Friday, June 15, 2012

The (Somewhat) Hidden Costs of Home Ownership

-- 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.


David Ricardo said...

I am somewhat at a loss to understand what I believe to be the policy position of your position, namely that personal homeownership vs renting is the best policy for everyone or is not the best policy for everyone. Obviously the situation is that renting is the best policy all the time for one group of people, owning is the best policy all the time for another group of people and there is a third group where owning vs renting is dependent upon their circumstances at a particular point in time, and market circumstances at a particular point in time.

For example, if the housing market is characterized by relatively high liquidity (houses can be sold in relatively short times) and by prices rising faster than inflation (but not so fast to create a ‘bubble’) then this tends to favor ownership over renting for those people who can go either way. If the market is similar to the current one with falling prices and less liquidity then those conditions favor renting.

All individuals are not alike. What you consider an expensive chore, i.e. maintenance, other people consider an entertaining activity. (You are obviously a city person.) And many people want to customize their living conditions and that is not possible with renting. Furthermore in addition to the point that you make about the cost of ownership falling when one has a 30 year fixed payment mortgage, we need to also recognize that home ownership is a form of forced savings.

From a policy point of view it seems what is needed is substantial financial education so that people can make the best decision for their particular situation. To try to develop a determination that homeownership is for everyone or for no one seems to miss the point.

Neil H. Buchanan said...

I appreciate TDPE's points, which he makes well. It is certainly true that people should be better educated about all financial matters, especially housing issues.

I mean something different, however, when I talk about my "policy position." The big policy question that I have been wrestling with for the last few years is whether the current pro-ownership policies should be eliminated. The problem is that the current policies are -- at least in effect, if not intent -- a mechanism by which public money is shoveled toward home ownership, favoring relatively privileged groups within society.

So, when I say "for all or for none," I don't mean that everyone should buy a home, no matter their circumstances (risk preferences, attitudes toward personal toil, etc.). I'm saying that we should either remove all pro-ownership policies (making them available to no one) or expand all pro-ownership policies so that everyone who wants them is able to take advantage of them (taking into account the realities of race, gender, etc.).

Finally, as to the point that it is impossible to customize living conditions while renting, that is currently true, but it need not be true. One could easily imagine a world in which renters and landlords routinely negotiated such things, yet in our world, even simple agreements to paint an apartment are rare and (according to friends who have done it) difficult. As a policy matter, we could pass laws designed to make it easier for renters to treat their apartments like homes -- that is, to discourage landlords from taking hard-line positions against modifications, and instead to negotiate over such things.

But that is a relatively minor part of the bigger picture. I'm not trying to put everyone into an owner-occupied house. I'm saying that, as long as we're committed to pro-ownership policies (and we clearly are), it is important to make sure that the policies that favor ownership are fair to all.

David Ricardo said...

Okay, that clarifies the issue and narrows the discussion to one of regardless of whether or not home ownership is desirable from a macro socio/economic point, should public policy encourage, discourage or be neutral (if possible, pure policy neutrality is much more difficult than people think) with respect to homeownership.

Just because an activity is beneficial or harmful does not mean public policy must become involved. For example, everyone would agree that consumption of large amounts of heavily sugared soft drinks is detrimental to health, but this may not mean a city should ban the sale of such drinks. With respect to home ownership it seems what must be determined first of all is whether or not it is beneficial for the macro economy and then secondly should public policy favor and support and subsidize home ownership.

It seems from the macro-economic view that home ownership is a benefit to a nation such as the United States. Certainly the economic progress from 1945 to 2007, fueled in some part by private housing supports that view. The large movement towards home ownership, fueled by the VA loans and by government agencies such as FHA, Fannie Mae etc. was beneficial to the post WWII economy.

Unfortunately determining whether home ownership is desirable at the macro-societal level is largely qualitative analysis. Many of the benefits of homeownership are in part impossible to quantify (neighborhood stability, quality of life etc) as are the costs (reduced labor mobility, increased risk from mortgage debt, etc.). But it just seems that as a general rule, having a large proportion of owner occupied housing is better for the United States than a large proportion of rental housing. But this does not mean that public policy should support such a goal.

Major public policy provisions that favor home ownership are in the tax code, deductibility for mortgage interest and property taxes for home owners. These provisions do favor higher income families. Low income families either do not own or do not have large enough deductions to qualify for itemized deductions or do not benefit at the margin. (The benefit of itemizing comes only from the amount of deductions in excess of the standard deduction, not from the full amount of itemized deductions. If the standard deduction is $12,000 and a person has itemized deductions of $14,000, the marginal benefit of itemizing is only an additional $2,000 deduction)

But does mortgage interest and property tax deduction really favor home ownership over renting? One could argue that eliminating these deductions is not neutral and favors renting, because these deductions are allowed for the owner’s of rental housing through a different part of the tax code (they are a business expense) and presumably at least some of that benefit is passed through to renters in the form of lower rents. Maybe allowing the deduction of mortgage interest and property taxes just makes the playing field more level between owning and renting?

