Men and Markets Observed: Home Investment can be a matter of timing if you want to get the best deals.

It generally pays to own a home over the longer term, although right now 16 million homeowners owe more on their mortgage than their house is worth.

Homes act as hedges against inflation and can bestow significant tax benefits to Americans. Real estate is a leveraged investment; a 10 per cent down payment produces a 1,000 per cent return if the price of a home merely doubles. Plus there are intangibles: Owning a home provides a sense of independence, security and community. And you get to live in your investment unlike with a stock.

If you own for a decade or more, price appreciation usually overcomes even bad slumps. Several booms and busts have occurred in the modern era of housing, which began when 30-year loans became widely available after the Second World War. This bust has been severe: Nationally, home prices are down an average 30 per cent from their peak in 2006.

Economists say home prices have risen by about half a per cent a year above inflation, or roughly 4 per cent, since the 1940s. That number, which is based on the median price of homes sold each year, was inflated a little by baby boomers starting families and building bigger houses. Since the National Association of Realtors began compiling statistics in 1968, the median sales price has climbed 6 per cent annually, from $20,100 that year to $195,200 this past August.

In the late 1990s, home values started growing like stocks. For the next five years, they appreciated at 8 to 9 per cent a year, or about 5 percentage points ahead of inflation. Homes bought in the 90's may be worth tens of thousands of dollars less than at the peak, but they're still frequently worth twice what the buyers paid. For example, a house in Ewing, N.J., that sold for $160,000 for in 1996 was worth about $410,000 three years ago. It's still worth $375,000 today.

Home buyer beware that price declines do occur with some regularity. Besides the 30 per cent price meltdown of the last three years, the Standard & Poor's/Case-Shiller index of home prices in 10 cities shows four declines lasting six months or more since 1990. The declines averaged 3 per cent.

And whether large or small, a drop can be followed by several years of flat prices. After the 1990-1991 recession ended a housing boom, prices didn't start increasing nationally until 1997. So homeowners who buy at the wrong time can go years without gains. The hefty costs of homeownership also take time to recover like transaction costs – home inspections, sales commission, fees, transfer taxes – run thousands of dollars every time you buy or sell.

Paying principal builds equity and is the equivalent of a forced savings plan, which can finance big expenses such as college tuition. In the long run, many people fund their retirement partly by selling a home they've owned for many years and moving into smaller, cheaper housing.

Some people buy a house because it is a leveraged investment; you pay only a fraction of the price with cash money, which can produce an enormous return. If you make a down payment of 10 per cent on a $200,000 house and it doubles in value to $400,000, your $20,000 investment has grown to $220,000, a return of 1,000 per cent. That's like buying a $40 stock and watching it soar to $440.

Buy or rent decisions can be made using the price-to-rent ratio. The ratio is determined by dividing the price of a home by the annual rent that could be earned from it. Since 1986, the ratio has averaged 9. Anything above that suggests it may be better to rent, depending on your area. After soaring to 15 at the end of 2005 – above 20 in some areas – the nationwide ratio has dropped back to 10, according to Economy.com data, making ownership far more attractive.

Prospective buyers can do the price-to-rent calculation themselves. For example, if you can purchase a home for $180,000 but can rent a similar one for $18,000 a year ($1,500 a month), your price-to-rent ratio would be 10, making the buying price reasonable and close to average. And you would have the tax benefits and equity that you don't get with renting.

Home prices did rise reliably and steadily a few years ago. But that “sure thing” is no longer. Short-term prospects are cloudy. Many economists expect home prices to keep falling through 2010 as mounting unemployment, foreclosures and a glut of unsold homes all weigh on the housing market.
Robert Shiller, a Yale University economist and co-inventor of the Case-Shiller index, says he expects home prices to be roughly flat for five years. Yet housing has proved a good investment if you stick with it. Prices have fallen 30% in the last 3 years making purchase attractive for a new buyer with a longterm perspective on ownership.