Thursday, December 16, 2021

Vulture Capitalism Comes to Your Cul-de-Sac

by Neil H. Buchanan

Is it a bad thing that fewer and fewer people own their residences?  Not necessarily, but as with all such questions, it depends on how well governments (federal, state, and local) structure and regulate the market for renting houses.  And as with all issues of legal structuring and regulation, the United States is failing miserably to protect people from powerful, ruthless predators.

Perhaps surprisingly, there is nothing inherently exploitative or even problematic about a situation in which people rent houses and apartments from non-resident owners.  It could, in fact, be a very good thing for everyone involved, and for our economy and society overall, for fewer people to own their own houses.  The problem is that this market can all too easily be allowed to operate in a way that makes renters easy pickings for those who have no boundaries or ethical limits.

This column is motivated by a piece in yesterday's Washington Post, "This block used to be for first-time homebuyers.  Then global investors bought in," which is part of The Pandora Papers project.  It is what good journalism is all about: deeply researched, connected to lived reality, and willing to draw connections that lead to important policy implications.  Given how frequently I excoriate the press, including The Post (and not only its op-ed pages), it is a pleasure to read this kind of long-form reporting.

It is also, however, in key ways naive and has the potential to reinforce bad public policy choices.  Sorting out the good from the bad is my mission here.

The most loyal of Dorf on Law readers might vaguely remember that I spent a fair amount of time in the 2008-12 period writing columns in which I argued that individual home ownership is a bad idea.  I wrote so many columns on that topic, in fact, that I collected them into a 60-plus page document that I posted on SSRN.  (If I recall correctly, I wrote a few more such columns after posting that document.)  The final Dorf on Law column therein, published in August of 2012, summarizes my basic position:
[I]t is quite possible to have a non-ownership approach to housing, even when the housing stock consists mostly of detached, single-family homes with yards. The basic idea is that management companies could buy up single-family homes and rent them out to people who might otherwise buy houses or rent apartments. (The Obama Administration has, in fact, issued calls for proposals to encourage such purchases of the abandoned and foreclosed homes that still sit empty, years after the housing bubble burst.) Those management companies would then run consolidated office and maintenance operations, allowing people to rent houses for less than it would cost to own and maintain a home as an individual.
What I described is not only possible but, as I suggested above, arguably superior as a matter of public policy.  How so?
To begin with the obvious point: Yes, I did back then and still do reject the gut-level presumption -- a belief so widely shared that it is unquestioningly included in what we arrogantly refer to as The American Dream -- that people should own their own homes.
At most, the arguments in favor of continued policies to promote home ownership are second-order, where a presumption against owning might be rebutted by path dependence, cognitive biases, or other real-world problems.  The best way to view The Post's Pandora Papers piece, then, is to understand it as an expose of "other real-world problems" -- to wit, rapacious financial capitalism.

Before getting there, however, it is worth summarizing the base case against home ownership by individuals.  In no particular order, the biggest problems include:
(1) Individual home ownership is the perfect example of the all-eggs-in-one-basket investment strategy that we otherwise beg people not to engage in;
(2) There are insanely wasteful transactions costs involved in buying and selling houses, most obviously everything swept into "closing costs" (the worst being so-called title insurance, which is a legally enforced scam);
(3) Owning a home creates a lock-in effect that makes it needlessly more expensive for people to move to a better job (which, at worst, can happen when the market is down, leading to big losses on resale); and

(4) Home ownership is highly unequal across races.  In fact, policies regarding home ownership (red-lining, federal loan guarantees, and so on) were among the most effective Jim Crow laws, allowing White people to accumulate housing wealth while preventing Black people from doing the same.  There is a leveling-up or leveling-down aspect to this that is beyond my focus here, but the immediate point is that our housing system -- even when it has been successful in doing socially beneficial things -- has hardly been racially neutral.

As I pointed out in some of my columns all those years ago, there is an additional cost to home ownership that is hidden and thus often ignored.  Homeowners are not able to exploit the economies of scale that make rental companies inherently more profitable, simply because homeowners do not have the resources or sufficiently frequent reason to establish ongoing connections with plumbers, electricians, masons, and everything else that goes into home maintenance.  Each homeowner thus spends stupid amounts of time and effort getting competing bids on jobs, but only if they have the time to do so and if the local tradespeople will even bother to show up.

But what about the belief that rent is "throwing money away" while mortgage payments are "building equity"?  Especially in the early years of a mortgage -- which is all that most people ever see, because the average person owns a home for six years, and many refinance their mortgages over the years -- the vast majority of a mortgage payment is "rent to the bank."  Even taking into account the mortgage interest deduction, it works out that an apples-to-apples comparison of "money you'll never get back" much more often than not shows that renting is cheaper than buying.

That means that the part of a mortgage that pays down the principal -- the build-up of equity -- could and should be deposited into a (diversified) investment portfolio, which for many people would simply involve maxing out their annual IRS/401k contributions and putting the money into an index fund.  This, in fact, is the first point at which the theory bumps up against reality, because cognitive biases cause people not to max out their savings to parallel a mortgage payment's equity component.  The fear of eviction forces people to save in a way that is difficult to replicate in savings schemes.