One could argue that better policy could be that the deduction of mortgage interest and property taxes for individuals should be replaced with a “housing cost” deduction available to everyone, say something like a deduction for total annual rent payments or total annual mortgage payments up to a maximum, with a minimum deduction for people who own but do not have a mortgage. That might be a more neutral policy and more “fair”.

In the end though the question of whether or not a society is better off with home ownership rather than rentals, and whether or not public policy should support home ownership, and if so, how is going to be a far more subjective rather than objective analysis. And that is why it is such a difficult question at the macro level and why thoughtful people like Mr. Buchanan and the rest of us (who are probably not as thoughtful) have to wrestle with it.

egarber said...

Has anybody ever carried out an earnest "rent and invest the difference" exercise in this area?

As an analogy, I always buy term life insurance, because whole policies -- which carry a much higher premium -- just don't seem to return much on the investment side. By going term, I can (at least theoretically) invest the premium difference in say, a Roth IRA, which is a pure play on (tax free) growth.

I'm pretty sure that my choice in this area is the right call. But is it also true in the rent vs buy home context? Many say it is, but I'm not so sure. For example, it's taken as a given that rent is generally cheaper than a mortgage payment for similar property -- and the boatload of mortgage leverage would be better applied elsewhere (home properties don't appreciate enough to make it worthwhile). How valid is all that, as an empirical matter?

And of course, trying to smooth out the totality of costs into an apples-to-apples picture creates all sorts of headaches.

You've probably covered this before, but I'll ask anyway.

As for yardwork, I'll keep doing my own for now. :)

Doug said...

"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" (boldface added)

When you build equity (savings) you expect a return on that savings. In the case of housing it is implied rent. The net cash outlay goes down (assuming rates stay the same) but the cost of owning does not necessarily go down.

Cost, of course, is what you give up. You are giving up the best alternative to the investment in a house. If you invested the money you would have a return of something -- it is the difference between the return on the next best alternative plus carrying costs (all on a risk adjusted basis) which is the cost. It could very well be that housing does poorly and the alternate investment does well meaning the cost of home ownership rises over time. Think of renting and investing in a blue chip pharma company over the past thirty years versus buying a place in a Detroit suburb. What you gave up to get the house rises over time (even once you pay off the mortgage and own the house outright it could very well be that the stock portfolio would be worth far more than the house and the dividend stream far more than the implied rent).

Unknown said...

Thanks, We have also been seeking info about that subject for a long time as well as your own is the better We have discovered until eventually at this point.Yet, think about the lower collection? Will you be positive in regards to the present? free online plagiarism checker

Unknown said...

It’s in reality a great and helpful piece of info. I’m satisfied that you simply shared this useful info with us. Please keep us up to date like this.for more click on Best limo service

Unknown said...

As long as their cool rubberized bottoms which cushioning conjointly surety your toes, hollister deutschland outlet tend to be soft to the amount of invest held despite truly a old. striking greater number in regard to sports mukluk purchased nylon uppers supplies which indulgence dramaturgical ft in the interest of pull plus spectacular action inasmuch as air spout. Click here

Unknown said...

I don't know how many times I've had to hire plumbers in Elgin IL, it seems my house's pipe are actively trying to die on me.

Unknown said...

Hey, i think they need to do 10 more shows on this topic and brake it down apartment,condo and house living are all so different and the cost of each to rent or own also way different growing up in the rental industry because of my father and have stayed in it being a contractor specializing in rent property i cant say i know any one that owns rental that looses money to compare a 900 sf apartment to a 3000 sf house is a wast of time but rent or own the 3000 sf home over 5 years better buy.Thank you!

Gujjar rehman said...

unless i've misinterpreted your column, affirmed was the last triple crown winner with three very close wins over alydar...Apple passbook store cards

Robert Jennifer said...

My partner and i wonder how you will bought so good. Hana! That is usually a amazing blog, a great deal of issues that I will wind up in. Something My partner and i simply want to say will be that your particular design is so perfect! For more info visit on.vaporizers australia

Robert Jennifer said...

i used to be appreciating viewing personnel seven days every week. Once regarding for my state of affairs bought a complete smaller from their york motorcycle insurance

Robert Jennifer said...

Your thanksgiving sounds a lot like how ours have changed. It used to be always down my parents but when they got to old to handle it all it moved to my sisters. Now for some reason its always at my brothers. I miss it being at my sisters, hers was much more relaxed and I got leftovers. Don't get either at my brothers. Its still nice but different. recuperar hd

Robert Jennifer said...

