Boom or bust, owning a home is still the key to wealth for most people, says Professor Gary Smith, who has charted a contrarian, common-sense
approach to the housing market.
By Karen E. Klein
All over the country, homeowners and would-be
home buyers are hanging back, nervously testing
the waters of the housing market: Has the bubble
truly burst? Have home prices hit bottom? When
will prices start to appreciate—and by how much?
They and their real estate agents are busy poring over sheets of “comps”—
recent sales prices for local homes that are comparable in location and square
footage to the homes they are interested in buying. They follow the fluctuations
of interest rates and home prices constantly, hoping to “time the market”
for just the right moment to make a purchase.
But they’re doing it all wrong, says Gary Smith, Pomona’s Fletcher Jones Professor of Economics. Instead of focusing on how much their home’s value
might go up on the local market within a few months or years, homeowners should focus on their “home dividend.”
In a nutshell, the annual home dividend is the owners’ rent savings for a
comparable house in the same neighborhood plus their mortgage interest and
property tax deductions, minus their mortgage payment, property tax and
other homeownership costs, such as insurance and maintenance. Rents are
often higher than mortgage payments, particularly as rents increase over time
and mortgage payments stay flat (if they have fixed interest rates). The
amount saved by owning a home can be viewed as an annual dividend. And if
that dividend is invested at a reasonable rate of return, it can generate considerable
wealth for the homeowner—even if the home’s market value increases
by only a small percentage each year, or not at all.
This home dividend—rather than any clever timing of the
market or short-term “house flipping”—explains why the average
homeowner has a net worth of $200,000, while the average
renter’s net worth is closer to $5,000, Smith says.
The home dividend concept is at the heart of a book Smith
and his wife, certified financial planner and registered investment
advisor Margaret Hwang Smith, have recently co-written.
Houseonomics: Why Owning a Home Is Still a Great Investment
(2008, FT Press) is Smith’s first book for a popular audience,
though he has written several textbooks and numerous scholarly
articles detailing his economic research in various journals.
The book relies on research the Smiths did in 10 cities,
looking at hundreds of homes for sale and rental rates for comparable
homes in the same neighborhoods. Despite the much vaunted
“housing bubble,” they conclude that home prices in
cities like Dallas and Atlanta were actually too low. And while
the prices in the Bay Area city of San Mateo were clearly too
high, the research showed that average homes in Los Angeles
last year were selling at reasonable rates. “All real estate is local.
There’s no U.S.-wide housing bubble and there never was,”
But with the book’s publication coming in the midst of the
housing downturn and the foreclosure crisis, the couples’ central
premise—that owning a home is nearly always a good
decision—has come under some scrutiny. “Do you still stand
by that idea?” asked a radio commentator skeptically, in an
interview shortly after the book came out. Smith replied
emphatically that he does, and went on to explain why in a
Smith is no stranger to proposing ideas that run against the
grain of popular wisdom or entrenched theories (see "The Contrarian" below). In
Houseonomics, he and Margaret explore the economics of homeownership
from a common-sense angle that nevertheless defies
the way real estate has been discussed for several decades.
Smith recognizes the disconnect, describing a presentation he
gave at a recent conference where he laid out the economic theories
behind Houseonomics and argued that the home dividend
made Indianapolis a great place to be a homeowner. But shortly
after he sat down, a prominent professor of real estate got up
and said that Indianapolis is a terrible place to buy a home
because prices only go up 2 to 4 percent a year. “Even esteemed
academics don’t seem to get it,” he says, shaking his head.
Houseonomics quotes a 2007 New York Times story stating
that homes have “no underlying revenue stream” upon which to
base an assumption of their true value. That’s just not true,
The book presents a case study on a home purchase in
Fishers, Ind., an attractive suburb of Indianapolis with average
income of $80,000. Although house prices have not historically
risen meteorically in the Midwest, particularly compared to
prices in desirable locations on the coasts, even a modest appreciation
of 2 percent to 4 percent can be a terrific investment if
the home dividend is calculated.
