I often see pundits separate investment spending into residential and non-residential categories. But I’m not sure why they do this. What makes residential investment so special?
At times there seems to be a sort of unspoken assumption that residential investment is akin to consumption, and that non-residential investment is more healthy, or virtuous, or growth-oriented. But why?
In 1991, I bought a 50% share in a handsome old brick two-family house in a Boston suburb. Over the next 26 years, I enjoyed a flow of housing consumption services from this capital asset, built back in 1923.
When the house was originally built, I imagine that lots of factories and machines and other types of non-residential investments were also being built. I wonder if the business press of 1923 thought that the non-residential investment was more useful than residential investment. In fact, my 1923 home was a much more “pro-growth, long-term investment” than New England shoe factories that become obsolete a few decades later.
If we want to boost the living standards of future Americans, housing investment is one of the surest ways of doing so.
READER COMMENTS
nobody.really
Jul 25 2019 at 10:26am
Sumner raises a larger question: How exactly should we distinguish between investment and consumption–and why?
If I buy a washing machine, thereby saving time and money I otherwise would have expended at the laundromat, is that an act of investment or consumption?
If I go on a vacation that will give me a stream of happy memories for the rest of my life, is that an act of investment or consumption? Should I distinguish between vacations taken when I’m young (and thus have a longer period over which to enjoy the happy memories) vs. when I’m old?
Taking this further: Caplan talks about the poor return on a college education. I sometimes wonder if his analysis misses this part of the return. Historically, college was a rite-of-passage for affluent young men to engage in before settling down to start families and careers. Their families would pay to send them on the most stimulating multi-year vacation imaginable–lived among peers, far from parents. Education was merely one of the many pleasures this vacation afforded. It was only in retrospect, when affluent white men felt the need to justify this institution in Protestant Work Ethic terms, did we invent the rationale that a university education–learning Latin and all–provides this great boost to future productivity. And judged solely on the basis of boosting productivity, perhaps the return on a college education isn’t so great. But productivity had always been only part of the rationale. College is an investment that yields a lifetime of dividends to the student–even if those dividends don’t end up in the GDP.
Mark Brophy
Jul 26 2019 at 2:01pm
Caplan doesn’t miss this part of the return to education. He says that the student enjoys the parties and other benefits as long as he graduates with a credential but the government that subsidizes students fails to earn a sufficient return.
Alan Goldhammer
Jul 25 2019 at 10:29am
Certainly one can participate by investing in various classes of real estate. Home ownership is a special class and one needs to carefully track all the costs of ownership in order to draw a conclusion of whether it was pro-growth or not. When you sold your home in Boston did you have a thorough accounting of expenses? We have been in our home for just over 30 years. The dwelling has no resale value as nobody will want a 1955 split level home. It will sell only for the property location for a new home build on the land. Looking at it this way, all of the improvements that we have done over the years do not add up to any increase in resale value.
I also wonder if the current limitations of SALT deductions will have an impact going forward. Location has to factor into this as well since appreciation of a home in Rochester, NY is likely to be quite different from one in Boston, MA because of huge changes in the job market between the two.
Scott Sumner
Jul 25 2019 at 2:15pm
Alan, Of course all capital assets depreciate. Houses usually depreciate more slowly than factories, machines, vehicles, etc. Many of our shopping malls are now becoming obsolete. What is special about housing?
Cliff
Jul 25 2019 at 4:34pm
The investment is made by regular people who are not trying to make a good investment, and so investments in residential housing are often bad and wealth-destroying. As an investor in rental real-estate, I know this. Many people would be better off renting, although you can always fudge it with psychic benefits.
TMC
Jul 26 2019 at 9:00am
Cliff, this doesn’t make sense. I also have several investment properties, and it makes little sense to rent rather than own if you are staying put in an area. How can I make a profit (and I do) on a property when someone could not own it to their advantage? If there’s room for profit in the rent they pay, then they could own it at an advantage to themselves.
Alan Goldhammer
Jul 25 2019 at 9:08pm
Scott – I probably was not clear in my post. In my case the value of the dwelling is close to zero (even though there is an assessed value of the house for property tax purposes) and the value of the property is say $800K which is probably what a builder would pay us (all cash up front and no real estate commission to pay).
If you subtract out what we paid for the house plus all the stuff we paid into the house (appliances, 2xheating/AC replacements, 2x roof replacements, kitchen remodel, patio, painting, window replacement, etc) the actual return is not all that great even though the house has appreciated significantly over the years we have lived here.
I’m in Cliff’s camp in terms of homes being potential wealth destroyers.
TMC
Jul 26 2019 at 9:14am
Alan, do you not think you are paying for appliances, 2xheating/AC replacements, 2x roof replacements, kitchen remodel, patio, painting, window replacement, etc when paying rent. Owning allows you to make these decisions for yourself, which is of value to me, and most people I’d guess.
Owning a home is an investment and consumption. It’s difficult to separate the two precisely, but think of it as you are renting the home to yourself. As in all rentals, there is investment, and ongoing maintenance. Also you are paying off the home, and enjoy the appreciation in value. You receive rent in the form of living there, which is consumption. You are competing against other landlords, which suggests that there is profit in the endeavour.
