Renting versus Owning and the Flexibility of Job Markets

Dean Baker says the government's plan to intervene in mortgage markets is a bad deal for some homeowners:

The hidden homeowner tax, by Dean Baker, Comment is Free: ...As we know, millions of families are facing foreclosure on their homes... This is a situation where the banks would ordinarily take a huge hit...

But politicians can't resist a bank in distress. They want the government to step in and either guarantee or directly issue new mortgages to these homeowners. When these new mortgages are issued..., they will be giving the banks far more money than they can reasonably hope to get if the houses had gone through ... foreclosure...

This can be viewed as bad policy because it is giving tens of billions of taxpayer dollars to the truly rich. But it should be viewed as even worse policy because it is effectively taxing millions of low- and moderate-income families to live in homes in which they have no equity. ...

Typically, houses sell for about 14 times as much as what it would cost to rent ... for a year. The run-up in house prices in the bubble raised the ratio ... to more than 20 to 1. While prices have begun to fall, in many areas that ratio remains nearly unchanged. ...

Suppose that a moderate homeowner gets a 6% mortgage, and then pays an additional 1% of the sale price each year on both tax and maintenance. This means that their costs of "owning" the house is equal to 8% of the sale price, not counting any payments of principle...

Let's put numbers in this story. Suppose the house would sell for $200,000. The 20-to-1 sale-to-rent ratio implies that it would rent for $10,000 a year or $830 a month. Instead, this homeowner is paying $12,000 a year in interest, $2,000 a year in taxes and $2,000 a year in maintenance for a total of $16,000 a year, or $1,330 per month.

This additional $6,000 a year in housing costs is likely to be large relative to the family's income. ...

Paying extra to own, rather than rent, a home could make sense if the homeowner was accumulating equity in the house. However, this is almost certainly not the case. House prices are falling rapidly and will likely continue to fall until the overhang from the housing bubble is eliminated. The vast majority of moderate-income homeowners facing foreclosure will never see a dime in equity on their home. ...

We need a housing policy that is designed to give people decent housing, not fulfill ideological commitments to an "ownership society".

There's something about owning a home - maybe it's the ability to paint the walls as you please without asking, put a garden in the backyard, have a dog or a cat - and much of it can't be capitalized into the price because it's unique to the individual (that carpet you chose might even lower the value to potential buyers). And if you do get out, especially with a foreclosure, will you be able to get back in later once prices have bottomed out? Wouldn't it be better to find a way to ride it out somehow even if it costs more now? Over several decades, won't I be likely to make money? I understand the financial argument, but there's something intangible about owning a house as compared to renting that the difference in prices doesn't seem to fully capture.

James Surowiecki says there's another cost to home ownership, slower adjustment to shocks, and my kind of thinking - getting a house somehow and then only reluctantly giving it up - makes it worse:

...Homeownership ... impedes the economy’s readjustment by tying people down. From a social point of view, it’s beneficial that homeownership encourages commitment to a given town or city. But, from an economic point of view, it’s good for people to be able to leave places where there’s less work and move to places where there’s more. Homeowners are much less likely to move than renters, especially during a downturn, when they aren’t willing (or can’t afford) to sell at market prices. ...[R]eluctance to move not only keeps unemployment high in struggling areas but makes it hard for businesses elsewhere to attract the workers they need to grow.

This doesn’t mean that the U.S. should become a nation of renters—even if both New York City and Switzerland show that high rates of renting are compatible with great prosperity. With the bursting of the housing bubble, though, it’s time not just to scrutinize the excesses of our home-buying process but to recognize the risks and costs inherent in owning a home. Sometimes the price—for the home buyer and for the economy as a whole—is too high to pay.

I struggle with this one a little bit. Should we, as official policy, expect people to move when things get bad - to leave their family and friends, to move away from the place they grew up and put their kids into new schools - or should government try to find a way to attract new business and provide enough jobs for residents? The latter strategy isn't always feasible, sometimes changes are permanent and nothing can be done about that, and attracting business is difficult in any case. When it isn't feasible, when change that is out of their control forces people to uproot and relocate, shouldn't we do what we can to help with the transition?

