Felix Salmon comments on rent own in Germany
Then there’s a scheme I’ve heard of in Germany. Essentially it takes banks and mortgages out of the picture altogether, and sets up a long-term contract between the buyer and the seller. The buyer pays rent monthly, the house is essentially placed in escrow, and the buyer ends up owning the house after a set number of years paying rent. I like this scheme because it involves buying a house without any debt — and the buyer can even move house and sublease the property, so long as she continues to make rent payments to the seller.
The wider question is why not simply sign long term leases. Perhaps, we are looking for greater stability. However, on average most American’s stay in their home about 7 years. After that time they’d be facing the loss from selling in a weak market or the increased cost of buying a move-up in strong market. A long term lease exposes most people no more market risk than buying, and possibly less.
Why then do we buy? Perhaps it has to do with monitoring costs. Someone could trash a leased home by far more than a damage deposit could cover. However, there is a robust market for both renting and buying in large cities. If the monitoring costs aren’t enough to stop people from effectively renting apartments why is it that anyone buys a condo?
I suspect that people want the collateral value of the home. That is, they want a large piece of property that they can readily borrow against. When people say owning a home provides security, what they really mean is “the ability to take out a second mortgage when things get rough” provides security.
If a second mortgage is not an option then you will be foreclosed upon as surely as you would have been evicted.
I am not sure what the implication for this are but it seems to me that it represents some type of dysfunction in financial markets or human discounting. Why is it better to accumulate a security through home equity rather than savings?
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Thursday ~ November 12th, 2009 at 11:02 pm
ao
What you are poking around at, but not quite hitting exactly, is that the value of a house to an owner occupant is not only the consumption value of it as a place to live, but the investment value of it as an asset. (This, by the way, is why the CPI is not calculated using the user cost of home ownership, because that would not accurately price the consumption value of the house, but rather the consumption value plus the investment value).
Why should homeowners buy a home as a bundle of consumption and investment goods rather than rent a home and invest traditional investments? In the long run, the asset value of a house owned by the occupant should be greater than the asset value of that same house owned by a landlord and then rented to the that same occupant. This is because the landlord/renter relationship is a principal-agent problem, wherein the full costs of wear and tear aren’t borne by the renter, and the level of wear and tear isn’t perfectly observable.
It’s the classic solution to a principal-agent problem where the owner of a company can’t fully observe the managers efforts: you sell the company to the manager.
Thursday ~ November 12th, 2009 at 11:59 pm
dWj
Unless I’m allowed to borrow more than the equity I have in the home, I can do better by sitting on the cash I would put down, and by putting into savings what I would otherwise be building in equity in the house. I’m pretty sure that, even with a solvency argument, you’re going to need either bounded rationality or market inefficiency.
Friday ~ November 13th, 2009 at 12:46 am
Felix
http://www.felixsalmon.com/000735.html
Friday ~ November 13th, 2009 at 12:13 pm
MattJ
I think that traditionally it has been viewed as an inflation hedge. In theory, a well-priced asset like a home will increase in value as the purchasing power of the currency decreases.
To do better in savings, you’d have to be able to beat inflation over time faster than the property appreciates.
Friday ~ November 13th, 2009 at 9:16 pm
Mutie
Not only is it an inflation hedge, it’s a leveraged inflation hedge, where the borrowed capital is at much better rate than one could get, say, on margin for equities.
Friday ~ November 13th, 2009 at 8:17 pm
Jim Kelly
I’m buying my modest house (almost paid for) in order to live in it, not as an investment to turn, although even today its current market value is considerably more than I paid. I am 62 and have not had employment which includes a pension, so my purchase will insure that I have a secure place to live when my income is reduced. Without the pressure of rent or house payments, I should be able to be comfortable on what Social Security will provide (that’s another can of worms, of course).
It’s not always about money. Security and peace of mind come into play as well.
Jim
Friday ~ November 13th, 2009 at 8:40 pm
cleek
Why is it better to accumulate a security through home equity rather than savings?”
why do you assume everybody sees the world as a function of equity, borrowing and savings ?
people buy homes because the places you can lease are nothing like the places you can buy. you can lease a condo (aka apartment with a mortgage), but to get a stand-alone house, especially a new one, you generally gotta buy.
Friday ~ November 13th, 2009 at 8:44 pm
Charles C
For me, financial considerations of any sort are far less important than that it’s MY house. If I want to make changes, I don’t have to ask anyone. No one else has the power to say I can do this, but I can’t do that. What if at the end of the long term lease, I want to stay, but the owner wants his house back? Or decides to renew at a much higher cost? Yes, I used to move even more frequently than every seven years. But now I’m where I want to be, I’ve been in this house for 20 years, and I don’t want to be subject to someone else’s needs, or whims. I will gladly absorb the lost opportunity costs of what I might have done with my money, in return for the serenity that comes from having no landlord.
