Your house is still the best source of your wealth
"Through the Roof!" Newsweek, August 9, 1999
The soaring stock market in recent years created unprecedented wealth (or paper wealth) to the American public in general. Yet, the volatile stock market cannot always be relied upon as a source of permanent wealth. Instead, the mundane residential house appears to be still the best source of accumulating personal wealth. In fact, the price of a residential house has increased significantly in the United States, almost matching the rise of the stock market in the long run, yet without the severe oscillation of the stock market. In fast-rising housing markets such as Seattle, the demand for the residential house is so great that a buyer often has to offer a price much higher than the asking price. A few hours of hesitation means the loss of a house to another higher bidder.
Annually, almost 7 million households buy a home in America. Homeowners collectively enjoy $1.2 trillion (one trillion equals $1012) in unrealized equity on their houses. The wealth effect of the stock market has been widely publicized, yet a similar effect on houses has been relatively quiet. In the 1990s, home prices increased by 46% in Nashville and Cleveland, followed by 44% in Seattle, 42% in San Francisco, 40% in Miami, 37% in Boston, and 10% in Philadelphia. Of course, these percentages reflect city-wide averages, and different areas in the same city experienced significantly dissimilar rates of increase. According to housing economists, the three most important determinants for the value of a house are "location, location and location." Obviously, locations offering a better primary educational system are more desirable. A large part of public primary education is financed by property taxes on houses, and areas with expensive houses are able to support a better educational system, which, in turn, increases the value of property, resulting in a strong linkage effect.
Why is the demand for home ownership rising rapidly in recent periods? Of course, a family house is the dream of every American household. However, an even stronger impetus has made the dream possible: the combination of historically low mortgage rates; a soaring stock market; unprecedented high salaries for young couples; both spouses working, especially in the high tech industry; and a large influx of recent immigrants who traditionally believe buying a home to be the best means of accumulating wealth and avoiding high inflation. As a consequence, Americans spend annually $222 billion to purchase new houses, and $182 billion to renovate the existing houses, including new additions of living space.
Traditionally, households are advised not to spend more than 28% of their total income on a mortgage. However, due to the extremely high price of a house, banks are willing to lend 36% or even 50% of a household's income for a mortgage payment.
One distinctive advantage of purchasing a house over stocks is a tax benefit. Up to a half million dollars in profit realized on the sale of a residential house is exempt from income tax. Due to rapidly rising housing values, such an amount of profit is not uncommon among average individual homeowners. The tax-free profit from the sale of a home may be very useful for retirement income. All told, it may be concluded that at least financially, anyone who can afford to buy a house misses out significantly if he/she chooses not to buy a house.