But I'm not sure what role the government should play in these cases. The difficulty that comes from leaving a place where you've lived a long time isn't just from home ownership, though that certainly contributes, so simply promoting more renting or even making it easier to sell a home won't fully resolve this "stickiness". If we want to encourage faster adjustment, then to help ease the transition I'd certainly be in favor of generous tax advantages for middle and lower income households who are willing to relocate if we can structure the policies to avoid the distortions that tax breaks for relocating create (e.g., we don't want people moving just to get tax breaks).

But tax breaks aren't the only possibility. Many families won't even move across town while their kids are in school because even if they are willing to provide transportation, the kids cannot stay at the same school due to residency requirements. Reexaming rules such as these could help promote labor market flexibility without costing taxpayers much. The point is that we can do a lot more than we do now to facilitate the transition for families willing to relocate for economic reasons and hopefully, when the administration changes after the next election, domestic issues such as these will receive much more attention than they have in recent years.

Comments

[save_the_rustbelt]

Being a child of a Dustbowl Okie, the idea of creating a vast class of nomadic workers who move from region to region at the whims of corporate America, renting as they go, has little appeal for me.

But then if that is the job market corporate America wants, and our politicians give them, and that fits neatly into economists' notions, then owning a house makes no sense.

Just what landlords are going to own millions of single family homes? Being a former landlord, owning single family homes in not a terribly efficient way to make money. So do we let the housing stock rot and build a new generation of multifamily ghettos?

Have to go now, I need to read the latest list of factory closings, off to China we go!

[save_the_rustbelt]

You load sixteen tons, and what do you get? Another day older and deeper in debt.

St. Peter don't ya call me 'cause I can't go, I owe my soul to the company store.

Tennessee Ernie Ford

[Idaho_Spud]

Once again I find myself in agreement with Rusty: Corporations are quite fond of disposable employees (automaker buyout, anyone?). What better state of affairs than for employees to consider companies disposable as well?

In fact, that is what we see today; outside of government and education, employment is short, nasty and brutish - at the whim of either party.

[Callahan]

Take this job and shove it, I ain't a workin here no more.

Johnny Paycheck.

Current employment conditions may cause a rise in crime?

[robertdfeinman]

Dean Baker's example has some errors in it. He neglects that one can deduct the interest on the mortgage from one's income taxes. So, the effective rate for a typical taxpayer would be more like 4% than 6%.

He also neglects the fact that as the principal is paid down the amount going to interest also declines. So, the $12,000 in interest is only true for the first year. I admit that this number tends to decline slowly at first, but one can't use first year numbers to prove a point.

He also neglects the income tax break on real estate taxes which will also lower them by 20-35%. Put all these together and the monthly carrying costs are several hundred dollars less than he calculates.

I also don't understand the concern over the decline in the value of one's home. I do understand the squeeze if one can't afford the monthly payments because of a variable rate loan, but if one has a fixed rate mortgage and one isn't planning to move then the market price is irrelevant.

As the old saying goes, you can't make land, so homeowners who stay put and continue to meet their payments will, eventually, come out ahead. Of course this is predicated on having purchased the home in a stable neighborhood. But that's always the case with real estate - location, location, location.

I don't know what most people who own common stock are doing, but the big funds always advise "don't panic". History has shown that those who sit tight through a dip end up better off over the long term. The same should be true of homeowners.

[ken melvin]

Again? Are people really supposed to serve their economy as they might serve some deity?

[reason]

What the government could do is
1. Increase LVT (so reducing the price of land and the capital outlay needed to buy it)
2. Minimise transaction costs.
Just saying.

[reason]

Why is it that costs of adjustment are costs to an individual but not to the economy as a whole (GDP)?

[lonesome moderate]

IdahoSpud:

Once again I find myself in agreement with Rusty: Corporations are quite fond of disposable employees (automaker buyout, anyone?). What better state of affairs than for employees to consider companies disposable as well?

In fact, that is what we see today; outside of government and education, employment is short, nasty and brutish - at the whim of either party.

Yup, that's our country's niche. We can't compete on price, but we can compete on "dynamism", which in practice means something like what you say above. Since I work in tech, that's been my reality for pretty much my entire career. The freedom can be nice, but it demands a lot more personal discipline.

Of course, as many others have pointed out, the "freedom" to work at a dozen different Wal-Marts is a losing proposition all around.

