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When should you buy a home?
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?
Posted by Tyler Cowen on September 5, 2007 at 07:07 AM in Economics | Permalink
Comments
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.
Posted by: John Dewey at Sep 5, 2007 7:54:46 AM
There are positive externalities in home ownership. Note the differences in maintenance, community involvement,
etc. in neighborhoods where people own homes vs. rent.
Posted by: bastiat at Sep 5, 2007 8:19:51 AM
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 nest home. 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."
Posted by: Bob Lawson at Sep 5, 2007 8:23:22 AM
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 nest home. 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."
Posted by: Bob Lawson at Sep 5, 2007 8:24:02 AM
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)
Posted by: Erich at Sep 5, 2007 8:31:00 AM
When we moved here, the plan was to go to grad school & move on. Fifteen years later, I'm REALLY wishing that we had bought at what was a local housing minimum. I've not tried a formal survey, but if you are going from your BS into a PhD program, a four-year flip, while somewhat risky in absolute terms, has as its practical downside delaying the post-graduation jump in lifestyle.
I would have gone nuts if we had been renters for the last ten years.
Posted by: Nathan Zook at Sep 5, 2007 8:42:41 AM
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'.
Posted by: Steven at Sep 5, 2007 8:52:46 AM
Rent, and for god's sake, stay out of the suburbs.
Posted by: josh at Sep 5, 2007 8:55:03 AM
kids = yes => buy
kids = no => rent
Posted by: Nate at Sep 5, 2007 8:58:34 AM
It seems to me that the insentives are better when the occupant owns the home.
Posted by: floccina at Sep 5, 2007 9:05:38 AM
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.
Posted by: Jacob at Sep 5, 2007 9:16:27 AM
Cost of home = Interest * [1-taxrate] + Transaction Cost + Cashflow Risk + Risk of having to sell in a down market
Do you expect to have to sell soon? If not, should you (as Tyler suggests)? It's probably the high transaction cost of selling early that can really jack up the equation.
Cashflow is as predictable as with rent.
Having to sell in a down market? You get a better job, you upgrade homes, your company forces you to move and you don't have other options, or you run into cash flow problems. Better job, just part of the decision on the job. Upgrading homes, the loss is outweighed by the better buy you're getting.
Posted by: aaron at Sep 5, 2007 9:16:36 AM
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.
Posted by: jn at Sep 5, 2007 9:22:12 AM
http://www.analyticalwealth.com has some posts on the topic..
Posted by: random african at Sep 5, 2007 9:32:45 AM
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?
Posted by: John Dewey at Sep 5, 2007 9:54:38 AM
nate:
"kids = yes => buy
kids = no => rent"
Please explain this, nate. I've never had kids but I've owned and lived in 5 homes. What is it I don't know?
Posted by: John Dewey at Sep 5, 2007 9:56:30 AM
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.
Posted by: albatross at Sep 5, 2007 10:21:39 AM
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.
Posted by: albatross at Sep 5, 2007 10:22:00 AM
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).
Posted by: nelsonal at Sep 5, 2007 10:22:13 AM
I agree that so much of it depends on where you live. In a large urban area, renting seems more ideal. In smaller towns or suburban areas, like In describes, renting may be less desirable. Once you start looking at renting a place with more than 2 bedrooms and 1500 square feet, the buying option seems more desirable. And there are benefits to community, school districts, surrounding yourself with similar socio-economic backgrounds, etc., something that you don't find as much in a rental community. And that seems to point to nate's argument. 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.
Posted by: econ2econ at Sep 5, 2007 10:23:23 AM
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.
Posted by: David at Sep 5, 2007 10:31:19 AM
"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 "
I agree that parents have great incentives to be involved in the community and to live in a safe environment. But so do husbands and wives who have no kids. So do many single persons. So do widows and widowers. So do empty-nesters.
Have you personally ever been involved with local suburban government? If not, it may surprise you to learn that the most enthusiastic citizens are usually the ones with free time - often empty nesters and childless couples.
In every suburb I've lived in, the homeowners who most enjoy taking care of their yards do not have kids. I cannot imagine these folks spending so much time dressing up a rental property.
People buy homes for more reasons than just raising kids.
Posted by: John Dewey at Sep 5, 2007 10:45:38 AM
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.
Posted by: John Dewey at Sep 5, 2007 11:01:09 AM
jn makes a good comment. In my area, it is not possible to find a pool of rental homes that are similar to the purchased homes, except at the low end. So, if I want something other than a condo or a 2/1 home, I need to buy. I suppose you can counter this with "so move to a different city" or "don't buy a mcmansion" or something similar, but those are irrelevant once I have decided that I want to live in *this* city and in *this* area within the city. There are lots of reasons to make that choice, and once you have, it's possible that you can't find similar rental units.
Here on the bay area peninsula, if you are sitting on a 4/3 home, it's worth anywhere from 1.2 to 1.8 million dollars. If you rent such a house, maybe you will get $5k a month or a little more. If you sell, you have $1M+ to use on your next home, or some other investment. So, people sell and they don't rent the houses out.
The result is a very limited rent vs. buy market beyond the entry level.
Posted by: Ron at Sep 5, 2007 11:04:49 AM
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.
Posted by: mobile at Sep 5, 2007 11:33:42 AM
