Jeff, a loyal MR reader, asks:
I’m currently considering buying my first home. I’ve aware of the condition of the current housing market, and am not counting on any appreciation to make this financially viable. However, I still am not sure that a home purchase will maximize my well-being. I won’t ask for a personal evaluation of my financial decision, but I am interested in where I should seek quality advice. I’m afraid my realtor’s incentives are structured so that he would like to see a sale irrespective of what is best for me. Is there a resource beside my realtor I should contact? In general what is some practical advice to reduce the principal-agent problem in my daily life?
Like Robin Hanson, often my preferred mode is meta-advice. Once you have received all the rest of your advice, in which direction are you likely to overweigh it?
My view is that Americans are more likely to overrate the value of buying a home, if only because they underestimate the probability of divorce. It is also harder for them to imagine career opportunities in other geographic areas, plus many people overestimate the historic returns to real estate.
I can’t think of comparable biases that would favor renting, especially in our sub-prime, not so liquidity constrained age, which in my view has been dented only temporarily.
An alternative approach is to see the buy/rent decision as equal in value for the marginal buyer, and ask where you stand relative to the market margin. Since this would be Jeff’s first home he is probably young and that also suggests renting.
Here is a good post on home ownership rates. Here is a good Arnold Kling post on real estate.
Readers, what do you all think?
Tyler,
If the home-ownership decision is just a financial one, then I would agree that many overrate the value of owning a home. For me, the emotional, the psychological benefit of home ownership far outweighs the financial benefits and costs. I decide the form of my little castle – the trees, the wallcoverings, the interior layout. Over the years I’ve been able to revise my home to meet exactly my needs.
Certainly we could move rather than remodel and rennovate as our needs changed. But we have the best neighbors we could possibly find, so why risk the change?
Homeownership is costly, both in cash outlays and in time outlays. But there is no way I’d give up owning my little oasis. Of course, here in low cost Texas, the little oasis I can afford is really not that little.
You’re being too much of an economist again! Buying a house is about signaling and identity. It’s about signaling that you care enough about your wife to buy her her very own
nesthome. It’s about signaling to the family that you’re a successful person. I’m an American; I own a house! It’s also about constraining your time-inconsistent future self. “I can’t quit my job and be a beach bum in Key West now, I’ve got a mortgage to pay.”The NYT had a fun flash applet for this decision.
http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?ex=1333857600&en=de85fd94520c0320&ei=5088&partner=rssnyt&emc=rss
(linked on my name too)
I wish you would have elaborated on “ask where you stand relative to the market margin.” for those of us who read your blog but lack the Economics’ background… must Google ‘market margin’.
kids = yes => buy
kids = no => rent
A home is not an investment. Its a bill. Home ownership doesnt really matter until your retired and looking to eliminate bills for a life on a fixed income. Consolidation, sure you could pay your housing bill to someone else, and save the money to buy a place to live when your old, or you can rent from yourself.
You also have to take into account the problems of poor substitution. If the homes you want to buy are virtually identical in type and location to the ones you can rent, then renting probably makes sense now. Unfortunately, in many parts of the country (true for much of Northern Virginia), nicer, larger homes in good areas with good schools are mostly available for purchase and not for rental. Rentals are heavily skewed towards condos and smaller houses. Yes, there is the occasional home for rent in the nicer areas but the choices are fewer. Usually, choosing to rent means giving up substantial options in terms of where you live, how nice the house is, and whom you will be surrounded by.
josh: “Rent, and for god’s sake, stay out of the suburbs.”
josh, have you ever owned a home in the suburbs? Why do you think so many people live in the suburbs?
On the meta-analysis front, perhaps a bias toward renting beyond when it makes sense comes from the desire not to feel tied down, even when you really are. I say this as a guy who rents a house, despite being married and having two kids, one of whom is in school. Bubble-inflated housing prices have made this decision somewhat sensible, but we have a long history of living someplace for 5+ years in a “short-timer” mentality, in which we rent, don’t get too tied down by commitments, etc. This works a *lot* better when you’re two adults than when you’re two adults and two small children.
John,
Generally homeownership is more expensive than renting (largely due to buying more land and or a bigger home than one would rent) and ownership conveys costly signals to your community. Typically, these signals are that one desires to be a more involved member of their community and that is usually something that a rational agent will more especially desire once they have produced offspring (and wish to lower the risk that their offspring will not reach maturity).
