who purchased houses in boom times on a thin equity, lost their homes by foreclosure in the first wave of hard times. Most of them never should have been home owners, of course, because they did not have sufficient means to protect their positions. One man I know had to give up his life insurance when his income dropped, in order to protect his equity in his house. Fortunately he did n’t die, but he exposed his family to a foolhardy risk.
Another family I know found many of their neighbors to be objectionable and had to sell their house at a sacrifice in order to move away. Another man of my acquaintance who bought a house early in life had his family outgrow it and sold it at a heavy loss in order to buy a larger one. Another had his office transferred to a different city. Still another changed his business, which necessitated a change in working hours that made the location of his home unsatisfactory.
Such things as these are likely to happen to anyone. They do not, in themselves, constitute reasons for not owning a home, except when those involved are not in a position to take the losses that usually accompany such developments. The point is that, for one reason or another, most people do not remain in one home as long as they think they will. Residential properties in the United States change hands on an average of once every seven years.
Many surprised home owners found out only in the last few years the meaning of the phrase ‘deficiency judgment.’ They thought that their possible loss on a house was limited to the amount of money they had invested in it. They found, to their sorrow, that when the property at forced sale did not produce the amount of the mortgage, they were still liable for the balance.
In the business world, there is no parallel for the sort of overborrowing that characterizes the field of residential real estate. In corporation finance, the purchase of assets in an amount equivalent to five times a company’s capital has been demonstrated to be thoroughly unsound. Four dollars borrowed for every dollar invested is a dangerous and topheavy arrangement. A few railroads and utility companies, suffering from delusions as to the stability of their income, undertook such a ratio of borrowing, but nearly all of them came to grief. Yet the employees of these and other companies blithely get their personal affairs into a similar tangle through the dollar-down-anddollar-a-week purchase of homes.
During the past, six years the home renter has enjoyed obvious advantages over the home owner. Rents in many cases have been substantially below the actual carrying charges on property. This situation, of course, cannot last indefinitely. There will be later periods in which ownership will be more economical than rental.
But when rents increase substantially, general conditions are usually improving to the point at which the income of the average man is somewhat greater. This means that he can probably afford the necessary increase in rental without undue strain on his personal finances. Likewise, when conditions are bad and incomes are reduced, rents also tend to fall, so that the home renter gets a downward adjustment when he needs it the most.
As compared with this more or less flexible situation, the expenses of the home owner are fixed. The situation may be likened to that of two corporations, one with preferred stock outstanding requiring dividends to be paid only when earned; the other with bonds outstanding, on which the first inability to pay interest results in default and foreclosure. The corporation without the fixed charges is obviously in the better position to weather economic difficulties. But it is likely to have to pay a dividend rate somewhat higher than the interest rate would be on a similar amount of bonds. The bonds are more economical for the company whose earnings are large and stable and whose surplus is large. If these conditions do not obtain, it is obviously more conservative to resort to the method which requires no fixed charge. The problem of home owning versus home renting shapes up in much the same way. The individual with substantial surplus and assured income can show a saving by assuming the fixed charges of home ownership. The individual not so situated will do better to adopt the more flexible method of renting.
IV
But how much saving does home ownership make possible? I have heard people say that they are planning to buy a home because they are ‘tired of paying rent.’ It is difficult to believe that such people can be so naive and unsophisticated as to think that their regular out-of-pocket expenses will be substantially reduced merely because they hold title to a house, subject to a large mortgage, instead of a lease on it. But I have known a few who were not actually aware that their payments of ‘rent’ continue in surprisingly similar amounts even after a home has been bought.