The couple in the book buy their home in Fishers for
$135,000, with $27,000 down. Even if the home appreciation
in the area is a low 2 percent annually, Smith points out, the
house is a financial boon for the couple due to the home dividend,
which he calculates at $5,622 annually. The dividend
works out to a 21 percent after-tax return on their investment
(the down payment of $27,000), which could be favorably compared
to a boom year in the stock market.
And as rents go up, and the equity in the house increases
over years of paying off the mortgage, the home dividend continuously
gets larger. So even in an area where a home purchase
does not seem to be a good investment due to slow property
appreciation, Smith contends, it surely is.
Timing the market—whether you are waiting to buy or holding
off selling—is a risky proposition, the book contends. Wait
too long to make the plunge and it’s possible that you will be
priced out of owning a home in your preferred area—not to
mention that you’ll be throwing money away on monthly rent
that much longer. He advises that individuals who plan to be in
an area for at least five to seven years should buy a home as soon
as they can. Although sales closing costs may affect your home
dividend in the first year or two of homeownership, particularly
if your mortgage payments and homeownership expenses are
initially more costly than local rents, over time the purchase will
pay off handsomely.
Just as with stocks, “it’s the cash flow that’s important [in
homeownership], not the selling price. I want a place to live in
for five to 20 years. I don’t want to be thinking about whether
the home will do well financially in a year or two,” Smith says,
adding that he has no sympathy for house flippers who’ve lost
bucket loads of money in the current price downturn.
Money aside, even an economist can recognize the intangible,
emotional payoff of homeownership. Having a piece of
property to call your own, a place that you can remodel and
decorate and count on for shelter after you retire, is an invaluable
asset. “My parents never thought of their home as an
investment. But, like millions of others in their generation, purchasing
a home was easily the best financial decision of their
lives,” Smith says.
Whether it's theories about the harvest moon, common
knowledge on investing or the idea of an athlete with "hot hands,"
Professor Gary Smith has a bent for contrarian research.
Economics Professor Gary Smith
seems to have a bent for contrarian
research. It’s not that he goes looking
for conventional wisdom to debunk,
it’s just that his life’s work is driven by his
“We look at the numbers and follow them
wherever they lead,” he says—even when the
conclusions are contrary to established ideas and
In one paper, Smith tested the “efficient market
hypothesis,” the widely accepted notion that great
companies don’t necessarily make great investments
because their well-known virtues already
have been factored into their
stock prices. Using Fortune magazine’s
annual list of mostadmired
companies, Smith and
co-researcher Jeff Anderson ’05
found these companies’ stocks
did indeed outperform the wider
market, calling the theory into
In a similar research project,
Smith determined that a portfolio of
companies with clever, eye-catching
ticker symbols (LUV for Southwest
Airlines, MOO for United Stockyards)
also beat the market.
Why does stock picking so often flummox
even the professionals? “There are anomalies
where peculiar things go on with emotions,”
Smith says. “We [human beings]
are all about processing information—
looking at the data and thinking about
it. But there’s no pure processing
because emotions and psychological
factors come into play, and emotions
influence how people process.”
Smith’s research has often taken
him far beyond the financial markets.
For instance, he has written
several articles disproving common
ideas about life and death.
One examined the hypothesis
that elderly Chinese-, Korean-, or
Vietnamese-American women can
prolong their lives until after the celebration
of the Harvest Moon festival.
Another article, co-written with
Heather Royer, looked at the idea that
famous people postpone their deaths until
after their birthdays.
In both cases, Smith concluded, the hypotheses
were incorrect. In fact, his birthday research
showed a relatively large number of deaths surrounding
While sometimes-sentimental beliefs about
death don’t pan out, according to Smith’s
research, some long-held hunches do seem to
have more going for them than superstition.
In another whimsical bit of research, with Reid
Dorsey-Palmateer, Smith discovered there may
just be something to the idea that athletes can
have “hot hands.” Their analysis of professional
bowling indicated that the probability of rolling a
strike is not independent of previous outcomes,
and that the number of strikes rolled varies more
between games than can be explained by chance
Does that mean that athletes really do get
“hot hands”? Well, maybe, Smith says: “It turns
out that the idea of getting on a hot streak really
does work, at least a little bit. As humans, we’re
pre-disposed to looking for patterns [where they
might not exist] but we’re also likely to undervalue
the influence of luck.”