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Today, we are honored to have Ken H. Johnson, Ph.D. — Florida International University (FIU) and Editor of the Journal of Housing Research as our guest blogger. To view other research from FIU, visit http://realestate.fiu.edu/. - The KCM Crew

Last week’s posting (Creating Wealth Through Homeownership – The Proof) concentrated on how homeowners, on average, accumulate more wealth than renters.  The gist of the posting was that, in an environment where most do not save, homeownership creates a “forced piggybank” for owners through amortization of their mortgages and prepayment of principal.  This conclusion comes from ongoing research being conducted by Beracha and Johnson.[i]

Additional evidence indicating that homeownership is really a savings vehicle is provided when Beracha and Johnson’s Buy vs. Rent model[ii] is employed to estimate the probability that renting is the superior economic decision and leads to greater wealth.[iii]  In particular, Beracha and Johnson balance the benefits of ownership against the costs of homeownership and compare wealth accumulation through home equity against wealth accumulation through investments created by a comparable renter.[iv] The model assumes an eight year holding period.[v]

Through thousands of Monte Carlo simulations (an advanced statistical technique where past outcomes are used to predict future results), Beracha and Johnson are able to derive the probability that renting will outperform homeownership in terms of wealth accumulation for each of the 30 plus years of the study.  When the probability for a given year is 50%, there is no clear winner between ownership and renting.  When the probability is greater than 50%, renting wins.  When the probability is less than 50%, ownership wins.  The results are presented in the graph below:

The top line in RED depicts the probability that renting will outperform ownership in wealth accumulation assuming that renters reinvest rent savings (difference between rent payments and mortgage payments).  Clearly, over the vast majority of the study period and under this very strict assumption of reinvestment of rent savings, renting provides the greater probability of wealth accumulation.

The bottom line in BLUE, however, depicts a different and perhaps more realistic outcome.  In particular, when renters are not forced to save and reinvest their rent savings and are instead allowed to spend on consumption, ownership becomes the probability winner in all of the wealth accumulation races.

Implications

Evidence is continuing to mount that renting is a better path to wealth accumulation in a strict “horserace” between buying and renting where renters are forced to reinvest any rent savings.  Therefore, for those that have the discipline to monastically reinvest rent savings, renting is probably the better path to wealth accumulation.  However, in perhaps a more realistic setting where renters can spend on consumption (beer, cookies, education, healthcare, etc.), ownership is the clear winner in wealth accumulation.  Said another way, homeownership is a self-imposed savings plan on the part of those that choose to own.

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Warren Buffet is seen by many as the greatest investor of our time. When he speaks, people listen. Like anyone else in his position of influence, he is criticized by some for using his bullhorn to promote his own business agendas at times. That makes it very interesting when we occasionally learn of how heprivately advises those closest to him.

Such a situation occurred this week. Debbie Bosanek, Warren Buffet’s secretary of 37 years, recently purchased a second home in Surprise, Arizona.

In an article in the Omaha World Herald, Mrs. Bosanek discussed her reasons for purchasing a second home and the personal advice she received from Mr. Buffet.

“I just thought it was time to buy a home. Warren tells me that it will be the best opportunity in my lifetime. Mortgage rates are low and prices have dropped dramatically…I share Warren’s view about the future of America, and we believe that our country will do just fine. I’m happy to make this investment.”

The greatest investor of the last century privately has told the people closest to him that buying a home right now “will be the best opportunity in [their] lifetime”.

That’s good enough for us. How about you?

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There is a growing belief among many experts that 2012 will be the year housing turns the corner and starts heading in a more positive direction. Whenever we write a post like this, we unleash the hordes of critics who say we are again wearing rose colored glasses or are puppets being controlled by the National Association of Realtors (NAR) and other industry groups.

It is for that reason we will not be covering the projections of those groups. Instead, we want to share the beliefs of other organizations.

Washington Post:

“Housing Market and Economy Showing Encouraging Signs.”

The Wall Street Journal:

“From Bottom Up, Signs of Housing Recovery”

USA Today:

“Housing Outlook is More Upbeat”

CoreLogic:

“CoreLogic’s chief economist Mark Fleming says housing statistics and the duration of the downturn to date indicate 2012 may be the year the housing market begins to turn the corner.”

Freddie Mac:

“With the New Year comes a sense of cautious optimism. There are some positive signs in the job market and consumer confidence; housing is starting to raise hopes for continued gradual economic recovery.”

Fannie Mae:

“The housing sector will likely take incremental steps forward in 2012 …according to economists at Fannie Mae.”