The Sovereign Mind

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The Housing Crisis: Rethinking Rent vs. Buy

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sad-shack

A few years ago, when my wife and I were looking to buy our first home, we had a conversation with a seller’s realtor that went something like this:

Realtor: “Well you know, when your considering how much you can afford for your home, you should take into account that your mortgage interest will be tax deductible.”

Me: “Yeah, that’s true. But this home still seems like it might be out of our price range.”

Realtor: “Really? Well, that tax deduction will save you a couple hundred dollars on a house like this.”

Me: “Actually, I’ve looked at the numbers, and that assumes that we are currently itemizing. Since we’re not, a lot of that tax deduction will just go to getting us over the line where taking the itemized deduction is better than taking the standard deduction on our tax returns. In our case, I think it will only save us about a hundred dollars.”

Realtor: “Oh… well, you should really talk to a financial advisor about that… so, let’s take a look at the basement…”

During our home buying experience we were bombarded by anecdotes about how much money people make from their home. People would tell me that they sold their home for $50,000 more after 5 years, but completely ignored the fact that they paid almost that much in mortgage interest and property tax over that same amount of time.

We did end up buying a house (not from that realtor), but I didn’t think of it as an investment primarily. What we wanted was difficult to find in a rental, and we wanted our own space. We bought in a location that was not part of the bubble for the most part, we got a fixed rate loan, and made sure we could afford the payments. I can’t say we were completely responsible: we did get a zero down payment loan.

My personal story aside, let’s re-think the rent vs. buy assumptions:

Most of the angst regarding the current housing crisis is related to this common theme:

Why should the little guy suffer because banks and real-estate investors made bad decisions?

That seems like a reasonable question. If the real estate market tanks, it makes sense that the investors and banks should lose money. They are the ones that had the money to invest and were making the decisions. But I have bad news: If you own a home, you are a real-estate investor, and a pretty badly diversified and leveraged one at that. And you’re not only invested in the real estate market, but also in all of the financial system that decides how it is managed. So that’s why the little guy (or at least the little real-estate investor) suffers because of the housing crisis.

So how did that happen? You wouldn’t take out a loan at 7% to borrow $200,000 to invest in the stock market, would you? That would be very risky because even if the stock market drops 1%, you are now short $2,000, or more considering your interest is still added in good times and bad. Of course you wouldn’t do that unless you have money to burn, but that’s what you are doing when you buy a home. Some thought the real-estate market was a safe investment (it’s not as volatile as a stock), but that was foolish thinking. If it can go up fast (which it did in many markets), it can come down fast. That is a basic principle of investment: The more reward, the more risk.

Not only that, but home ownership also makes you less mobile, making it more difficult to find new jobs in new places during economic trouble.

This lesson comes too late for the 10% of home owners that find themselves upside down in their loans, and there’s no doubt that mortgage brokers who sold them on false hopes have their (big) share of blame as well. But what about the future? What should be done to prevent this from happening again?

I think the answer is simple:

The concept of home ownership should no longer be part of the American dream.

Apparently I’m not alone. Even Barney Frank, who has been one of the biggest proponent of the home ownership for all (otherwise known as the “everyone should be a highly-leveraged and badly diversified real-estate investor” policy), is now saying that perhaps home ownership for all was not the right policy to pursue:

One of the problems that we got into was we did way too much home ownership and way too little rental housing. And [we need to start] getting the federal government back in the business of rental housing. And passing legislation to restrict bad subprime loans will be high on our priority list.

I’m not sure I agree with his knee-jerk reaction that the government needs to provide said rental housing, but I agree that “we did way too much home ownership” as both a government and a society.

For years people have been saying that renting is “throwing your money away” and promoting home ownership as the basic status symbol of economic prosperity. Who has been saying this? Well, the same Barney Frank for one. His own website touts the benefits of the “Expanding American Homeownership Act of 2007”, some of which include lower down payments and more mortgages to higher risk borrowers.

But politics aside, I hope we will learn this lesson from this crisis: The American Dream cannot be purchased with a credit card. The American Dream is not about what you own; it is not about short-cuts or get rich quick schemes; it’s about what you do; it is about freedom: freedom to work, be smart, innovate, struggle, and succeed.

Written by Mike

February 6, 2009 at 9:19 pm