For all the doom and gloom about the housing market, it still generally pays to own a home.
That might be a tough case to make right now to the 16 million homeowners who owe more on their mortgage than their house is worth. But history suggests the American Dream is a pretty safe bet.
Homes have appreciated by an average of 4 percent a year since World War II. They act as hedges against inflation and bestow significant tax benefits. Real estate is a leveraged investment; a 10 percent down payment produces a 1,000 percent return if the price of a home merely doubles.
Plus there are intangibles: Owning a home provides a sense of independence, security and community. And you get to live in your investment. You can't do that with a stock.
Of course, historical trends don't pay the mortgage. People who wade in and out of the housing market too often, or who buy at the wrong time or price and need to sell quickly, can get burned.
But if you own for a decade or more, price appreciation usually overcomes even bad slumps.
Tony and Liz Iacobelli, who are far under water on the home they bought in the Phoenix suburb of Buckeye three years ago, aren't panicking. They owe about $177,000 on their mortgage on a house worth only $132,000, which is about 40 percent of what they paid.
"Houses generally go up in price, and this one will again, too," says Tony, 51, a retired New York City policeman.
Several booms and busts have occurred in the modern era of housing, which began when 30-year loans became widely available after World War II. This bust has been severe: Nationally, home prices are down an average 30 percent from their peak in 2006.
The collapse of the housing market may have put an end to the notion of using a home as a speculative investment akin to a hot stock. And that may not be a bad thing, economists say.
"People should recognize that value comes from a lot of other things besides a possible return on the investment," says Joel Naroff, chief economist at Naroff Economic Advisors.
Economists say home prices have risen by about half a percent a year above inflation, or roughly 4 percent, since the 1940s. That number, which is based on the median price of homes sold each year, was inflated a little by baby boomers starting families and building bigger houses. Since the National Association of Realtors began compiling statistics in 1968, the median sales price has climbed 6 percent annually, from $20,100 that year to $195,200 this past August.
In the late 1990s, home values started growing like stocks. For the next five years, they appreciated at 8 percent to 9 percent a year, or about 5 percentage points ahead of inflation.
You won't find many skeptics among people who bought homes in the '90s and still live in them. Their homes may be worth tens of thousands of dollars less than at the peak, but they're still frequently worth twice what the buyers paid. For example, a house in Ewing, N.J., that sold for $160,000 for in 1996 was worth about $410,000 three years ago. It's still worth $375,000 today.
Home buyer beware, however: Price declines do occur with some regularity. Besides the 30 percent price meltdown of the last three years, the Standard & Poor's/Case-Shiller index of home prices in 10 cities shows four declines lasting six months or more since 1990. The declines averaged 3 percent.
And whether large or small, a drop can be followed by several years of flat prices. After the 1990-1991 recession ended a housing boom, prices didn't start increasing nationally until 1997. So homeowners who buy at the wrong time can go years without gains.
The hefty costs of homeownership also can work against people who aren't committed to settling in for a while. Transaction costs — home inspections, sales commission, fees, transfer taxes — run thousands of dollars every time you buy or sell.
And most people overestimate the tax benefits. They don't realize the standard deduction they would get if they didn't itemize might be nearly as great as their housing deduction, says Dean Baker, co-director of the Center for Economic and Policy Research in Washington.
For example, a homeowner with a $200,000 mortgage might pay $11,000 a year in interest and $2,000 in property taxes. That's $13,000 — a healthy deduction, but just $2,100 more than the standard deduction of $10,900 for those married filing jointly.
And as a homeowner pays less each month toward interest and more toward principal, the deduction will shrink — until it falls below the standard deduction, which rises to keep up with inflation, Baker says.
Of course, paying principal builds equity and is the equivalent of a forced savings plan, which can finance big expenses such as college tuition. In the long run, many people fund their retirement partly by selling a home they've owned for many years and moving into smaller, cheaper housing.
Another reason to buy a house is it's a leveraged investment; you pay only a fraction of the price with your own money, which can produce an enormous return. If you make a down payment of 10 percent on a $200,000 house and it doubles in value to $400,000, your $20,000 investment has grown to $220,000, a return of 1,000 percent. That's like buying a $40 stock and watching it soar to $440.
Buy vs. rent
But how can you tell in the short run whether it's better to buy or rent? There's a way to gauge how expensive homes are — the price-to-rent ratio.
The ratio is determined by dividing the price of a home by the annual rent that could be earned from it. Since 1986, the ratio has averaged 9. Anything above that suggests it may be better to rent, depending on your area.
After soaring to 15 at the end of 2005 — above 20 in some areas — the nationwide ratio has dropped back to 10, according to Economy.com data, making ownership far more attractive.
Prospective buyers can do the price-to-rent calculation themselves. For example, if you can purchase a home for $180,000 but can rent a similar one for $18,000 a year ($1,500 a month), your price-to-rent ratio would be 10, making the buying price reasonable and close to average. And you would have the tax benefits and equity that you don't get with renting.
It would be nice to say home prices rise reliably and steadily — and a few years ago they seemed to. But that "sure thing" is no longer.
Short-term prospects are cloudy. Many economists expect home prices to keep falling through 2010 as mounting unemployment, foreclosures and a glut of unsold homes all weigh on the housing market.
Robert Shiller, a Yale University economist and co-inventor of the Case-Shiller index, says he expects home prices to be roughly flat for five years.
Yet housing has proved a good investment if you stick with it. And with prices already having fallen so far, buying now could make it an even better one.