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The Illusion of Housing as a "Great Investment"

Yale professor Robert Shiller, author of the new book Finance and the Good Society, says that historically home prices have not been a good financial investment -- they essentially tracked the rate of inflation from 1890 to 1990.

Yet during the housing boom of the 2000s, the mind-set of most Americans was that housing was a great capital-gains-generating investment. I recently asked Shiller, one of the leading thinkers on U.S. housing, how we collectively fell into that illusion. Hear his explanation in the video below, excerpted from my interview with him in front of a live audience at Motley Fool Headquarters. (Running time is 3:51; a transcript is provided below.)

Robert Shiller: There's no guarantee that home prices are going to go up. I think we've gotten into an illusion about that. We got into an illusion and it created this spectacular bubble. We have to reflect now that we had a kind of crazy mind-set in the last couple of decades, and we have to get back to thinking like people used to think. Housing is a depreciating asset, goes out of style; it's going to end up in the wrong place. People will want to live somewhere else, so it's not any automatic capital gain.

Brian Richards: You've written extensively about investor behavioral psychology. How did we fall into that illusion and how do we work ourselves out of it?

Shiller: That's a very interesting question. How did we get this idea that home prices only go up? There are a number of elements of it. I don't know where to start. One of them is that we had a lot of inflation. I'm talking psychology now. You're asking how we got into a wrong view. In the 70s and 80s, we had a lot of inflation and then Paul Volcker came in and stopped it. So inflation has been declining now for 30 years, and we've lived our lives in that environment.

But we still encounter examples when someone says, "My grandmother just sold her house." Especially five years ago, say this happened five years ago. Grandma sold their house for $300,000, and do you know what she paid for it in 1952? It was only $30,000 or something like that. So it went up ten-fold. Now those stories are in all of our repertory, but when you really look at it, what was just consumer price inflation over that period? It was something like that. She really didn't make any money off of it. And she was putting money into it year after year and maintaining it. So we forget that. It's that kind of bias.

Also I think that we're influenced not by population growth so much, but by the sense of the growing wealth of the world and the finiteness of land, and we mistake land for…well that's another thing that happened. We started to think of urban real estate as land. And that's a change in our thinking.

If you go back hundreds of years, there was land speculation in this country, but there was no housing, not much urban housing speculation. So it was common sense. Talk to George Washington, if you could, all right? George Washington was a land speculator, and he owned Mount Vernon as among his speculations. But for George Washington, speculating in real estate meant buying thousands of acres for a shilling an acre or something like that. Not buying a house in the city, so we've changed. It's become much more proliferated as something that everyone does. You buy this house and it's going to make you a lot of money.

It's also just the bubble itself -- the Fed had very loose policy and that encouraged the bubble and prices were going up fast, so that proliferated stories about real estate as an investment. Anyway, that's a complicated analysis of our psychology. But it is a unique phenomenon, really, that it was so national. And it also reflects our better communications now. It wasn't as easily so national in the past.

For more insights from my talk with Robert Shiller, see:

Brian Richards is the managing editor of Follow Brian on Twitter: @brianlrichards.

Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

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  • Report this Comment On April 13, 2012, at 3:05 AM, enchantedbear wrote:

    After putting $30k in the cpi calculator it comes out to $250k, during the last 60 years

    A 17% return with the tax breaks in home ownership is not bad at all. While many peoples pay rent that only goes up, my mortgage payment is the same every month and eventually it will be $0 while the renters monthly rent will never be $0

    It's sad to see people dissuaded by articals like this because I don't often see people's apartments nicer then my home

    For homeowners they can pass on the assist to a child or family member, if you don't own a home what will you pass on?

    Home ownership also give you the option of renting out your home while renting a smaller place when you retire. You also can live off of some of the rental money to suppliment retirement

    Stocks can crash because of the fear of some tiny country needing a bail out. Our stocks fall even though that small contry won't really effect most of our country. All it really will effects is the consumer confidence. So because of the sensitivity of stocks they arn't really any better of an investment

    Articals like this show how any topic can have a downside that people can exploit to manipulate a situation. It's like the upgrade and dowgrade updates that come in, to produce movement and volatility, fear and doubt.

    If everyone says my home is now worth $1, maybe so and that's fine with me, but if everyone says my $500,000 stock portfolio is now worth $1 I'm in serious trouble. In the end you can't live in your 401k

  • Report this Comment On April 13, 2012, at 8:42 AM, CluckChicken wrote:

    Though these have all made a very nice conversation I think the like "every market is different" needs to be applied.

    This site has a nice collection of charts:

    If you take a look through them you can see that in some areas that even after the crash a house purchased in 2000 has done well, in others poorly.

  • Report this Comment On April 13, 2012, at 10:29 AM, tredadda wrote:

    I disagree that owning a home is not a good investment. Unless you are going to be homeless, you will live somewhere. The question is, are you going to dump your money on a dwelling that will eventually give you a return on your investment or are you going to dump it into a dwelling that gives you NO return on your investment? Even if you sell your house and make only $1000 after taxes, that is still $1000 more than you would have made by renting. If you get a house you can afford (which many during the bubble did not) you can still invest your money in the market while having a safe long term investment in your home. Many old people who have large amounts of disposable income have it because they own their home meaning outside of property taxes they are living some place for free. In many areas (mine being one of them), it is cheaper to buy than rent so by renting I would actually have less disposable income and more headaches with neighbors above, below, or a sheet of drywall away from me.

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