Should you buy a house to save for retirement?

If you live in a major city like London, New York, or Paris, one of the most prominent complaints is how expensive houses are. House prices have outpaced wage gains for several decades now, making it harder and harder for first-time homebuyers to get on the property ladder. In cities like London, house prices are so high that young people typically cannot afford to buy a home without the help of parents. Government subsidies like the UK “Help to Buy” scheme don’t alleviate the problem either because they are only available for property valued less than £500,000. In London, you have to move far out into the suburbs to get something at that price.

From a societal perspective, rising house prices had two major effects.

First, it has increased inequality, but not between the rich and the middle class but between the middle class and the working class. Put in simple terms, the wealthy hold most of their savings and wealth in stocks and businesses. The middle class tends to hold most of their savings and wealth in their home, while the working class tends to have no savings or hold their savings predominantly in cash and other safe assets in order to access them in times of need. But if you plot house prices relative to wages, there has been a steep increase for the last forty years in the United States, the UK, and other countries. Germany is a different case here because homeownership rates there are lower than in other countries, Germans are more debt-averse than other peoples, and there never was a housing bubble. Thus, housing affordability has improved in Germany while it has deteriorated pretty much everywhere else. And as housing affordability has deteriorated the wealth gap between the middle class and the working class has increased.

House prices relative to wages

Source: Bank of England, Jordà et al. (2019)

The second effect of rising house prices was that middle-class people increasingly use their homes as the main way to save for retirement. After forty years of steadily deteriorating housing affordability, it has become gospel amongst middle-class Americans and Brits that the best way to create wealth is to buy a house or a flat in a big city early in life, flip it a couple of times and then sell it at retirement and move to the countryside where housing is cheap.

But whether this conventional wisdom is going to work out for Millennials is not clear anymore. House prices have benefitted from several decades of declining interest rates. As I have shown here, returns on houses have historically not been that great.

And if we extend the chart above into the past, we can see that house prices outpacing wage growth is historically an aberration. For more than a century before the 1980s, house prices have grown less than wages across the globe. In this environment, it would clearly have been suboptimal if workers had put their savings into houses. And once they retired, the piggy bank that is their house would not have paid off a lot. As interest rates are likely to stay low for years if not decades to come, we shouldn’t expect house prices to decline anytime soon. But the younger generations of today should also be aware that getting onto the property ladder as a way to generate retirement savings is unlikely to work as well as it did for their parents. Diversification across assets will become more important for this generation and renting may once more become a viable alternative to owning a home from an investment perspective.

House prices relative to wages in the long run

Source: Bank of England, Jordà et al. (2019)