Thursday, June 02, 2011

If Renting Houses Were a Good Idea, Wouldn't It Already Be Happening?

-- Posted by Neil H. Buchanan

There was more bad news about the U.S. housing market this week. After plunging from their peak in 2006, housing prices had stabilized over the last few years, even recovering a tiny bit as the economy continues to struggle. The latest data, however, show that those minor gains have all been lost, with April's prices hitting a new post-bubble low. Also, the latest numbers show that home ownership is at a several-decade low (although more than 60% of households still own their homes).

Naturally, experts and forecasters disagree about the prospects for the immediate future. The more optimistic group says that the market has finally hit its low, but that the recovery will be long and uneven. The pessimists say that there is still reason to believe that prices will plunge further. As prices have given back only about half of their gains since 2000, there is at least reason to worry that we have not reached a "natural bottom," whatever that might mean. In any case, no one believes that a boom is on the way any time soon.

Ever since the housing bubble burst, I have been pushing the idea that public policy should not be based on an ideal of individual home ownership. (The most recent post is
here.) I have made similar arguments in teaching my various courses, usually in the context of discussing the mortgage interest deduction. There are many aspects to the argument, but my bottom line is that it is a mistake to encourage people to put their life savings into one asset, especially since renting can have all the advantages of buying, with none of the disadvantages. (Note that my argument merely coincides with the bursting of the bubble. Even in good times, I would argue that individuals generally err by owning their homes.)

People often misunderstand me to be saying that I want people to live in apartments rather than houses. While there is a strong anti-suburbanization argument to be made, that is not my point when I advocate renting over owning. My point, instead, is that the current housing stock should not be owned by the people who occupy it. Instead, institutional investors (private and, where appropriate, public) should own the housing stock, renting both houses and apartments to individuals and families.

While the usual understanding of the rental relationship is based on a single building -- with a superintendent managing the apartment building on behalf of a (usually absentee) owner -- it is now common for companies to own and manage multiple buildings across the country. The company that owns and manages my apartment complex in suburban Maryland, for example, is based in Rochester, New York. There is nothing, therefore, that says that the ownership or management of housing units must be limited to a single building or location.

This means that, just as some companies choose to buy and manage rental buildings (with multiple units) in many locations, companies could buy and manage a portfolio of rental buildings that includes single-family houses. The advantages to this would include the economies of scale from centralizing maintenance (yard work, roof repair, and so on), which should give well-run companies an opening to offer rental prices that could easily compete with the typical homeowners-on-their-own approach to buying and maintaining individual homes.

Moreover, the housing bust has created a simple transition path to a world in which people rent single-family homes. The foreclosure crisis involves throwing people out of homes that they formally owned, with the mortgage company taking possession from people who really, really do not want to leave. The foreclosing company then holds an empty house that it is unable to sell in a market with fewer and fewer qualified buyers, none of whom is willing to take a risk in a sinking market. While some evicted former owners would not be able to pay even market rent, some would. Certainly, there would be situations in which people could pay rent on a single-family home as reliably as they pay rent on a three-bedroom apartment nearby.

The housing crisis thus has the additional perverse effect of raising rents on apartments, which are the destination both of former owners and scared non-owners (as well as people who, like me, simply prefer to rent). Millions of housing units sit idle, losing value through neglect and vandalism, while the people who lived in those units compete for traditional rental units.

All of this suggests that, setting aside my policy reasons for wanting fewer people to own their own homes (single-family homes or otherwise), there is reason to believe that there is profit to be made in turning formerly owned houses into rentals.

One of the more annoying misapplications of "market reasoning" is the idea expressed in the title to this post: If your idea is so good, it would already be happening. I have heard this applied to any number of different situations, from proposals for new scholarly journals to ideas about cell phone pricing. While such reasoning breaks down quickly upon inspection – amounting, after all, to the idea that nothing could ever change, because change would mean that what was replaced was inferior to the new situation, which utility-maximizing people would never have accepted -- there is nonetheless a basic truth at work. An intelligent analysis of any proposal should include an assessment of why a good alternative is not already being pursued. If there is profit being “left on the table,” why are greedy people not grabbing for it?

One possible answer here is that current policy pushes people to own their own homes. This, however, explains only why people generally try to own rather than rent. It does not explain why, in the midst of a historic housing crisis, people who can no longer own the house with the white picket fence are not renting it instead. Again, millions of units are empty (costing the companies that foreclosed on those homes billions in lost rental payments), and millions of people would like to occupy such houses. What is stopping the owners and the potential renters from reaching a mutually agreeable, arms’-length deal?

While there are surely policy changes that could (and, in my opinion, should) be made to make such deals more likely, it is a bit of a mystery why the business model that I am describing has not taken off. Of course, some experiments along these lines might well be underway, and I might simply be unaware of them. At the very least, there has been no reported trend in this direction, in a market that has been under close scrutiny for years.

Beyond policy barriers, however, it seems that both the potential landlords and the potential tenants are “choosing” to pass up good deals. From the potential landlords’ perspective, there might simply be too much uncertainty involved in this new business model. Even with Corporate America sitting on trillions of dollars of cash, and with millions of people available to work for newly-created suburban home management companies, this might not be the time to experiment. It is even easier to imagine what is going on from the potential renters’ perspective. They have no market power at all; and if they were to ask the foreclosing company for the ability to rent the home, they would be given the standard response: “That’s not our policy.”

Meanwhile, millions of people are being displaced, and the nation’s housing stock decays. No matter the reason for “the market” having failed to innovate its way out of this mess, there are good reasons to change policies to correct that failure.


Doug said...

It's easy - evicting people is hard and renting out property involves legal risk - banks want to simply sell the property off so won't rent them out (and if they are simply servicer of debt that has been packaged they have no financial incentive to rent either).

Michael C. Dorf said...

Doug is right that these are both factors but neither fully answers the question Neil poses. After all, the banks are sitting on lots of empty properties, so the eviction issue isn't present for those. As for legal risk, there's a risk of non-payment in renting apartments too, but we have a robust rental market there. The risk from damage is greater for houses, but it's not clear why that couldn't be reflected in the price. (I have been a landlord for both a house and an apartment; I had to carry more insurance for the house, even though the apartment was more valuable, but this is a small piece of the overall cost structure.) I think in the end that a piece of the answer lies in the realm of psychology: For Americans, much of the appeal of house occupancy is home ownership and much of the appeal of home ownership is house occupancy. If I'm right that the "American Dream" does not usually include renting a house or owning an apartment, then the missing market is partly explained by missing demand.

Doug said...

Michael, I would disagree about the eviction risk. Once you get a tenant the tenant protection laws kick in and it is hard to get rid of them even if they trash the place and don't pay anything - what you want to do after all is keep the place looking nice so you can sell it. Those who could afford a high price aren't the same ones as being foreclosed on (generally) from the liar loans.

When the housing market picks up a bank wants to sell off its stock of houses quickly which means keeping them in decent shape and ready for someone to view and move into. If the house stinks and looks like a dump because of bad renters (or even looks lived in - think of home staging to increase purchase prices) this makes things more difficult.

Anonymous said...

While there are certainly changes in policies that could (and, in my opinion, should) be done for these transactions is likely a bit of a mystery why the business model I am describing does not sound off. Of course, experiments in this direction could be running, and I just could not ignore. At least, there was no trend in this direction in a market that has been under close surveillance for years.RS GoldCheap tera goldCheap Tera GoldTera Power LevelingTera AccountTera ItemsRS GoldBuy RS Gold Eden EternalEden Eternal ReviewEden Eternal Gold

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