Dudes! Here in Los Angeles, where a postage stamp house costs a billion dollars, everyone has gone into HUGE debt to buy a house, and so they throw up a ‘guesthouse’ and rent it. For nothing. That’s where WE come in. We live in Malibu, in a gorgeous guest house, and rent it, for an EIGHTH what we’d pay in a mortgage. Are we crazy? Sure! We have no kids, and someday I’ll inherit some dough from the Momster and we’ll buy then. That’s the plan — and I guess a billion things could go wrong with it — we’re grasshoppers, not ants, right? So freakin’ what? We have an amazing ocean view, NO neighbors but our landlords, and THEY worry about all the property owning stuff. Call us Commies — we’re extremely happy.
econ2econ: “While that isn’t a rule, home ownership usually is more beneficial to families, who usually need more space (hard to find in rentals), more stability, and who benefit from equity and good school districts.”
Right. So why are Del Webb and Meritage and Robson and so many other builders of active adult communities are thriving? Why are the most expensive homes in any community so often inhabited by empty-nesters?
Toll Brothers changed its strategy a few years ago and went on to be the most successful builder in the nation. Here’s what CEO Robert Toll had to say back in 1999:
“Whereas five years ago we were only in the move-up market, where a typical buyer was a 42-year-old, today we are in the empty-nester business and we are in the age-restricted [business].”
I’m not sure where you’re from, econ2econ, or how old you are. You may legitemately have an entirely different perception of the desires of childless families. But I know positively that home ownership is extremely important to most middle class mature Americans. That’s pretty much proven by the homeownership rates of the middle-aged.
The unexpected (though obvious in hindsight) benefit to me of home ownership is as a vehicle for forced savings. If you don’t get too much over your head (that is, don’t force yourself to save too much!), and if you’re not just making the minimum payment on your interest-only loan, you may be surprised at the equity you’ve accumulated after a few years. There’s risk in this investment, of course (I call my house “my highly leveraged undiversified real estate portfolio”), but the risk is comparable to stocks — the other appropriate investment vehicle for our age group. If you’re good about saving money and not letting it burn a hole in your pocket, then this insight won’t apply to you so much.
In hindsight I agree with Tyler about underestimating the probability of divorce, but we’ll burn that bridge when we get to it.
John Dewey, I’m in a large US metro area with few single-family homes, where renting is more desirable. I think your point about middle-to-older age homeowners has a lot to do with the fact that once you’re in the home-ownership tract, it makes a lot less sense to get out of it. Strangely enough, that’s the opposite of what we did. We sold our home in a small, inexpensive area to come to the Big City, where we’ve chosen to rent for the time being. We’re a youngish, childless couple who are unsure about where will be over the next 5 years. I think as we come closer to knowing what our long-term plan will be, we’ll choose to buy, regardless of whether we have kids (something we’re also undecided about), because I know that the long-term benefits of homeownership outweigh those of renting.
I just think a lot of people buy because they think that’s what they are supposed to do, even when it doesn’t really make sense for their current life or financial situation. That’s what we did. Fortunately, we were lucky enough to buy and sell within the bubble expansion, so we came out ahead after only living there 2 years.
If I could find a bank that would loan me the equivalent of a 10% down mortgage on a portfolio of stocks, relatively safe like S&P 500 Index or MSCI Global, then I would take that over a house.
Home ownership is an investment to reduce future expenses. You basically are investing to lock in 30 years of preset payments instead of agreeing to floating “rent” payments. For example if I purchase a home today, I know for the next 30 years my payment is $X and it will not grow or decline any faster than insurance and tax increases on the property. On the other hand renting means I now must assume my payments will grow considerably faster over time.
Home ownership at retirement is a massive investment in reduced monthly expenses. Home ownership can also go a long way towards self financing (second to die) personal long-term care expense exposure.
O/T, but should cities look into providing the financing for property purchases?
The value of a property is primarily the function of the community and communities government, yet the vast majority of the value goes to banks as interest payments. Couldn’t cities afford some of the risk the bank takes on? Could this encourage better decisions in communities, making decisions that improve property values even more lucrative?
obviously rent is not tax deductible. This is substantial. As a recent grad working in a large urban area I wish I could afford a down payment on a condo. My rent eats up like 30% of my monthly income. If I could have a mortgage at the same amount of my monthly income the net savings would be a 12% increase in my net wealth.
Agree with Max. He’s probably much clearer than my earlier post.
Here’s my brother’s determination in Manhattan.
Interest adjusted for taxes + Maintenance Cost > Rent
Obviouse choice is rent there. The cost of financing plus maintenance is greater than paying rent. That’s one of the only places in the country that’s true.
I’ve ignored the difference in transaction costs. How you handle that should depend on how long you’ll be living there (Of course, that will also determine how much interest you ultimately pay too. Your interest payment goes down with time, a by product of that whole forced savings thing — Yeah, that’s right. Buying means your rent goes down with time rather than up as with actually renting.).
