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Why you’re wrong to think that your house will finance your retirement

Treating houses as a financial instrument leads to an undiversified investment portfolio, with a large proportion of wealth concentrated in a single asset

Satyajit Das in The Independent


According to English writer Virginia Woolf, a woman in Victorian England needed money and a room of her own in order to write. In the modern world, housing itself has become a work of fiction.
A house provides shelter and a dwelling place. But increasingly this simple consumption good has been converted into a financial asset or investment as well as instrument of policy.

Governments subsidise home ownership in different ways. They may provide tax benefits such as tax deductions for mortgage-interest payments or lower taxes on capital gains from the sale of a residence. Common concessions include lower property taxes or stamp duty of property transfers as well as direct assistance for the purchase of homes. It also includes housing finance on preferential terms.

The subsidies mean that where they can, people buy multiple homes. The affluent own holiday homes which stay empty for much of the year, while less well-off are made to make do with sub-standard accommodation or, in the case of the poor, no homes at all.

Houses become larger. Virginia Woolf would have recognised these MacMansions: “Those comfortably padded lunatic asylums which are known, euphemistically, as the stately homes of England.”
Over-investment in housing is economically inefficient. Unlike businesses, houses once constructed generate limited income, profits, employment or investment.

Excessive housing investment also creates an inflexible labour force, reducing the mobility of workers. The ability to follow employment opportunities is restricted by fluctuations in house prices, the lack of liquidity of the housing market and high transaction costs (buying and selling can cost 5-10 per cent of the value of the house). It also limits wage flexibility, as workers are constrained by their mortgage commitments.

The replacement of company or government-funded retirement with self-funded arrangements means that houses have become a means for wealth creation. As homeowners pay off their mortgages, their home becomes a major financial asset. But residential property produces no income even where they increase in value. Maintenance costs, utility bills and property taxes mean that houses require rather than provide cash.

Homeowners must generate income by borrowing against their home to finance consumption and eventually finance retirement. The strategy requires realising the home equity (the difference between the value of the house and the mortgage debt outstanding) by either borrowing or selling the property, moving into a smaller house or a rental.

Treating houses as a financial instrument leads to an undiversified investment portfolio, with a large proportion of wealth concentrated in a single asset – the home, which does not produce income.

Investors also buy houses and apartments with borrowed money to rent out. The income from property is rarely higher than that on other income-producing investments. Where borrowed money is used, the rent may not fully cover interest and other outgoings. There is speculative reliance on ever-increasing property prices to boost returns or repay the debt used to finance the property leaving a profit for the buyer.

Reliance on houses creates exposure to volatile house prices. As the global financial crisis illustrated, prices can be affected by a confluence of adverse events – economic cycles, the availability of credit and demographics where large cohorts may retire at the same time. Price fluctuations are exacerbated by the illiquidity of the asset.

Many economies now rely excessively on the housing market. Housing investment sustains economic growth. Unlike many industries, it is largely domestic, driving employment, income and economic activity. In The Age of Turbulence, Alan Greenspan approvingly quotes economics columnist Robert Samuelson’s assessment of his policies in the early 2000s: “The housing boom saved the economy… Americans went on a real estate orgy. [Americans] traded up, tore down and added on.”

Governments continue to promote housing and home ownership using rising wealth from home ownership to mask lack of growth or declines in real income levels and uncertain employment for the population. But the policy is paradoxical.

Current policy, lower interest rates and increased availability of housing finance, boosts the price of existing housing stock rather than increasing housing construction. If it succeeds, then higher house prices ironically make housing unaffordable for large portions of the population.

Where the policy fails, an unwinding housing bubble is difficult to manage, as evidenced by events in the US, Ireland and Spain.

Economic activity slows as individuals and investors suffer large falls in wealth. Governments suffer revenue losses from lower property taxes. At the same time, government expenditures may rise as savers are forced to turn to available social services due to falling income and wealth.

Banks can find their solvency affected quickly by a fall in houses prices because of their high exposure to mortgage loans or property as security, requiring government support.

A considered debate about housing is needed to improve the structure of economies. It may also have an unexpected collateral benefit, improving TV entertainment beyond shows about the property or housing ladders and lift the standard of dinner table conversation above the level of: “Do you know how much they got for the house down the street?”

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