[paine]

"As the old saying goes, you can't make land"

no but you can make
more house lots
change floor plan to lot ratios
and building heights
and floor counts too

the infrastructure can be ramped up
with ground rent taxes fed back
into these infra improves.....

no the value of your lot could fall
and stay fallen
in real terms for quite a spell

[paine]

"Are people really supposed to serve their economy as they might serve some deity"
no
the gods of private profit max
make exceptions

its not all of the people and not all of the time

just most of um
and way too often

[paine]

owning a house lot
of your own
is
the jobbled american dreamers fools gold

free to mow my lawn
to neighborhood standards

free to redecorate

my my
community AND independence

the life of Riley
unity of opposites
the yeoman reduced to his quarter acre
of grass garage terrace tarmac
and 2k of walled in
wall to wall carpet

praise the lord
and pass the dunkins

[fabian59]

Wow, I just thought that both of these articles – James Surowiecki’s and Dean Baker’s – were excellent. They just seem to be lone rational voices in a virtual sea of irrationality. I must admit that it was a bit difficult wading through Dean Baker’s examples, but I get very similar results for the cost of renting versus buying when I use my own simplified calculator that includes calculations for things like tax benefits and maintenance costs. In essence, the cost of owning in my area of the country appears to be about twice the cost renting. Five or six years ago, this wasn’t the case, as the cost of owning and the cost of renting were nearly equal. I thought that Sorowiecki’s line that “homeownership isn’t building wealth for these people; it’s locking them into indentured servitude” is right on target.

I simply do not understand how our society can validate a 70 percent run-up in real housing prices over the past decade, after 100 years of relative price stability (see data such as that compiled by Robert Shiller and/or Dean Baker). While I can see that the rapid run-up in housing prices has probably been great for the majority of American households, I feel that it has left a large chunk of U.S. families and individuals in the dust. Although renting certainly isn’t my first choice, I just can’t see the logic in paying out nearly twice the amount on a monthly basis to own than it costs me to rent a similar property. Given the current level of prices, it’s just very hard to imagine further increases in housing prices and the long-term financial benefit that would then accrue to me via home ownership. Average incomes certainly haven’t increased by 70 percent in constant dollars over the past decade, I know that mine hasn’t.

I realize that not all areas of the country have seen the price of housing in their neighborhood’s double, triple, even quadruple over the past decade (I live in the Washington, DC area), as the 70 percent increase in constant dollars is a national-level statistic. So, at some level, I can see the perspective from which Dr. Thoma and some of the other commenters to this article are speaking from when they espouse the benefits of home ownership. Unfortunately, I have my own reality regarding the prospects of home ownership, and it doesn’t seem very bright. Also, one of my genuine fears is that the housing and rental markets will eventually come back into their long-term alignment, and they will do so not through a decline in housing prices but through an increase in rents. This fear is rooted in what seem to be strong signals from our government and industry that maintaining housing prices at or near current, highly-inflated levels is a ‘good thing.’

[paine]

a nation of job chasing nomads

lets not over play the hand here

why so bad
a certain rootless %
of jobblers ???

in the long run
familly and community
are no
a match for market atomization
and the kool soul of anomie

[richb]

"I understand the financial argument, but there's something intangible about owning a house as compared to renting that the difference in prices doesn't seem to fully capture."

There might be some intangible benefits to owning vs. renting, but, presumably, the owner's premium shouldn't change over time. Have home makeover shows on cable tv suddenly become so popular that everyone is now willing to pay an even higher premium than they were 5 years ago in order to be able to paint their own walls? Likewise, while Dean Baker's calculations might now have included every single tax benefit, there's still no reason for the ratio between rent and purchase price to have fundamentally changed.

[paine]

fabian 59
rental rates tend to obey local income ratios
pretty well
i'd expect the lot values to hang in nominal suspension
till other prices and of course incomes catch up

right now the policy intent
seems to be

" hold up lot values"

prevent a price cratering

and
to prop the house lots
various market manipulations
are feasible ...underway ...planned
some uncle gub
open to the public stuff
and
some closed door
evil bankic riggery

eegardless of policy
the greatest micro by the millions
market prop force
remains
mark's
irrational home sweet home effect

clingonism
as in
we all kin
ride it out pard
till better times come round agin

quite
a stink hole sink hole

[cm]

Welcome to "euro" sclerosis.