Thursday ~ November 19th, 2009 at 2:59 pm
Eric
> “For me, financial considerations of any sort are far less important than that it’s MY house. If I want to make changes, I don’t have to ask anyone. No one else has the power to say I can do this, but I can’t do that.”
On that note, I’ve never understood why anyone would agree to live in a homeowner’s association.
Saturday ~ November 21st, 2009 at 12:14 am
mars
Au contraire, you do not have limitless freeedom to make any changes to your house you see fit. There are health and safety issues, and neighbors to contend with. They may see your changes as lwoering not only your houses resale value but also theirs if your changes are extreme.
Friday ~ November 13th, 2009 at 8:51 pm
K and J Investigations and Case Management » Cultural Symptoms: “Why Buy Homes At All?”
[...] drift so far from reality. Modeled Behavior ask the question I have been asking for years “Why Buy Homes At All?” Here is an excerpt that helps illuminate in part the psychology inside the current [...]
Friday ~ November 13th, 2009 at 8:55 pm
Adam
I bought my house and continue to live in it because I enjoy improving and maintaining a property. I enjoy gardening in the summer and working indoors in the winter. Working with my hands is an absolute joy, and I love seeing materials come together into the shape that I want.
Friday ~ November 13th, 2009 at 9:26 pm
Simple
Not too complicated…
It costs more to rent the same home..than it does to own it.
Common sense dicates that the owner of the house will NOT rent it out for a lesser cost than he has to own it.
He will rent it for his COST + a Margin of Profit for himself. This margin of Profit covers the increased utility he is providing by renting the house.
The answer is NO more complicated than this.
Friday ~ November 13th, 2009 at 9:33 pm
Mark
“A long term lease exposes most people no more market risk than buying, and possibly less. ”
Really? I can think of a number of risks:
1) House is sold by owner, or is foreclosed on. In many jurisdictions, the lease does not transfer, and the occupants are out with 30 or 60 days notice. (Sometimes zero in the case of foreclosure.)
2) Reduction of services by landlord. You see this all over the place, where landlords try to take away things that have been provided to long-time tenants who are paying below market rents. The tenants have to go to court.
3) Rent increases. Many jurisdictions allow rent increases after a year of tenancy, regardless of the length of the lease. Certainly, if landlords agreed to 7-year leases, they would work such provisions into the contract. This would likely not be a 7-year-fixed arrangement.
4) Subleasing restrictions. If you fall on hard times, you can rent your home or part of it to cover your mortgage and go sleep on the couch if you really need to. You would not have that ability in a rental given that most jurisdictions allow landlords to control who lives in the home.
5) No mechanism for rent decreases. Ever try to negotiate a rent reduction with your landlord? Very difficult. Ever try to get a lower interest rate from your bank on a home loan? My personal experience is that it’s much easier than convincing the landlord…
Basically, with a long-term lease, you can very easily get stuck with a place that you can’t afford, can’t sublet and can’t break the contract on without incurring massive financial losses. One-year leases came into being and have continued to exist because that is the length of time after which terms need to be renegotiated in living situations.
Friday ~ November 13th, 2009 at 9:48 pm
brad
A home is protected during bankruptcy in a privileged manner that other savings and assets are not. With medial bankruptcy for bills into six and seven figures for a serious illness common, this is a very serrious advantage.
Friday ~ November 13th, 2009 at 9:56 pm
Stephen
This is silly. People buy homes because renting sucks. For some reason, becoming a landlord turns most people into assholes. It sucks to have some asshole in control of one of the most basic aspects of your life: where you live.
Friday ~ November 13th, 2009 at 10:31 pm
Better than gold
You’re thinking about homes as just another financial asset, and that’s why you’re confused. For many people, it really has a lot to do with risk.
The value of stocks and bonds are determined by factors that are outside the control of most people. The value of a home, on the other hand, is determined by how much I like to live there. If the economy were to fall apart tomorrow, I’d know that my family will have a roof over its head as long as we can pay the taxes. No landlord, no lease renegotiation. Better than gold.
There is also the “forced savings” factor. If I’ve invested my savings in liquid assets and suddenly I have an urge to splurge, it’s easy to tap into my savings. It’s harder to tap into home equity, and some people I know count on that extra barrier to keep them from blowing their life savings.
