There has long been a strong ideological bias in the United States that has pushed families toward becoming homeowners. Instead of resisting this bias, many people in the policy and advocacy community unthinkingly echoed this ideological refrain, joining the push toward homeownership.
This would have been problematic at any time, but pushing homeownership at the peak of a housing bubble was a recipe for disaster. In the wake of the collapse of the bubble, it would be great if we could promote some clearer thinking on the relative merits of ownership and renting.
At the most basic level, it is important to recognize that ownership will not always be desirable for every family at all times. First and foremost, homeownership will typically only make economic sense when families can expect to stay in a home for a substantial period of time. If there are family or employment reasons that make long-term tenure unlikely, then homeownership is probably a losing proposition.
The arithmetic on this is fairly straightforward. As a long-run average, house sale prices equal roughly 15 times annual rent. This means that a unit that rents for $1,000 a month can be expected to sell for roughly $180,000 (15 times the $12,000 annual rent). The combined buying side and selling side transaction costs average roughly ten percent of the sale price. In other words, the roundtrip transaction costs will typically be equal to one and a half years of rent. In this example, the transaction costs associated with buying and selling the home would be equal to $18,000, which is one and a half times the annual rent of $12,000.
The high transactions costs associated with buying and selling a home mean that anyone who does not stay in a home for a substantial period of time is likely to end up losing as a result of owning rather than renting. In an examination of the length of tenure of moderate-income families who bought homes in the 80s and early 90s, before the housing bubble, the median tenure was just over four years. At this length of tenure, the transaction costs effectively add an amount that is more than 35 percent of the annual rent to the cost of owning a home.
Assuming that there is no unusual appreciation in the market or an extraordinarily low price-to-rent ratio, a family will almost certainly be losing by owning under such circumstances. Unless the transaction costs can be averaged over a considerably longer period of time, renting is likely to prove a better economic decision than owning.
There are other important cost factors that are often ignored by those pushing the case for homeownership, most notably the inaccurate accounting of the mortgage interest and property tax deductions. While these deductions can be valuable to upper middle-class households who are in upper tax brackets and have other deductions, the mortgage interest and property tax deductions are likely to be of little or no value to most low- and moderate-income families who already have minimal tax liability.
Even in the cases where families are paying income taxes, it is easy to overestimate the benefit from these deductions. The value to the homeowner is the difference between their total deductions when itemizing and the standard deduction. In many cases this gap will be trivial.
Taking the example above, suppose that a family has a $150,000 mortgage at six percent interest. If they also pay property taxes equal to one percent of the house price, their housing-related deductions will total $10,800 ($9,000 mortgage interest, plus $1,800 property tax). With a standard deduction for a couple of $11,400, this family needs $600 in other deductions just to break even. In the event that their other deductions totaled $4,000, then the net reduction in taxable income associated with home ownership would be just $3,600. If this family is in the ten percent bracket, the benefit comes to $360 a year. If they are in the 15 percent bracket, then the benefit comes to $490 a year, less than half of one month’s rent.
While there are low- and moderate-income families that can see more benefit from home ownership-related tax deductions, these are likely to be the exception. For the vast majority of low- and moderate-income families, these tax deductions are likely to be of little consequence.
Homeownership in a Bubble
While there is no excuse for the lending practices of many major banks during the bubble years, or the failure of regulators to stop these practices, it is important to recognize that home buying in the peak bubble years would have been a financially disastrous decision for most families even if they had gotten a low-interest, fixed-rate mortgage. Housing prices were hugely over-valued, and people who bought into homes at these prices were virtually certain to suffer large losses, just as people who bought into the NASDAQ at the peak of the stock bubble were virtually certain to suffer large losses.
Given the unprecedented run-up in house prices in many bubble markets, with no remotely corresponding increase in rents, it should have been apparent to policy analysts and advocates that house prices were temporarily inflated and would eventually fall back toward their trend level. Those who were concerned about the financial well-being of low- and moderate-income families should have been doing everything possible to discourage them from buying homes during the peak years of the bubble, regardless of the type of loans that they could get.
If the price of a house falls by 30-50 percent, as has been the case in many of the most inflated bubble markets, then homeownership will not be an effective way to build wealth. These price declines should not have been surprising. The "experts" who did not warn of this risk, or worse, and who insisted that price declines were not a risk have much to answer for. Their failure had disastrous consequences for millions of low- and moderate-income families, many of whom will never recover from the economic hit they took with the collapse of the housing bubble.
In our society, it is usually only those in less privileged positions who suffer the consequences of their mistakes. Dishwashers who break dishes and custodians who don’t clean the floors get fired. Policy analysts who totally fail in their area of presumed expertise are not held accountable. That is unfortunate from both a moral perspective and, perhaps more importantly, it is not an arrangement that is likely to lead to good policy analysis.
Towards a More Balanced View of Housing
Housing policy has always been tilted toward promoting ownership over renting for ideological reasons. This has resulted in a situation in which renters in large parts of the country are treated as second-class citizens. For the reasons laid out above, there will always be many families for whom homeownership will not make sense. Historically, roughly one-third of households have been renters. There is little reason to believe that this will change substantially any time in the foreseeable future.
Low- and moderate-income families do and will continue to make up a disproportionate share of households who are renting. For this reason, it is important to focus on improving the plight of renters if we want to provide good, secure housing for the less well-off segment of the population. While landlord/tenant law is largely determined at the state and local level, the federal government can put more money into Section 8 and other subsidies for rental housing.
The federal government effectively provides enormous subsidies to middle- and upper-income homeowners through the mortgage interest tax deduction and the exemption of most capital gains on house sales from taxation. If a family in the 33 percent tax bracket pays $24,000 a year in mortgage interest, the mortgage interest tax deduction is equivalent to a subsidy of $8,000 a year. Getting $400,000 in capital gains on a house sale, free of any taxes, is a subsidy of $60,000. It is not unreasonable to expect some comparable level of subsidies from the federal government to low- and moderate-income families who rent rather than own.
At the state and local levels, there should be more priority on ensuring that housing is maintained at acceptable standards. In addition, tenants could be provided with some of the security of homeowners, with relatively little cost to the landlord.
For example, state and/or local governments can provide some security of tenure to people who have been renting for a period of time. Many cities require just cause evictions, allowing tenants to remain in their units unless the landlord shows that they have been disruptive, damaged the property, failed to pay the rent, or committed some other action warranting eviction. Long-term tenants can also gain a right of first refusal in the event that their unit is sold.
There are many other measures that could be taken to improve the conditions of tenants that readers of Spotlight know quite well. However, this will require a change in policy focus that recognizes that many people will be renters for much of their life and that, as renters, they still need good, secure housing.
There is one final point on the owning versus renting choice that it worth noting. Homeownership has been a way in which many families have accumulated wealth to support themselves in retirement or to pass onto their children. While it can be a route to build up savings, the events of this decade should make it very clear that it is not always.
Low- and moderate-income families desperately need new mechanisms that will allow them to accumulate savings that don’t involve homeownership. At this point, pension policy is in complete disarray, with the vast majority of workers facing retirements where they will be overwhelmingly dependent on Social Security. The key to allowing families to better save for retirement and/or to leave an inheritance for their children will depend on rebuilding the pension system. That is likely to prove a far more direct and effective path than pushing homeownership with the hope that house prices will rise.
– This article was published on August 24, 2009 by Spotlight on Poverty