[save_the_rustbelt]

Listening to Bernanke this morning I ran some numbers in my head. This would apply where a foreclosed home has little or no resale value, likely because the entire neighborhood is trashed or being trashed.

Cost of foreclosing on a house with $80,000 past due mortgage, no prospects for resale:

$80,000 loss on mortgage
$10,000 legal, board up, insurance (maybe), taxes

Cost of just giving the house free and clear to the occupant:

$80,000 loss on mortgage
$ 1,000 legal work

Crazy idea? Maybe, but it could preserve some neighborhoods which could prevent even more foreclosures.

[nihil obstet]

Another intangible is that homeownership makes the owner feel that s/he is in control. Renting, every year or two the rent goes up, and you don't know in advance by how much. If the location has become more desirable, it will go up by a lot. The landlord may not maintain your unit or the premises. Theoretically, you can move, but in good times you may have trouble finding a place, and in bad times, do you want to incur the costs of moving? The property may be sold to be altered or even torn down to put the land to more profitable uses. The risks and problems with homeownership are different (maintenance costs and hassle, changing neighborhood for better or worse, change in property taxes, less mobility when you want it, et al.), but visions of being able to sell when you want to create a sense of more options, whether the sense is true or false.

[Walker]

He also neglects the fact that as the principal is paid down the amount going to interest also declines. So, the $12,000 in interest is only true for the first year. I admit that this number tends to decline slowly at first, but one can't use first year numbers to prove a point.

Average homeowner owns their home for 7 years in today's market. Growing up in the 70s and 80s, my family never lived in a house for more than 7. Seven years, with closing costs accounted for, is not enough for this to pay off.

And while Baker is ignores the tax savings, his property taxes are very low. Here in central NY I see $900/month rent for $225k properties (near his multiple). Property+school tax is 3%. Even considering principal reduction+tax savings, ownership has a $300/month premium. And that is assuming that prices do not fall.

Is the homeownership premium worth that or comparable places?

Another intangible is that homeownership makes the owner feel that s/he is in control. Renting, every year or two the rent goes up, and you don't know in advance by how much. If the location has become more desirable, it will go up by a lot. The landlord may not maintain your unit or the premises.

Get a better landlord. It amazes me how little research renters put into selecting their landlord. Good property managers will do everything within fiscal reason to keep good tenants. If people put as much research into renting as they do buying a house, they will discover that many of these supposed buying advantages go away.

[odograph]

It seems obvious that every government homeowner incentive was a one-shot deal. As soon as the market devoured the incentive, home prices rose and the advantage disappeared.

That leaves us with disadvantaged renters, and home buyers with no benefit.

Where would home prices be, for instance, if ever seller paid capital gains *before* climbing to a bigger house?

[johnchx]

I think Surowiecki's point is an important one.

Think about it from a risk-management, or portfolio-diversification point of view. Most households -- those with currently employed workers, rather than retirees -- place a large, undiversified bet on the local labor market. That is, the household's income depends heavily on the local employment picture, and there's no convenient way to insure or hedge against exposure to local job-market risk.

Housing prices also depend a great deal on the local job market, which means that buying a house amounts to doubling-down the initial bet, only this time with leverage.

So the policy question is: why are we encouraging individuals who are already over-exposed to their local labor markets to commit most or all of their savings to a highly leveraged bet on exactly the same risk?

[Patricia Shannon]

I read a study years ago that found that communities depend on the stable residents. Eg., they are the ones that stay informed on local things and go to city council meetings.

I lived in Huntsville, AL for 30 years. I was buying a home. I was active in my community.
Since I moved to Georgia, I have not felt a part of my community. This is made worse by the fact that for most I've my jobs, I've had a long commute. I can't afford to move all the time.
Also, I have several pets. Trying to rent with even one pet is hard. It can be hard to rent if you have children, even.

[Callahan]

I'm thinking of joining up with an American Indian reservation. There must be a little Indian blood in me even if only from the blood brother thing.

Yippe kiy yi aye, I'm on my way.

