The debate between owning versus renting a home has continued through the years and has recently become a hot topic again. In this post, I plan to discuss one of the benefits of homeownership (which is often left out of the debate) rather than fully compare and contrast all the benefits of owning versus renting.
I will make two points to the overall subject of owning versus renting: (1) if you are not going to live in a home for at least two years, then you should probably rent. Why? You are unlikely to cover the transaction costs associated with the purchase (unless you rent the home after you move out) and (2) in my opinion, owning a home remains one of safest assets you can invest in; it is the excessive leverage alone that creates the risk (more on this topic in future posts).
So, what is the hidden benefit of homeownership that is often left out of the debate?
The benefit is the inflation hedge that you acquire when you purchase a home.
The inflation hedge benefit usually has two dimensions: (1) the monthly payment benefit and (2) the asset replacement benefit.
Before I discuss the two potential inflation hedges of homeownership, l will address the following questions: (1) what is inflation, (2) why is it bad, and (3) what is a hedge.
Inflation is usually created when too many dollars are trying to purchase too few goods and/or services. In other words, the country is creating less output of goods and services than it is creating dollars to purchase those goods.
The result is that the price of the goods and services being produced goes up, so, unless an individual’s wages go up at least as much as the increased prices, then that individual can purchase less (This is “the rub” so to speak). We are all subject to inflation and the potential for decreased purchasing power, so we can either just “roll with the punches” and hope it doesn’t decrease our purchasing power too much or we can try to hedge against it.
A hedge is an investment aimed at reducing the risk of a specific event (i.e. an increase in inflation).
Now I will discuss the first potential inflation hedge involved in homeownership: the monthly payment benefit. This benefit typically exists if you have a fixed rate mortgage payment. When you obtain a fixed rate mortgage on your home, the interest rate is fixed at a certain rate that has a built-in assumption about inflation expectations. If inflation increases beyond these expectations (or other factors occur), the market interest rate will likely increase whereby increasing the monthly expense of owning a home, but your payment will be protected against such an increase (i.e. hedged against increases in inflation expectations).
Additionally, if the inflation expectations (or other factors) reduce the market interest rate, you may be able to refinance your mortgage and benefit from the lower interest rates.
The second potential inflation hedge of homeownership is the asset replacement benefit. Whereas the monthly payment benefit was related to inflation implicitly through market interest rates, the asset replacement benefit is more directly related to inflation and its effect on the price of goods and services. In an inflationary environment, the cost of the goods and services required to build a home (e.g. masonry trade labor, lumber, concrete, flooring, etc) increase.
All these “small” increases add up to a potentially big increase in the price of a home. If you own a home prior to these inflationary increases, you will likely benefit as compared to people that purchase after those increases. Often, I have seen charts of home prices over time which illustrate a rather humble appreciation over time, say maybe 3%. Usually, when I read the fine print, the home values that they have charted are inflation adjusted values, which basically means that the inflation was stripped out of the values.
Although there are good reasons to use this method, I find that this method makes the chart a little misleading, because, if you were not invested in a home (or some other asset) at the time of the inflation, you would have had a negative real return on your money.
* Please be advised that this post is editorial in nature.