Even at the beginning of the story, then, the rent-rather-than-buy story needs to be qualified, at least as a matter of public policy.  I can (and always do) tell young people not to fall for the "be an adult, buy your own home" hype, and I then advise them to save as much as they would otherwise build up in housing equity (more, actually), but even if I am completely persuasive, public policy has to be based on a reality in which most people will not save as much as the theory says that they can.  At the very least, then, a move away from policy incentives to buy houses would need to be paired with policies to encourage (or force) people to save at least as much as they do now.

The piece in The Post, however, focuses on the point that I made in the block quote above.  In response to people being evicted from houses during the Global Financial Crisis, I surprised myself by sounding like an orthodox economist, essentially arguing that private ordering could solve the problem.  Other people were worried about neighborhoods emptying out, but I was focusing on the profitable opportunities that this would surely create for companies that were willing to buy up those homes and start to manage portfolios of single-family houses in the same way that rental companies own and manage apartment buildings.

It was obvious even at the time that this would have some bad optics, because it would unavoidably involve having well-financed, for-profit companies swoop in and buy up distressed properties.  Even worse, as far as ick factors go, the most sensible thing would then be for the new companies to rent out the houses to the very people who had been living in them.  "I was kicked out of my house by a mortgage company, and now I'm paying rent to some billionaire's hedge fund" was never going to go down well.

As I noted above, however, there truly are good reasons for policymakers to prefer a move toward renting over individual ownership.  Moreover, the economies of scale available at scale mean that this would be a permanent advantage, not just something that goes away after a financial crisis ends.  And as The Post's piece points out, there is currently something like a ten percent cost advantage for institutional investors, compared to individual families.  No surprise that the people who believe in the mythology of independent home ownership are disappointed.

The writers of that piece, as I noted above, do go a bit overboard in places.  For example, they quote extensively from what is obviously corporate boilerplate extolling the virtues of renting, and they then interview corporate spokespeople in ways that make them sound like handmaidens of evil.  And indeed, those companies are doing some evil things, and some of the people who work for them are undeniably tone-deaf at best and gleefully uncaring at worst.

Even so, there is no reason for The Post's writers to include this (quoting one of those corporate shills): "'I laugh because when people try and distinguish owning a home from renting a home, the reality is most people don’t own a home — they rent the home from the bank,' Hamilton said. 'From the outside, it really looks the same.'  One key difference unacknowledged in her remark, however, is that a family’s monthly mortgage payments can build equity in the home; rent payments have no such benefit."  For the reasons stated above, that is either grossly misleading or flat-out wrong.

At the beginning of this column, I noted that "path dependence, cognitive biases, or other real-world problems" present second-order -- but still potentially dispositive -- reasons that we might not decide now to shift gears and put in place new policies to encourage a shift toward renting.  Path dependence here simply means that there are plenty of reliance interests in place (most obviously that so many people already own houses, including me), and I have already mentioned an example of cognitive bias.
Where The Post's piece truly shines, however, is in laying out the full depth and breadth of those "other real-world problems."  Left to their own devices, profit-seekers will take every advantage of their customers that they can find or invent.  And sure enough, the investors who could make an honest buck from renting out houses cannot hold themselves back.  They exploit people's weaknesses in all of the familiar ways, from tacking on fees wherever they can, failing to tell customers about legal protections, and so on.  Again, the new ownership companies are able to hire competent lawyers to profit from economies of scale, but then those same lawyers figure out how to use contracts of adhesion and all of the other old tricks to bleed customers dry.

The strongest impact of the piece is the description of how the villain of the story apparently ignored anti-eviction rules early in the COVID-19 pandemic, destroying people's lives without conscience.  The article also, however, includes some other important policy discussions, especially a good description of how our extremely corporate-friendly tax laws create more advantages than market fundamentals could otherwise justify.  My friend and tax professor colleague Reuven Avi-Yonah (who teaches at the University Michigan Law School) offers some extremely clear explanations of how tilted our tax laws are, especially with respect to real estate.

This, then, is merely another of many examples that make it clear that "letting the market solve the problem" is an empty dodge.  Even someone like me, who thinks that home ownership should be discouraged, would never say that we can simply expect private investors to treat people decently.  They will treat people -- especially when the product is one's residence, where there are significant barriers and costs militating against "taking my business elsewhere" -- exactly as well or as poorly as the law (as written and enforced) allows.
As a final side point, I should emphasize that this kind of consumer protection approach to public policy would also be essential in setting up the kind of savings programs that I mentioned above, shifting the forced savings of monthly mortgage payments into diversified savings in other assets.  Just as predatory investors can skin people alive in renting houses, they can do the same with people's savings.  The market has no tender mercies.

I thus disagree with the underlying emotion of The Post's piece (movingly quoting people's desire to own houses) but nonetheless applaud its power.  If people, for any reason, are going to be living in houses that they do not own, we have to carefully structure and regulate the market for rental homes.  That can be done well, but no level of government in the United States has yet done so.  I doubt that they ever will, but that is a different matter entirely.