An actual case that recently came to my attention clearly shows the small difference in continuing cost. The house involved was offered for sale at $20,000 and carried a governmentguaranteed mortgage of 80 per cent, amounting to $16,000. Annual interest and ‘service’ charges on this mortgage, at 5½ per cent, amounted to $880. Taxes were approximately $300 per year. In addition, there was a premium for FHA insurance of $80 a year. If insurance at $30 per year and a $300 allowance for annual upkeep and repairs are added to this, it becomes clear that the necessary cash outlay of the owner would be $1590 per year. This makes no allowance for interest the owner could have received on his $4000 investment in the house, which pays him no income. Figured at 5 per cent, this represents another $200 annually in lost income, bringing the total cost to $1790 annually. This takes no account of the possibility of tax increases, special assessments, or other unexpected expenses that often work such hardship on the house owner who is working on a close budget. Moreover, it takes no account of amortization charges. It is not fair to include such charges, because they increase the owner’s equity by a corresponding amount and do not represent a true expense.
The same house was offered for rent at $2040 annually, or $250 per year more than the cost of owning it. At this rental, the landlord would have shown a net return, after all expenses, of better than 11 per cent on his $4000 investment, which indicates that the rental figure was not unduly low.
Thus in this case, which is a fair example, the man who rents this house pays only $21 per month additional. If this is considered as the cost of insurance against the risk of loss on a $20,000 investment, it seems rather cheap protection. If you don’t believe this, just try to get anyone to insure you against loss on property any time you want to sell it, for an annual premium equivalent to 1.25 per cent of the value of such property.
Despite its obvious fallacies and the agony and unrest it has caused, realestate speculation under the guise of home ownership remains hallowed. Individuals who suffered losses on other forms of property during the depression received only sympathy. But the plight of the dollar-down home owner was recognized officially by the government, and the Home Owners Loan Corporation was launched to effect a rescue. This was undoubtedly a sound venture under the circumstances for social reasons, and because it checked the downward spiral of real-estate values by preventing further foreclosures and forced sales. But unsound practices of the past forced HOLC to utilize $3,000,000,000 of Federal credit to refinance insolvent home owners, many of whom had no economic justification for owning the property they did. Uncle Sam is now discovering this to his sorrow, as witness the fact that more than 70,000 HOLC mortgages have already been involved in foreclosure proceedings, while new foreclosures are being instituted at the rate of about 5000 monthly.
Because the government has guaranteed the obligations of HOLC, any losses resulting from this gigantic salvage operation will eventually have to be met by the taxpayers. So we may yet be treated to the spectacle of rent payers putting up additional taxes to make good the losses caused by home owners who should have been rent payers. Who will be the more substantial citizens in that case?
With billions of dollars of government-guaranteed debt standing as mute evidence of the weakness of the dollardown system of home ownership, you might suppose that something would be done to prevent a recurrence of such excesses in the future. The evils of security speculation have been duly impressed upon the public, and drastic steps have been taken to discourage it. But in the field of real estate what do we find? We find that the government, far from discouraging excessive borrowing, which has been the primary cause of past difficulties, is instead actually urging people to increase their debts against real estate. Government agencies are coöperating with private lenders who advance loans up to 80 per cent of values, and who receive from a government agency a guarantee against any loss on the principal. The government is not merely making these accommodations available. It is showing the lenders new methods of promoting their business and furnishing them with advertising material intended to attract borrowers.
In fairness to the government’s programme, however, it must be admitted that one extremely bad feature of former mortgage practice has been corrected. In place of tiie usual shortterm, unamortized mortgage that had to be renewed at regular intervals, the Federal Housing Administration has substituted the long-term mortgage with a definite schedule of amortization calling for complete retirement by maturity. Such mortgages, if they come into general use, should prevent in the future the many foreclosures that used to occur when borrowers were unable to obtain mortgage renewals during periods of money strain. Moreover, the amortized mortgage forces the borrower to increase his equity steadily.
In addition to relaxing credit terms for the purchase or building of homes, the Federal Housing Administration is also offering present home owners — many of whom are already overextended — additional credit for improvements and additions to their property, thus further increasing their debt burden. The current plethora of credit, coupled with the trend toward more liberal mortgage terms, seems destined to foster a wave of speculative home building. With the average home owner more undermargined than before, and with the government already liable for billions of real-estate obligations, what will happen when the next downward spiral starts?
In view of the record, is it not time that the financial hazards of home ownership were frankly discussed and recognized, so that those financially unqualified can be deterred from entering prematurely into a transaction that may bring them heartbreak and disaster?