[Gerard MacDonell]

The issue here is not that home owners are not mobile. The issue is that the housing stock is not mobile. In a downturn, lower rents will tie folks to the distressed area and ration them away from the prosperous area. Six of one, half a dozen of the other. What Surowiecki actually means is that we should all live in trailers, so that the operational force -- the dwelling itself -- is mobile.

That aside, I think the issue of macroeconomic stability is not getting enough attention here. These interventions are designed to avoid a very bad outcome of massive unemployment, not just negative equity for dummies or losses for bank equity holders.

[donna]

I tend to think the problem has been more the distortion of the housing market itself, where "larger" has become equated with "better". We live in arelatively small home, 1300 square feet, and while it feels cramped at times, it is more than adequate for us. We have the same lifestyle as those who live in larger houses in our area, the same schools, and a heck of a lor more savings and investments. We are far more wealthy in many ways than a lot of those with larger houses and newer cars, and yet they perceive themselves to be better off.

This is the illusion of the American lifestyle to me - that there is this faux wealth of a large house, big car, big TV, but no money, and a big pile of debt.

Regardless of renting versus buying, isn't this the real problem of American society right now? How do we get back to generating real jobs, real incomes, and real wealth, instead of living off the inflated value of assets?

[save_the_rustbelt]

Callahan:

On average, Indian reservations are the poorest places in the country, and don't take kindly to Irish Indians.

So unless you are 1/8 Native, you have to stay in the honkie 'hood with the potato farmers.

"Yippe kiy yi aye" Ah, that is cowboy talk y'all.

[Jim D]

"I understand the financial argument, but there's something intangible about owning a house as compared to renting that the difference in prices doesn't seem to fully capture."

Well, I can capture it well enough to know that it's not worth $10k or $20k per year. Can you?

"nihil obstet says...

Another intangible is that homeownership makes the owner feel that s/he is in control. Renting, every year or two the rent goes up, and you don't know in advance by how much. "

And every year as a homeowner, your furnace may break, or your roof may leak, and you don't know how much that will cost. Also, if you have an ARM (and most people in California who bought in the last 3 years do) then your payments on your bank-rent for the mortgage will go up too, and you don't know how much. If you live in Florida, your insurance could double, and you don't know how much it might go up.

Also, every year for the next couple years, your equity is going to go down. And you don't know how much.

Yeah, that sounds like control to me.

Seriously, do you guys know what it's like to have bought a home in the last couple years? Read a newspaper or something.

[Gerard MacDonell]

Donna: The problem is self-correcting. You are about to find out the answer to your question! The inflated assets part is going away fast.

[Lord]

New York has a lot of rent control that transfers effective ownership from the owner to renter. That isn't much of an endorsement of rental markets.

Elimination of all costs of moving would be some improvement, no capital gains, portable property taxes, but there are still many non-financial costs to moving. I have doubts about how much moving should be encouraged though. The costs never really seem justified and are wholly understated in policy.

[paine]

"we should all live in trailers"

i'll second that !!!!

[paine]

"Since I moved to Georgia, I have not felt a part of my community"

welcome to ...NOW

[Callahan]

Save the Rust-ed Belt,

Thanks for the tips and all, but poor as reservations are, you must remember I'm from Michigan where nobody ain't poorer than we are.

Back in the saddle again.

[Jay]

Baker dances around what many have learned a long time ago. If you buy a house you are purchasing a liability, not an asset.

[save_the_rustbelt]

Callahan:

I'm in Michigan today, and Pine Ridge is worse.

Pick a reservation tied to a really successful casino.

[Andrew]

Patricia Shannon says...

I read a study years ago that found that communities depend on the stable residents. Eg., they are the ones that stay informed on local things and go to city council meetings.

Flexible labor markets are a good thing, right?

Move to where the jobs are. Where the money is.

Where your family isn't.

Where you're friends aren't.

Where your kids go to a new school. New is good, right?

All politics is local. Where are the locals? (Generally, they're not the ones who had to be 'flexible')

Who needs community when you have a good job? Who needs a support network?

Not me. I'm flexible.

[reason]

Andrew...
what a great comment. But that IS the missing piece of the jigsaw isn't it. Stability is a value on its own. Economists tend to forget that everything of value is not in the market.