Saturday ~ November 14th, 2009 at 12:57 am
aprof
In addition to previously mentioned reasons, there’s the fact that many people want the right to do modifications to their dwelling. Even in a long-term lease situation a tennant generally can’t do much more than paint the walls a different color, and sometimes not even that. Even if they don’t make much use of it, people want the right to redo the kitchen cabinets or maybe even punch out a wall. Heck, for plenty of suburban families home improvement is basically their main hobby. Even if a landlord lets you do improvements, tenants have a disincentive since it’s the landlord who will reap the benefits of any increase in home value that comes from the improvements.
Saturday ~ November 14th, 2009 at 12:58 am
Kim Scarborough
How about for home improvement? Every apartment I’ve lived in has had multiple problems; the kitchen has no ventilation, the bathroom’s too small, the electrical system is from 1930… with a house you can just fix things that annoy you.
Saturday ~ November 14th, 2009 at 1:10 am
jay
as said earlier — it’s cheaper to buy the house then to rent it. but in more ways than one, not only is the monthly nut cheaper (because you will be paying for your landlords, PITI plus) but most of that monthly nut is deductible. So obviously you get your home for a small monthly cost and then your cost gets written down a bit more when you deduct your interest and taxes.
But I think for me the first time I purchased a home it was for the security. As a renter if lost my job my landlord could have me out in 30 days, with no room for recovery. As a homeowner I had 6 months to a year to rebound financially. That was a big draw for me. In the last 20 years 1 found myself behind the 8-ball once, and since I owned my home I had the time to recover which thankfully I did. It was hard but it wasn’t as hard as if I was out in the street or my car.
Saturday ~ November 14th, 2009 at 1:58 am
Peggy
You’re assuming people all move frequently. In my city, most people buy a house and stay there. They plan to have it paid off before they retire, so they can live on a reduced income. I wish we hadn’t taken out a second mortgage, so we could look forward to this, but several of my friends are on track to own their homes free and clear.
Saturday ~ November 14th, 2009 at 4:41 am
Gerald Fnord
Houses owned in free-hold have some immunity to seizure in bankruptcy; there may be other rights, or the deep perception that such exist, fossilised into the Law from the many days when property ownership was a perfect marker of kinship with those making the laws.
Saturday ~ November 14th, 2009 at 8:27 am
Kent
In addition to the ownership advantages mentioned above (interest deduction, renovation rights, bankruptcy protection, etc.) there is the serious risk for rent-to-own lessees of losing the accumulated lease payments, even after many years of steady payments. In the short run this risk is worse for the home buyer (upfront mortgage costs and down-payment are at risk) but after several years it is likely that the appreciation in home value together with pay-down on the mortgage will create residual value for the owner that can be captured upon sale. With a long-term lease you could forfeit, for example, 28 years of payments. That is why most rent-to-own leases in America only contemplate accumulation of a down-payment, rather than pay-off of the entire purchase price.
Saturday ~ November 14th, 2009 at 8:51 am
Julian
I think you’re all off trying to interpret common human actions through obscure economic principles. When people say a owned home provides security, they mean exactly that; rent can’t be increased and they can’t be kicked out. They own it; it belongs to them. That’s why people buy homes, not as investment collateral, which in much of the union is an innovation only about a decade only anyway thanks to homesteader laws, but as a safety net of last resort. If you own a home, no matter how poor you are, at least they can’t take that away from you outright.
There are other reasons, of course. For most westerners and mid westerners, homes are the basic and traditional form of residence, and thus, failing to own a home is failing to meet the basic requirement for minimal success in life. This thinking is taken so far in fact that, in my home state of Texas, it is not uncommon for a single man to own a home of his own instead of living in a rented space. And considering that most western states have absolutely atrocious renter protection laws, home ownership is often seen, in the long term, as much safer, both for the pocketbook and one’s physical health, than renting. Even east of the Mississippi, most people see purchasing a home as vital in regards to raising children and establishing a family.
My point is this; in general, most home owners do not think of their homes as commodities. That it can be securitized through a mortgage may be seen as a bonus later on when they need money for something, but homes and home purchases aren’t approached as specifically economic investments anymore than cars are purchased for the resale value they’ll likely have in 10 years.
Saturday ~ November 14th, 2009 at 11:29 am
Mike
I agree with the post. We need to re-think our policy and culture that glorifies home ownership. There are two aspects to home ownership: One is having a place to live, and the other is investing in real-estate. The assumption over the past few decades is that these two things must go together, which in fact there is no reason they need to.
