NEW YORK (MainStreet) — Yes, gains in home prices are slowing, according to an S&P/Case-Shiller report. But homeowners are still making a pretty respectable return, thanks to low inflation.
"The broad-based deceleration in home prices continued in the most recent data," says David M. Blitzer, chairman of the Index Committee at S&P Dow Jones Indices, which puts out the report. "However, home prices continue to rise at two to three times the rate of inflation."
Two or three times the rate of inflation is pretty good for a fixed-income investment, which is basically what a home is. You won't make that on CDs or Treasurys.
The firm's national index showed a 5.6% gain in home prices for the 12 months ended with July, though there was great variation around the country — prices rose 12.8% in Las Vegas, 0.9% in Cleveland. Many areas had seen double-digit annual increases in recent years, a bounce after the price collapse that came in the Great Recession. Over long periods, home prices gain 3% to 4% a year.
But investment returns should always be viewed in the context of inflation. Since inflation averages about 3% a year over the long term, the average home gains little or nothing in the average year.
During the 12 months that home prices rose 5.6%, inflation was only 2%, producing a "real," after-inflation return of 3.6%. A 10-year U.S. Treasury Note currently yields about 2.5%, which means the investor is making only 0.5% once inflation is taken into account.
Is it really appropriate to view a home as a fixed-income asset rather than a more speculative holding like a stock?
Granted, a home is not the same as a bond with yield guaranteed by the government. A home is riskier. But, unlike a stock, a home does not entitle its owner to a share of a company's profits. A rising home value due to inflation is like a bond yield, and additional gains or losses are caused by fluctuating demand, much as a bond's price can fluctuate in the years before it matures.
For another analogy, consider what happens as you pay principal on your mortgage, either as part of the regular monthly payment or as something extra. Every dollar to principal reduces the interest charge in subsequent months. It's like earning interest at the loan rate — 4%, 5% or whatever the mortgage charges. That too is like a fixed-income yield.
So a home is more like a bond than a stock, making today's returns pretty decent.
Another similarity between homes and bonds: Each is riskier than people like to think. Even Treasurys, with principal and interest guaranteed by the federal government, can fluctuate in price in the years before they mature. If new bonds pay higher yields, old bonds lose value, because who wants to earn 2% if you could earn 4%?
Homes too can lose value when demand drops, as it did in the Great Recession. "As of July 2014, average home prices across the United States are back to their autumn 2004 levels," the Case/Shiller report says. In other words, if you'd bought a home in the fall of 2004, you'd have made nothing over the past 10 years. Essentially, paying your mortgage was just like paying rent, providing shelter but no investment return.
Things are even worse for people who bought during the home-price peak of June and July 2006. The average home is still worth 16% to 17% less than it was back then.
So all in all, homeowners should be pleased with recent home-price gains. The returns aren't stupendous, but for a fixed-income holding - OK, a quasi-fixed-income holding — they're far from shabby.
— By Jeff Brown for MainStreet