[mark ii]

Where is the mention of the fact that the homeowner, after a number of years, stops having to pay the mortgage while the renter gets to pay rent for the rest of his/her life?

How much of the current housing bubble was caused by extra demand from people buying property for rental?

The joys of being 'rootless' have been adequately discussed in previous threads -- I can only assume that the people singing its praises here are landlords (or employers looking for cheap compliant labour).

Here's an idea: legislate a fixed percentage of the housing stock is allowed to be for rental purposes (5% ought to keep employers on the edges of their seats). All stock presently above that percentage is allowed to remain as rental property, until sold when it has to be sold to owner/occupiers.
Consequences:
No more housing bubbles (unless you allow banks to make 50 year home loans that is).
Higher rates of home ownership.
By cutting out a large section of the demand from prospective landlords, lower home prices.
And all that money used to inflate the housing market would instead have to do something productive like creating much needed jobs.

Sounds good to me.

[reason]

mark ii - that is OK for major cities, but wouldn't work for tourist locations. Also there is no guarantee that it would make difference to the price of land. The problem is growing total demand, whether it is satisfied via rental or purchased properties.

[Callahan]

Save the Rusted Belt

Casino, yes that's what I had in mind, thinking I could be a Blackjack dealer.

I'd be dealing with a full deck, I'd have a new deal, I'd maybe get free meals.

Sounds good to me.

[mark ii]

reason says...

mark ii - that is OK for major cities, but wouldn't work for tourist locations.

Yes, 5% was just a number I plucked out of the air; presumably different localities would need different ratios.

Also there is no guarantee that it would make difference to the price of land. The problem is growing total demand, whether it is satisfied via rental or purchased properties.

Either way, lower demand, by cutting out a segment of buyers, leads to lower prices.

The question is: how much rental accomodation do we really need/how much do we really need rental accomodation? There is a reason 'rent seeking' is a pejorative term.

[Real Person from the Real World]

We have to develop ways to handle the possibilities of remote working in a way that helps people, not harms them. We started by importing consultants for per hour contract work. These people live like gypsies, in the new trend in long term hotel/motel residences and extended stay places. Find for some poor serf imported from the 3rd world or a kid out of college looking to amass experience, but everyone wants roots at some point in life. We need to encourage some of our own young people to take jobs overseas, and get the experience US companies are too stingy to provide. Almost all the Visa serfs I see, were vetted thru outside the US foreign companies, including those from their home countries. If US companies are too cheap to train and provide entry level, lets develop policies to get US techies into foreign own companies overseas!

[btg]

"Homeownership ... impedes the economy’s readjustment by tying people down. From a social point of view, it’s beneficial that homeownership encourages commitment to a given town or city. But, from an economic point of view, it’s good for people to be able to leave places where there’s less work and move to places where there’s more."

Except there other other societal costs to consider.

Assume that large numbers of people leave City A for City B. City A, with massive depopulation, means that housing sits empty and someone has to pay to maintain, or demlosih it. House prices also decline for those who remain.

There is infrasturucture - roads, sevwers, schools etc. - with fewer people and many of these costs fixed or locked in for the future (municipal bonds to repay,...) then the remaining people face higher costs per capita for taxes

meanwhile in City B, the boom leads to increases in property values because of increased demand - so there is a transfer of wealth here from the have nots to the haves. new infrastructure and housing stock must be built and paid for (while the infrastructure in City A goes to waste)

if this is a short or medium term cyclical change in the economies of these 2 cities, then in a few years, as people move back to City A, people in City B suffer form the problems of decline and the built in "overcapacity" of infrastructure, while City A returns to normal.

now if there are permanent economic factors involved, like resource depletion in City A, then perhaps this is beneficial that people relocate - here in Canada, the landscape is littered with ghost towns from these permanent changes.

Change is expensive. Economic cycles can be expensive and ineffeicient if viable capital assets are liquidated to to short term phenomenon - such as a business that took decades to build goes into bankruptcy - it value as an ongoing enterprise goes to waste, and when conditions change and new businesses start up, they have to go through the learning curve that the previous company had already undergone.

As service industries close in City A, and new ones are created in City B, there will be these sorts of costs.

Destruction is not always "creative destruction" - and so there might be circumstances where it is better/less expensive for society for people to stay where they are