Josh Barro observes that home ownership is a really bad investment strategy insofar as it involves putting an awful lot of eggs in one basket — indeed, for many people it involves putting more eggs than they’ve got in one basket, since the mortgage market allows you to sink more than your entire net worth into a single house.
In fact, it’s even worse than Josh says. If your house is located anywhere near your workplace (in other words, if you’re almost anyone) then a local economic downturn can devastate your home value at exactly the same time that it’s costing you your job. That’s a whole lot of unnecessary risk.
As Josh acknowledges, that doesn’t mean you shouldn’t own a house; it just means you shouldn’t fool yourself into thinking it’s a wise investment.
But Dan McLaughlin at the Federalist isn’t satisfied:
Economists … should never make the mistake of ignoring consumer behavior they regard as irrational…What Barro should have asked himself (as any real economist should) before declaring that vast numbers of homebuyers and homeowners have been acting irrationally for millenia in buying their own homes is: what are they getting out of it that my analysis is missing?
I enthusiastically endorse the sentiment that when we observe “inexplicable” behavior, our first instinct should be to ask “What am I missing?”. But Barro at least tried to do that — he pointed to “a sense of security” and the desire to customize one’s residence. I agree with McLaughlin’s assessment that these are pretty weak answers, but unfortunately McLaughlin’s own “answers” are even weaker. According to McLaughlin, we own houses because we don’t like to move, and he elaborates at length on the reasons why —- moving is expensive, it means adjusting to new neighborhoods, uprooting your family, etc. etc.
The thing is, though, none of this is a reason to own rather than rent. You could accomplish all of the above with a 99-year lease (binding for the landlord but not for the tenant) which would give you all the residential stability of home ownership while transferring the risk to a professional landlord with diversified holdings.
So why do people buy houses? Offhand, I can think of three answers:
1. The rental market is beset by moral hazard problems. When you rent a house, you pay a premium to compensate the landlord for the possibility that you’ll tear up the floorboards and kick holes in the walls, or in less extreme cases you’ll fail to report routine maintenance problems until after they’ve grown into major headaches. People don’t want to pay those premiums.
2. The tax code provides a big incentive to own rather than rent — and no, it’s not the incentive you’re thinking of. The mortgage interest deduction is not a net incentive to own, because it’s offset by the fact that mortgage interest is taxed as income to the lender — so there’s no net tax on the transaction, but no net subsidy either. Instead the relevant tax argument is this: If I rent you my house, I pay income tax on the rental payments. If instead I sell you my house for the present value of the stream of rents, I pay capital gains tax on the transaction — usually at a lower tax rate. There’s my incentive to sell, which of course the market will translate into an incentive for you to buy.
3. 99 year leases are not available. This, however, does not actually answer the question of why people buy houses; it merely replaces it with a different question, namely: Why are 99 year leases not available? I have a sneaking suspicion this can be traced to some screwy government policy, but that’s just a guess. Maybe some reader can fill in the details.