Scott Sumner
Jul 26 2019 at 3:31pm
I don’t see your point. What’s a 50 year old strip mall worth? How much does it cost to maintain and update? How about a 100 year old factory–what’s that worth?
nobody.really
Jul 26 2019 at 2:33am
This would not be uncommon in Japan. For a nation that reveres all that is ancient, the Japanese have developed a curious tradition of knocking down their houses every 20-30 years and rebuilding on the same location. Yet I’m told that the Japanese still impose the most rigorous demands on the lumber they import, and require the most elaborate trusses and jointwork.
Does this alter the judgment about whether this is consumption/investment?
Benjamin Cole
Jul 26 2019 at 12:01am
Okay, I am a wag wearing a tin-foil hat, so I wonder aloud this:
For most of my literate life, I have thought consumption should be taxed, and not investment. Investment is virtuous. Consumption, especially excessive consumption, is decadent. I even lived my own life by these rules, and fairly rigorously (in many ways I am a Scott Sumner clone or doppelganger).
Okay, so today we have a global capital glut, and Japan is about to raise the national sales tax to 10% from 8% despite the fact that AD in Japan is a bit soft.
If the world is saturated with capital, if nearly every industry has too much capacity, don’t you want more demand?
Has something flipped? Should we lower taxes on consumption or income taxes on people who will consume extra income?
As for housing, my take is housing is an investment until it crosses over into opulence, when it starts becoming consumption. You can draw that line anywhere, usually right at the level where housing becomes more opulent than what I live in.
nobody.really
Jul 26 2019 at 2:43am
In a world of scarcity, we raise our kids to have a certain amount of stoicism and acknowledge that “you can’t always get what you want.”
In a post-scarcity world, will that make sense? Arguably we’ll want more demand, so we should raise our kids to have exacting tastes. The real advantage of this behavior will be to ensure that the consumer derives maximum satisfaction from the consumption, and to provide the producer with a challenge and a sense of purpose and accomplishment at having met someone’s demands. Because in a post-scarcity world, the scarcest commodity may be an actual consumer who has not already been satiated by all the other producers.
Thaomas
Jul 26 2019 at 3:33pm
Sure we need more demand, but not necessarily more immediate demand for consumption. (Although if markets had confidence that he Fed had really abandoned its inflation rate ceiling policy and that the trade wars would revert to phoney, private investment might be higher.) The investment demands for dealing with climate change will be enormous.
Thaomas
Jul 26 2019 at 6:56am
I think the reason is to separate out the “animal spirits” of different kinds of people, plus we fiddle with tax incentives for non-residential investment often and presumably want to know if the fiddling has any effect. Did the “Tax Cuts for the Rich and Deficits Act of 2017” lead to a boom in business investment as promised?
Scott Sumner
Jul 26 2019 at 3:33pm
Everyone, These comments pretty much confirm my intuition. There is no good reason to focus on non-residential investment.
Michael Pettingill
Jul 27 2019 at 10:59am
Residential capital is owned primarily by individuals producing income to the individual (imputed). Its the closest to a homestead available today, the foundation of the US.
Businesses, even most small businesses are collectivist enterprises, with individuals seldom in control. Even sole proprietors depend on key employees who make or break the business, thus holding imputed ownership.
Michael Rulle
Jul 27 2019 at 12:55pm
I might be off base on why I agree with this essay, at least in the sense of agreeing for the right reason. I often think of Europe——particularly cities which were not bombed out in WWII. Let’s take Paris as an example. I have always thought they have received great benefits from a large stock of long ago built housing. Even though official stats shows income as less than the US on average, I have perceived this as understating the comparative standard of living. Your example is also like that.
Lorenzo from Oz
Jul 27 2019 at 10:13pm
Residential investment is more broadly based (in who does it) than non-residential investment. Which strikes me as a political, not an economic, reason to differentiate.
I suspect that residential investment is seen as generally being “investment for one household” while non-residential investment is seen as generally being investment beyond one household. Which is a more economic reason to differentiate, but a bit fuzzy at the edges.
LK Beland
Jul 29 2019 at 5:10pm
“I often see pundits separate investment spending into residential and non-residential categories. But I’m not sure why they do this. What makes residential investment so special?”
Tentative answer: because they are financed differently. Residential investment tend to be financed via (government-backed) mortgages, while the later tends to be financed via equity, non-secured business loans and bonds (with no government backing).
The rational is probably that given that they operate via different financial channels, they are stimulated differently by fiscal and monetary policy, and thus should be tracked separately to evaluate the effectiveness of these policies.
nobody.really
Jul 30 2019 at 12:52pm
Wait–perhaps I misunderstood the question.
I share Sumner’s skepticism about the merits of distinguishing between housing expenditures as consumption rather than investment. But now I see that Sumner was specifically asking about why pundits obsess over housing spending. And that may be because housing has historically been a leading indicator of recessions and expansions.
Specifically, while housing is not a huge share of the economy–currently only about 4 percent of GDP–is is a peculiarly volatile share. A house represents the biggest single investment that most households will ever make, and today people (and banks) tend to be risk-averse. So the pool of people seeking a new house can evaporate overnight, and the number of new home starts will follow close behind. The St. Louis Fed reports that during the 2007-09 recession, construction and related sectors accounted for a little over a third of the decline in output, and about half of the job losses.
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