Can housing be affordable and a good investment at the same time?

Considering how much I spend on housing, I wanted to understand better the relationship between how good an investment housing is and how housing returns affect its affordability.

House prices are determined by supply and demand. People want to move cities because cities offer better job prospects with higher wages. When the housing supply is fixed—for example in a big city where zoning laws do not allow to increased density—and demand is rising, the equilibrium price that clears the market will rise.

It is not inevitable for housing prices to rise, even in big cities. If a country is experiencing a fertility crisis, there may be few people left who can move to the city and those who already live in the city may not have enough children to replace the elderly.

Cities with high demand may also increase the housing supply, either by allowing densification or by expanding. In that case, prices may remain stable and affordable. For housing to be affordable, the cost relative to income must not rise over time. It must be such that the fraction of income allocated to housing is relatively low.

For housing to be a good investment, it must at least deliver returns similar to or higher than average returns on capital. In the West, with current trends, a naive analysis may conclude that since returns on capital are higher than salary increases, housing cannot be both affordable and a good investment. However, this is not the whole story. Since housing prices are determined by supply and demand, in situations where there is little new housing stock entering the market, salary increases will cause prices to rise to a new equilibrium. The new price may leave housing almost as unaffordable as before or even worse in some cases (in terms of fraction of income allocated to housing). So even if salary growth outpaced returns on capital, that would not make housing more affordable, but it would make housing an even better investment.

There is possibly a fine line, where both housing supply and salaries increase in such a way that housing offers attractive returns but remains affordable. This would be a situation with high productivity growth, where real wages increase at least as much as returns on capital, while housing supply expands sufficiently to keep the equilibrium price stable relative to wages. While possible, I think this situation is unlikely. Currently, wage growth in the West is lower than returns on capital and many cities face many restrictions on building new housing.

Considering longer time-frames, it is possible for housing to be affordable today, and a good investment in the long term. Those who buy now will benefit from appreciation, but this generally means that housing will be unaffordable in the future.

Another aspect that I have not considered is intergenerational wealth transfers. If several generations already own their homes in a given place, their descendants will benefit from price increases and accumulated wealth. The benefits may include help with down payments or financial support for mortgage payments. Descendants will be able to enter the housing market earlier, thus benefiting from lower prices as housing appreciates further over time, and will be able to accumulate more wealth than someone without family support, who has to save for a down payment while also paying rent.

For recent immigrants, the picture is different. They may be attracted to higher wages in the city, but they may not earn much initially. They may need to save and wait until later in their careers, when they can expect higher salaries, to be able to buy a home. In the worst case, if prices increase faster than their salaries, they may never be able to afford to buy at all.

My conclusion is that in general, housing cannot be affordable and a good investment at the same time. In growing cities with strong demand and restricted supply, prices will be unaffordable. Only exceptionally, with the right mix of wage growth and increasing supply, can housing be both affordable and provide good returns.