House as sure investment could be thing of the past

Easy money, low inflation weaken value of fixed rate


Easy money and low inflation have combined to undermine the value of buying a house with a fixed-rate mortgage, a conclusion that might surprise home buyers who rapidly have been bidding up house prices in recent years.

But a new economic report suggests the financial advantages of buying a home today are the lowest they have been since 1970, and the analysis suggests that low-income families are taking greater risks in buying a house as an investment than are high-income households. "The new housing game is more dangerous and seems less intended to build security for the future," wrote Robert Brusca, chief economist at Facts and Opinion Economics in New York. "It is more about profit-maximizing."

In the first quarter of 2005, U.S. house prices were nearly 10 percent ahead of a year earlier. Economists have been debating whether house prices have climbed too far too fast and are ready for a fall.

Brusca's report doesn't speculate on that topic but warns that the financial risks of homeownership extend far beyond the prospect of a bubble about to burst. Zero-down-payment, interest-only and home equity loans have served to undermine the returns of owning a house, as households either build little equity or use their stake in a house to take on more debt. Those practices only add to the prospect of diminishing returns - or no returns - on houses as an investment, he said.

Brusca said that buying a home solely as a place to live, and not as a piggy bank, still makes sense. But the housing market is rife with financial risks that go far beyond worries about whether double-digit gains in prices in some markets inevitably will lead to a residential real estate crash, he said.

Consider inflation trends.

From 1969 to 2004, housing prices outpaced inflation two-thirds of the time - 25 out of 36 years. Relatively recent home buyers have known only success, however. Since 1991, Brusca calculates, house-price appreciation beat inflation each year.

Low inflation sounds like good news for homeowners, but Brusca notes that inflation has worked to the benefit of homeowners for decades by lifting the value of houses while eroding the value of money devoted to mortgage payments. In the early 1980s, double-digit inflation not only propelled real estate prices but also diminished the "real" value of money. In a year when inflation rose by 10 percent, people making a $1,000 mortgage payment were returning money that was worth only $900 at the end of the year.

But with inflation rates closer to 2 percent to 3 percent in recent years, the "inflation advantage" to borrowers has diminished considerably. The National Association of Realtors, which has kept track of U.S. median home prices since the late 1960s, suggests that periods of double-digit gains in house prices are an anomaly. "The historic average [home price] increase is rate of inflation plus one or two percentage points," said Walter Molony, an NAR spokesman. "The historic average is 6.3 percent."

But Brusca and other real estate watchers note that tax laws can make home buying riskier for low-income families than for more prosperous buyers.

Brusca offers an example, assuming a fixed, 30-year mortgage at 6 percent interest:

A taxpayer in the 15 percent marginal tax bracket - paying 85 percent of the interest costs of a mortgage, after taxes - would need his house to appreciate 5.4 percent a year to "break even," or see annual appreciation equal the cost of mortgage payments. A taxpayer in the 30 percent bracket, however, would need only a 4.2 percent annual rate to break even. The high-income earner, with a 50 percent marginal tax bracket in areas with state and local income taxes in addition to federal, would need just 3 percent a year house appreciation to break even on mortgage payments.

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