One of the main reasons (not the only one, granted) people buy homes is as an investment. It has the potential of a high return and protects against inflation. But, as far as investments goes, putting hundreds of thousands of dollars into one home is a very high risk investment. As we’ve seen over the past few years, what can go up can come down. For some people that have other, safer, investment, maybe that risk is acceptable. But for people to rely on their home as their principle form of savings and investment, as many people do, is foolish. And shame on the government policy makers for promoting this “home ownership for all” mentatility (otherwise known as the “everyone should be a highly-leveraged and badly diversified real-estate investor” policy).
If you want to protect against inflation and have tolerance for the high degree of risk in the real-estate market, there are other ways to do it rather than buying a home. You can invest in real-estate securities which give you a share of the risk and reward across a more diverse subset of the real-estate market.
Several of the objections on this thread stem from the perception that “rent sucks” or that you can’t find a decent rental property. That may be true, but the point is that would change if we de-emphasized home ownership. The reason it is so hard to find good rental properties is because there is such a incentive (pushed by both government policy and our culture) to buy/sell any property that has 4 walls, rather than rent it.
Also, we’re talking about long-term leases here, not short term ones where the rent is renegotiated every year.
“Not too complicated…
It costs more to rent the same home..than it does to own it.”
This may be true over the long term. A land-lord is making a long-term investment. Over the short term, it can cost more to buy a home then rent it (when factoring in mortgage interest and property tax). Most people, especially lower-income people, don’t live in their house long-term. And even if they do live in their house long enough to break even, that doesn’t mean that it justifies the increased risk associated with home ownership, as the current housing crisis attests to.
I’ve written previously on the subject here: http://sovereignmind.wordpress.com/2009/02/06/the-housing-crisis-rethinking-rent-vs-buy/
Saturday ~ November 14th, 2009 at 11:35 am
Mike
Also, there is a potential compromise to be reached here for those who want to own their own home (ie. have flexibility to make changes to the home, etc) but don’t have the risk-tolerance for the investment. We could have a system where traditional mortgages are given, but then the bank shares in that investment. So, the bank would share (maybe 50/50) the appreciation (or depreciation) of the home value. This would function to lower the investment risk of home ownership.
Yes, it would mean less flexibility (the bank would likely need to approve any improvement projects you wanted to do), but I did say this was a compromise.
Saturday ~ November 14th, 2009 at 11:41 am
JonF
For anyone who has had to deal with landlords, this question should not be a puzzler. You buy a home so you don’t have to deal with a landlord. Even good ones can be annoying at times, and a long term lease will not
protect you from the idiocies of a bad landlord.
Buying a home gives you greater latitude and freedom. As long as you make the payments the bank leaves you alone. It won’t tell you that you can’t get a dog, can’t take in a roommate, can’t paint the bedroom hot pink or jet black, can’t add a bathroom downstairs, can’t dig up the backyard for a vegetable garden.
This shouldn’t be hard to understand.
Saturday ~ November 14th, 2009 at 1:53 pm
J in Austin
I think this article makes a false assumption: that people will be paying some form of rent/mortgage for their entire lives.
I’ll tell you why I bought a house. I’m close to paying it off completely and then I’ll never have to worry about rent/mortgage again. The only thing I’ll still be stuck with (in Texas) is property tax, which is annoying but manageable.
If I lose my job or the real estate market goes to crap, I’d much rather have the roof over my head bought and paid for. It’s peace of mind; the fact that I could then use my home equity as a bank is just a small bonus.
Friday ~ November 20th, 2009 at 12:28 am
Mike
To those who argue that buying a home is beneficial because it’s your house, so you can do what you want with it, not deal with a landlord, etc. I say, that’s great. If you buy a house that’s a benefit you get, but it’s a benefit that comes at a price and a high risk. If your in the financial position to do that, then great. If you’re not, then don’t do it and don’t expect the government to bail you out because you took too much financial risk because you wanted to paint the walls.
I’m not trying to be critical of home-owners that wound up in trouble due to the most recent housing bubble. However, I would hope that we would at least learn from that and change our behavior in the future to avoid the same problem again.
I’m not saying no one should own a home. I’m saying that it is a risky investment. Even if you are not in it for the investment, it is still an investment and a huge liability.
Friday ~ November 20th, 2009 at 12:30 am
Mike
Huh, the most recent comment I was responding to apparently has been deleted. It showed up in my RSS reader, but is not on the page. Weird. Sorry if my comment seems like it’s coming out of left field, although it still applies to many of the previous comments.
Monday ~ January 2nd, 2012 at 12:19 am
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