To those of us living in the twenty first century the tradition that the color of the wedding dress must be white seems like a tradition that must go all the way back to the garden of Eden. After all, wasn't Eve's fig leaf ensemble not made of white satin Seagrove Beach

Best economical Dymo Labels said...

llo there, just became aware of your blog through Google, and found that it's really informative. I'm gonna watch out for brussels. I will appreciate if you continue this in future. Lots of people will be benefited from your writing.poolpower salt cell

Alat bantu sex pria wanita said...

I am grateful for the information that I have seen this, with this content can make me grow my knowledge, once again I thank you wrong me kami jual alat bantu sex, sebuah alat bantu pria dan alat bantu wanita yang dapat untuk di gunakan memuaskan diri sendiri, pengetahuan kami ada disini

Unknown said...

Very awesome post , i am really impressed with it a lot

فوائد الزنجبيل

فوائد الرمان

فوائد الحلبة

فوائد البصل

فوائد الزعتر

فوائد زيت السمسم

علاج البواسير

فوائد اليانسون

فوائد الكركم

قصص جحا

صور يوم الجمعه

علامات الحمل

تعريف الحب

حياة البرزخ

فوائد الزبيب

Abo omar said...

كشف تسربات المياه

شركة تسليك مجاري بالدمام

شركة تنظيف شقق بالرياض

شركة تنظيف منازل بالرياض

افضل شركة تنظيف خزانات بالرياض

شركة نظافة بالرياض

شركة تنظيف بالرياض

شركة نقل اثاث بالرياض

شركة تنظيف مجالس بالرياض

شركة تنظيف فلل بالرياض

كشف تسربات المياه بجدة

شركة تنظيف شقق بجدة 

Unknown said...

achievable when M2M revenue would be derived from utilizing the intelligence generated from machine data or in enabling enterprises to develop new functionality or new services to their end customers,” says Zhong. best dentist in plano

Robert Jennifer said...

We found it interesting above all else. Well done. saltmate salt cell

Robert Jennifer said...

This is a great video and I watched it with my friends and we all like it so much. Thanks free leads for network marketing training

Robert Jennifer said...

First You got a great blog .I will be interested in more similar topics. i see you got really very useful topics , i will be always checking your blog thanks.

Robert Jennifer said...

I really appreciate that you wrote this article and shared some really good information on this specific topic. I was in vital need to get some information on this topic and thanks to you, I've got that! Thanks, once again!Jobs in UAE

Robert Jennifer said...

Write more, thats all I have to say. Literally, it seems as though you relied on the video to make your point. You definitely know what youre talking about, why waste your intelligence on just posting videos to your blog when you could be giving us something enlightening to read? Silver Jewellery

Unknown said...

Since the above manual workflow is dependent on workers actually managing each bill many times, handling can take weeks or even months. baltimore pest control

Robert Jennifer said...

The information you have posted is very useful. The sites you have referred was good. Thanks for sharing.fewo usedom

Unknown said...

coach outlet store online
michael kors outlet
jordan 4
prada shoes
louis vuitton handbags
timberland shoes
hollister pas cher
tod's sale
nhl jerseys wholesale
kate spade handbags
beats by dre
prada outlet
kate spade uk
prada handbags
ray ban
louis vuitton outlet
new balance shoes
burberry outlet
coach outlet
tods outlet
adidas wings
coach outlet online
toms shoes
foamposite gold
lacoste outlet
adidas shoes
christian louboutin
kate spade outlet
tiffany and co jewelry
michael kors canada
toms shoes outlet online
giuseppe zanotti outlet
kobe 9 elite
michael kors handbags
converse outlet
michael kors outlet
foamposite shoes
michael kors outlet

Unknown said...

I am happy to find this post Very useful for me, as it contains lot of information. I Always prefer to read The Quality and glad I found this thing in you post. Thanks.Glass Curtains Spain

Robert Jennifer said...

Great article Lot's of information to Read...Great Man Keep Posting and update to People..Thanks hallandale beach condos for sale

Robert Jennifer said...

This article gives the light in which we can observe the reality. This is very nice one and gives indepth information. Thanks for this nice article.Seiko Kinetic

Robert Jennifer said...

Thank you a bunch for sharing this with all of us you actually realize what you are talking about! Bookmarked. Please also seek advice from my site =). We could have a hyperlink change contract between us!Swarovski 2014 Crystal Snowflake Ornament

Robert Jennifer said...

I already saw many blogs but I like this commenting platform. Thanks a lot for your guidance and sharing information.Change Management Models

nejjovpn said...

شركة مكافحة النمل الابيض بالرياض

شركة مكافحة النمل الابيض بالرياض

شركة مكافحة حشرات بالرياض

شركة تنظيف شقق بالرياض

شركة كشف تسربات المياه بالرياض

شركة رش مبيدات بالرياض

شركة رش مبيدات بالدمام

شركة تنظيف فلل بالدمام

شركة تنظيف شقق بالدمام

شركة كشف تسربات المياه بالرياض