Make sure you know what your taxes, utilities, and maintenance expenses will be.
Best option is to buy. But don’t over buy. Just get what you need to be comfortable in an area you like. Something similar to what you’d rent. Try to get your monthly cashflows (include the transaction fees) the same as what you’d rent and compare what you get. Can you be comfortable?
Jeff, Buy and do things like paint, tile, removing popcorn ceilings, renovating the kitchen, redoing bathrooms, etc. It’s a great hobby that will keep you out of trouble,
Oh, and about the tax issues: overrated. Your tax deduction for mortgage interest is [just the interest part of your payment + taxes on the property + points paid if applicable] X [your tax bracket]. In a modest home with a good rate, it may amount to less than the standard deduction, although I admit that is unlikely. Many homeowners seem to think that every penny that goes to the mortgage company is a penny they don’t have to pay Uncle Sam, and it’s not true. Any financial adviser who tells you to buy a big house primarily to lower your taxes should be fired immediately.
Telnar: “I think that the key to this decision is thinking about the non-cash pieces of it.”
I agree.
Telnar: “While there are financial factors which other have mentioned or touched on …..the personal factors probably matter more at the margin.”
Yes. It’s more a lifestyle decision than a financial decision. I’m not saying one should ignore the costs, but in most parts of the country the cost to rent and the cost to buy shouldn’t be hugely different.
Not sure why Ken and Brad Hutchings are so negative about home ownership. I think the world disagrees with them, as almost every married couple eventually buys a home and stays in one throughout their lives. If it were such a bad deal, people would begetting out in huge numbers – which they are not.
I don’t see how anyone can be anything but emotionally invested in buying a house – especially the first one. Despite ShortWoman’s warnings, there’s really nothing one can do to prevent that.
Renting is usually cheaper initially, but the increases are unending. In the long run, buying is the better option as inflation works against the renter and for the owner, but, as now, that can be a very long time. The NYT applet is good about this.
It really is a lifestyle decision though. Deal with a landlord or deal with a property. Free to move, or freedom from moving. More free time or more time to invest.
Read my renter’s manifesto and related thoughts. If I had purchased a home while living in Orlando, chances are I would not have traveled as much as I have nor would I have come back to school for my PhD. I also would probably been more cautious with some of my career choices. (The risks I was able to take changing companies twice helped increase my income substantially.) Renting also made the lifestyle transition to grad school much easier.
On the other hand, if I had purchased as soon as I was able, I would have probably had a higher net worth by now.
On the whole, the trade-offs have been well worth it for me.
Tom,
Land is scarce in the London area, right? Is housing so expensive everywhere in Great Britain?
I think home ownership costs also far exceed rental costs in older U.S. cities where land is scarce. But land is abundant around our large sunbelt cities – especially Dallas, Houston, Atlanta, and Phoenix. Homeownership costs have remained low. For example, in Dallas suburbs one can purchase a new 1800 square foot home on a 7,000 square foot lot for about $160,000 (That’s about 79,000 pounds, right?) At today’s interest rates, that should be affordable for 75% to 80% of households. Homes are even cheaper in our smaller sunbelt cities.
Cheap land is just one reason housing is affordable. Across most of the southern U.S., inflation-adjusted construction labor costs are lower than ever. That’s due to Mexican immmigrant labor, of course.
Just a different viewpoint: In many parts of the country the tax deduction for interest payments/property tax does not exceed the standard deduction.
When I bought my home I think the only year I itemized deductions was the year I purchased and had a lot of extra closing costs rolled in. In year 2 threshold not achieved.
Home purchased in 2000 in TN for $140K. 20% down, 15 year fixed. This is a fairly common home – maybe a little lower end – but I currently don’t even come close to exceeding the standard deduction.
You get that back when you close out… unless they take away the tax deduction before then.
One should also take into consideration landlord-tenant law in your state. Some states mandate a cap on rent increases and grant certain rights to renters, while others (coughUTAHcough) are more… how shall we put this… 18th century. One of the reasons we bought instead of renting, even when we got a horrible deal on our mortgage and didn’t know if we’d like the neighborhood, was because in Utah, renters are basically all lined up and bent over before the landlord, who can do just about anything he pleases– raise the rent by ungodly amounts, find excuses to kick the renters out, not maintain the property because no enforcement entity can make him fix it, etc. Utah is full of dark, moldy basement apartments with 6 foot ceilings and 1 foot windows, and townhouses with mildewed cabinets and only a few rotted shingles left on the roof. And it’s all legal.
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