Should you buy a house?

I don’t know. Alex Tabarrok has an answer, though I’m not sure its sufficiently skeptical.

Of course, housing is overrated as a financial investment, largely because for most people it isn’t a financial investment, as much as a hedge against an increase in price of rent. You don’t get “a great investment and a place to live” primarily because you only get a place to live and very little investment. When the S&P500 shoots up, most of us can sell and live richer lives. When the housing market goes up most of us can sell… and buy another house a market that has already realized appreciation.

There are instances in which you might notice a genuine increase in wealth associated with a tighter housing market. If the price of large homes outpaces that of small homes, and you’re about to retire at that moment, you might be in luck. If a new job takes you away from San Francisco where prices have skyrocketed, you might be in luck.

But in general it’s not exactly easy to predict these trends – and it certainly shouldn’t be the province of homebuyers and the real estate agents that inform them. That doesn’t mean home ownership is a bad idea. In general, we don’t like cash flow volatility. A young couple working at Facebook, with enough cash for a downpayment and enough earning power for a good mortgage, might prefer to avoid the ups and downs of a tumultuous Bay Area rental market by purchasing a house. We’re all short the market to some extent.

In parts of the country without stratospheric home prices, a rental market is pretty nonexistent for affluent buyers. To the extent you want a nice family home with a pool in a safe, Iowa suburb, you may not have the option to rent. Indeed, “should you buy or rent a house” is question relevant only for affluent urbanites who have both the option to rent a decent place and credibility to borrow on good terms. The best argument to buy is that you probably live in a city where only kids at the local college rent.

The tax benefits of ownership are also questionable. While a mortgage interest deduction certainly exists, this is passed through to renters. In general it subsidizes building property since land is inelastic, and therefore is likely most beneficial for affluent midwesterners who like a lot of property on worthless land. This is not to say ignore the benefit in your calculus, as much as not to tell yourself that this benefit militates in your favor without actually looking at the numbers – more precisely, learning that there is such a deduction without any further information shouldn’t change your decision.

A thought experiment is useful. Imagine a town with some borrowers, owners, and a few landlords. If the government subsidizes interest on houses, market competition only increases the value of land relative to everything else but doesn’t change the relative price. Marginal investment is poured into building more property on top of that land. The supply of property-intense housing increases, and the price falls. Renters and owners both benefit equally, and because of competition not at all. The only obvious winners are landlords. The mortgage deduction doesn’t benefit the affluent, it benefits large landholders and their investors. Yet another tax debacle that benefits the superrich.

The pass through effect is muted somewhat by the asymmetry of potential buyers and renters in that some individuals might be “captive renters” as they can’t access affordable, long-duration credit on the principal at hand. Though this is almost tautologically irrelevant for markets where the question “should I buy or rent” persists; for any given house the individual who can pay the most, either capitalized or amortized, can afford to borrow.

Of course, accepting that housing is rarely an investment also challenges the associated wealth effects, either positive or negative, that many economists have observed. To focus the skepticism a particular theory, the Sufi-Mian leveraged loss multiplier, consider liquidity instead of solvency. The prevalence of non-recourse borrowing in the United States meant borrowers could pull residual equity into cash and leave if that value was above the collateral value.

Between 2003 and 2007 we had a bunch of people with high propensities to spend with access to non-recourse financing collateralized on a volatile asset. This was money that would be paid back only if prices kept rising. They weren’t leveraged precisely in the state of the world where that leverage would have been binding. It turns out that this was the state of the world that came to be, but the decline in spending wasn’t a question of solvency but loosing access to extremely cheap liquidity. Of course consumption and residential investment fell most in the leveraged areas where it increased most because that’s where closing the tap of free cash most dramatically affected ability to spend.

The best reason to rent might be that many educated people think housing is a good investment increasing the price of housing credit beyond what is justified – and an unlimited supply of conforming loans doesn’t really matter in this case since the people for whom this question is relevant are almost certainly buying a house above the conforming limit. People may also tell themselves that they get a tax credit one way and not the other (even though this is priced in both ways to begin with) which would further distort the market in favor of renters.

And even if housing was an investment, buying a house would infrequently be the best way to get there. The home you own faces plenty of idiosyncratic risk against the market as a whole – by region, by local policy, by construction style, etc. It would be foolish to expose yourself to this risk without relevant expertise – something both homebuyers and their real estate agents certainly lack.

There are other ways to express your beliefs about the housing market. If you already own a home, get a second mortgage against it and use that to buy an ICF index, your financial position might be closer to what many financial writers ascribed to middle-class Americans in 2005. Though, as you can see, that is probably far from where you actually were at the time.