-- Posted by Neil H. Buchanan
As regular readers of Dorf on Law know, I have been doing quite a bit of thinking over the last few years about the owning-versus-renting question, in terms of personal residences. (Actually, that question is equally applicable to vacation homes, automobiles, and so on, where the details are different in each case. My strong -- though rebuttable -- presumption in every case is NOT to own.) Having reluctantly come around to an odd sort of pro-ownership position -- both as a policy matter (where I have recently concluded, in essence, that we as a society should encourage home ownership for all or for none, and it is impossible to see how to eliminate the many encouragements to own), and as a personal matter (having bought a house of my own in April) -- this seems like a good time to think about what we must do to make meaningful apples-to-apples comparisons between owning and renting primary residences. One can think in the abstract about these issues, but after living the reality again even for only a month or so, I am here to report that the world can look quite different from this side of the divide.
In response to my post announcing my purchase of a house, a former student wrote in a comment: "Best of luck with the new home. I will appreciate any updates to your analysis of 'cheapness' once you have to account for rapidly growing lawns and towering leaf piles as an owner rather than renter!" That comment was in response to my claim that the net-of-everything cost of a rather spacious house in a Maryland suburb of DC was, much to my surprise, significantly less than the cost of a nice 2-bedroom apartment in (a much less nice part of) the same town. Indeed, this question goes far beyond the issue of lawn care.
When I sold my last house (in South Orange NJ) to move into an apartment in Manhattan, I marveled at the extreme economies of scale that were available in a high-density living arrangement. Nobody had to shovel sidewalks in winter (back when the Northeast had winters), saving themselves not only time and effort, but trips to emergency rooms (to treat the inevitable victims of over-exertion) and sometimes even morgues (for those who could not be brought back). Although my phrasing here is admittedly flippant, my point is serious. Individualized work effort has many upsides (exercise, personal fulfillment, and so on), but it also has hidden and unappreciated costs. Division of labor puts the people who are most willing to shovel snow -- and who are, therefore, more likely to be properly equipped, both physically and in terms of machinery -- in the business of shoveling snow, and everyone else out of that business.
This might seem like an unfair comparison. After all, the difference between South Orange and Manhattan is not just that people generally own in the former but rent in the latter. The bigger difference is that Manhattan has no yards, no private sidewalks, and virtually none of the items that people would need to care for personally. Maintenance of the common areas is understandably farmed out, via management companies, and so on.
That does not, however, solve the deeper question. As I have argued many times, there would be nothing (as a logical matter) stopping a management company from owning all the houses in South Orange, renting those houses to families, and then providing maintenance services as part of a rental agreement. This would take advantage of the division of labor that economists have loved at least since Adam Smith, thus reducing the time and effort necessary for any individual homeowner to mow her own lawn, shovel her driveway, and all of the other things that homeowners now routinely take on as a matter of course.
What one cannot truly appreciate until one spends a few weeks in the midst of the reality of home ownership, I think, is just how much of the economy of scale involves a reduction in transactions costs. Without a management company to do it for them, homeowners individually have to figure out how to find the best alternative to expending their own time and effort. This means finding individual contractors, calling them, having them come to the house, haggling over prices, hoping they come to do the work when promised, hoping they do the work well, and paying them. (And later, perhaps, suing them.)
This is bad enough, even for the regular maintenance issues that homeowners face, like lawn care and house cleaning. The internet is helping, too, with the emergence of sites like Angie's List (the existence of which amounts to a group primal scream: "How the hell are we supposed to know whom to hire?!"). Even so, if a person (like me) were attempting to construct an apples-to-apples comparison of owning versus renting, would that person actually remember to include these regular maintenance costs on the owning side of the ledger? (I did, of course. Occupational habit.) And of those who did remember, how many would adjust for the search and other transactions costs described above? And how would one even put a number on them? (I did not even think of this in advance, and I still cannot figure out how to do so.)
Now consider the less-than-regular costs of home ownership, which is an entirely different set of issues that renters never have to consider. First, there are the upfront costs involved in the purchase of the home. How does one distribute closing costs over the period of home ownership, when one is unsure how long that period will be? Then, there are the big, occasional maintenance items. The roof of every house has to be replaced on a periodic basis, as do furnaces, sidewalks and driveways, windows, some pipes, and so on. Some repairs will occasion decisions to improve the home, but it will be unclear how much of the money spent will show up in the resale price of the house. (The maintenance-versus-improvement divide is a knotty issue in tax law, too.)
Readers who own their homes are surely smiling wanly at this point. I am hardly describing something new (to them, or to me, given that I owned five homes before buying my current place). That, however, is the point. We limp along in a bizarre world where people spend untold amounts of time dealing with window salesmen, cleaning services, real estate agents, lawn services, roofers, pavers, handymen, and every other kind of individual contractor. Cocktail party conversations and sitcom plots are rife with horror stories of contractors who make homeowners' lives miserable. By contrast, renters benefit from a system in which they do not have to worry about how old the roof might be; nor do they have to shop for a plumber if the pipes burst.
That is not to say that rental management companies handle these things uniformly well. Far from it, of course. But that, too, is part of the point. The uncertainties on the renting side ("Will I have a super who actually responds when I have no hot water?") are nearly impossible to compare with the uncertainties on the owning side.
Finally, consider an issue that another commenter on my earlier post raised -- a point that has nothing at all to do with maintenance issues (even broadly construed). Because home loans are subject to amortization, the net cost of home ownership goes down over time. How can that be? Say that a person buys a house for $500,000, with a $400,000 mortgage. The monthly payment on a 30-year fixed-rate loan, at 4.5%, is just above $2000. In the first month of the first year of the loan, $1500 of that is interest, and the rest reduces the principal on the loan. Because of that reduction in principal, the fixed monthly payment gradually becomes more tilted toward principal, and less toward interest. The first month of the second year of the loan, the split is $1475 for interest, and the rest principal. In the first month of the fifth year, just under $1400 is for interest. In the tenth year, $1240. In the twentieth year, less than $800 is being paid toward interest, and the remaining $1200+ is increasing the equity in the house.
Because equity is equivalent to savings, it is not a cost of home ownership. Indeed, many people consider building equity to be the major benefit of buying a house. (Issues of financial diversification arise here, of course.) This means that the net cost of owning a home goes down over time. Adding to the uncertainties of how to spread the initial closing costs and infrequent (but predictably periodic) maintenance costs, therefore, is the reduction in interest cost as the time of ownership rises.
Obviously, this only scratches the surface of the issues that one could discuss, both general and specific, with regard to owning and renting. The point is that the confidence with which I (and many other economists) wave away concerns about "minor" issues like transactions costs is, especially in the housing context, truly baffling. As a personal matter, I continue to be amused by it all, managing to maintain my equanimity as I deal with yet another contractor who is supposed to be at my house at 10am tomorrow (but who knows, really?).
My bottom line is to say that my former student was right to wonder whether I was really taking everything into account, when I blithely said that the net-of-everything cost of buying was, in the specific circumstances that I faced, clearly in favor of owning. I still suspect that it was, but even as someone with so much hard-won experience, I now see that it was surprisingly easy to ignore many of the hidden non-joys of home ownership. Many are temporary, and many will become manageable with familiarity, but they are still costs on the side of owning. As a policy matter, if we are going to push even more people into home ownership, this is another set of issues that deserves serious study.