Bailout

How buying a home is gambling

By Felix Salmon

Ryan Avent adjudicates the homes-as-investments debate, and comes to a positively Solomonic conclusion:

Sure, it’s fine to think of homes as investments, so long as the kind of investment you have in mind is the highly risky sort you wouldn’t recommend to anyone who didn’t have the ample knowledge and financial cushion you’d expect to see in a successful entrepreneur. And that does not describe most potential homeowners.

I think that both Adam Ozimek and I might well agree with that. Here’s Ozimek’s latest:

I agree with Felix that buying a house is not a certain investment; you can lose your money and your home. Obviously in the past few years many people have, and that?s terrible. Where I disagree, is with his contention that since the outcome is so bad, the potential investment returns are never worth it, and you should stick with other investments which don?t have the added downside of homelessness…

Why can the potential cost of losing your money and your home be worth it for the consumption or psychological benefits, but not for benefit of potential financial returns?

The problem here is that no one ever buys a house with their eyes that wide open, fully cognizant that they are taking a calculated risk in which they know full well that there’s a non-trivial probability that the consequences of their “investment” will be foreclosure, bankruptcy, and homelessness. Investments don’t work like that: if you’ve laboriously saved up enough money to scrape together a downpayment on a home, that’s money you’re not going to gamble. The number of people genuinely comfortable with taking that kind of downside risk is basically zero, as it should be. (Remember that most homeowners have families to support: they’re not just gambling their own livelihood, but that of their family too.)

So yes, Adam, I do feel comfortable giving this much investment advice: no potential investment returns are worth it if the downside is that there’s a good chance that you’ll end up financially devastated. That’s not sensible diversification: it’s putting all your eggs into a basket that you have essentially no control over. Avent is right that buying a home is a bit like starting a small business, but the big difference is that the value of a small business comes in large part down to the owner. Whereas in the property market, the owner can only affect value at the margin.

If you have essentially no control over the outcome of your investment, and you have no way to exit that investment if it starts to go bad, then you’re a gambler. And as Avent says, that does not describe most potential homeowners.

Update: Konczal also weighs in, and reckons that buying a house is basically the same as buying a hedge fund with a 2-and-66 fee structure.

Full post as published by Macroprudential on December 11, 2009 (boomark / email).