Scott Burns is just about my favorite real-world financial columnist. I have read him on and off for two decades. I used to read him in the Dallas Morning News. He was always sensible.

Recently, he wrote a piece on where you live. It was an article on real estate. He observes what is obvious to most people: their homes are appreciating faster than the stock market or the bond market.

The biggest influence on our financial health isn’t how much we save. Nor is it the funds we choose in our 401(k) plans. It is our ZIP code — where we buy and own a house. Pick the right area, and your future is golden. Pick the wrong area, and you’ll always be behind the folks who happened to buy in the right place. As you will soon see, no matter where you live, it is likely to be more important than your 401(k) plan.

This is not the way it was supposed to be. Thrift, not real estate, was the way to wealth, except for investors who followed the Miller/Schaub strategy for buying homes.

Thrift made savings available to businessmen, who in turn found ways to increase production. We got richer by increasing our own productivity. Not these days. We get richer by buying a home with 5% down at 5.7% per annum for 30 years. We become debtors. We spend ourselves rich.

Franklin Roosevelt was right! Or was he? On paper, as of today, in some markets, he was. Burns comments:

I’ve suspected this for years simply because the most valuable asset most of us own is our home. Check the net worth of different households, and you quickly learn that homeownership is more than important for most Americans. It’s the whole ball game — 70%, 80%, 90% or 100% of net worth.

One odd side effect is that people in some parts of the country are becoming much richer than people in other parts of the country not because of the work they do, the income they earn or the investments they make — but because of where they live. As one Boston economist remarked to me several years ago, “You know, I’ve made more money on my houses than I have ever made as an economist.” (The economist had owned homes in Wellesley, a Boston suburb, Beacon Hill and Washington, D.C.)”

This is true of almost every academic economist. But that is old, old news. It was true in 1995, too, before the housing bubble appeared in Boston.

You can see the impact by reading the most recent house price index report from the Office of Federal Housing Enterprise Oversight, better known as OFHEO. Unlike the median home price resale figures provided by the National Association of Realtors, the OFHEO figures are based on tracking the resale and refinance data of the same homes over time. As a consequence, its figures aren’t affected by increasing home size and other factors — they are a good indicator of what you’ll experience in any given area. Every quarter the office provides index data for states and Metropolitan Statistical Areas for the preceding quarter, year and five years. It also provides an index from 1980 to the present — 24 years.

Over the five years ending Dec. 31, 2004, the typical U.S. house has appreciated a whopping 49.67%. That’s a compound annual appreciation rate of 8.4%, more than three times the 2.56% annualized rate of inflation over the period. For most people, that gain more than offset any stock-market losses suffered when the Internet bubble burst.

Burns even provides a handy calculation approach that lets you see how well you have done.

You can get an idea of the bonanza this has been by measuring it in years of owner earned income. If the value of your home was equal to three years of your income five years ago and you owned an average U.S. home, your net worth has increased by about 1½ years of income.

Here is the problem. For most people, the return on savings cannot compete with this increase in net worth. But, long-term, we get rich because of increased productivity, which in turn rests on a combination of thrift and successful entrepreneurship by the people we handed our money to. Burns spots the cause of the problem:

Now ask yourself: How long would it take to accumulate 1½ years of income through savings?

If you save 6% of your income in a 401(k) plan, get a 50% employer match and earn 9% on your investments, it would take nearly 10 years — twice as long — to accumulate 1½ years of income. Your 401(k) plan assets would all be taxable. Home appreciation is tax-free. Adjust for a relatively low 15% tax rate, and it would take nearly 12 years to accumulate the purchasing power an average homeowner may have gained in five years of home appreciation. In addition, you have to save actual money in a 401(k) plan, while your home appreciation is “free money.” (The actual figures will depend on how much your house was worth relative to your income.)

Twelve years is a long time.

BAD SIGNALS

Burns has provided the figures for what most of us have sensed. These figures tell us: “Don’t save. Buy a nicer home instead.” But, as he shows, you must be careful to buy it in the right zip code area.

Over the last five years, homes in California doubled in value, rising 102.35%. Comparable California homeowners saw their net worth rise by about three years of income. It would take nearly 15 years of saving in the same 40l(k) plan to accumulate the same amount of money, nearly 18 years after adjusting for taxes.

Texas homeowners, on the other hand, would have seen home appreciation of only 24.27%. That’s better than inflation, but half the national average. It’s also an increase of only nine months of income. They could accumulate that much in about six years in a 401(k) plan, seven after adjusting for taxes. Believe it or not, eight states did worse than Texas — North Carolina (23.63%), Ohio (23.18%), Alabama (22.86%), Mississippi (22.14%), Nebraska (22.05%), Tennessee (21.56%), Indiana (20.02%) and Utah (16.17%). . . .

You get a visceral idea of the power of home appreciation when you notice that only Utah homeowners, the worst state in the nation for this five-year period, did slightly better in a 401(k) plan than with their homeownership.

These signals tell people to save less. Of course, that’s because they don’t listen to John Schaub. John has been buying several homes each year in Sarasota, Florida since approximately 1970. His friends will not have to organize a benefit for his widow (who is a lawyer).

The problem is not that housing is too risky today. That depends on where you live. The problem is that housing, purchased as a consumer good rather than as a capital asset, is not productive. People think they can have their cake (nice home) and eat it, too (retire in luxury). They can’t.

The money lured out of the capital markets and into housing is not going to make investors richer unless they really are investors, buying as investors, managing properties as investors, and renting their houses to productive people who can pay the rent.

The only way for these renters to become productive is through capital accumulation by investors who employ workers. This takes thrift.

CONCLUSION

We can’t make a living by taking in each other’s washing. We can’t get rich selling houses to each other.

To get rich, we must save. Most Americans have stopped saving.

We will live in nice, old homes in declining neighborhoods. Our houses, like us, will go the way of all flesh.

Even Sophia Loren is down to a 7.

June 15, 2005

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