87,000 Hours or: Thoughts on Home Ownership
Edited to add epistemic status and summary:
The basic thesis of this post is that, for many reasons, the volatility (riskiness) of buying a house are significantly higher than generally believed.
The considerations explored here are the result of discussions with a financial advisor and plugging various pieces of publicly available data about housing markets into adhoc models of long run performance. Ultimately, predictions about asset classes usually come down to reference class forecasting, as any appeal to ‘over’ or ‘under’ priced is relative to some trend, and choice of the timescale on which trend following is expected can be chosen to tell a story. E.g. two people arguing can have one arguing for a reversion to a long run historical trend while the other argues for a reversion to a short run trend. They may both be right on different time scales going forward too. This post attempts to surface reasons why buying may be more expensive than a popular model one might encounter, which may have been generated by people in the pro real estate camp. Thus it argues that people’s confidence intervals, especially to the downside, are too narrow when modeling home buying. Losses in the housing market are hard to get quantified data on since they are private and often vary enormously due to imputed rents and opportunity cost being idiosyncratic between individuals. A small thumb on the sale at each step in a multiplicative planning space can add up to a lot by the time you reach the output of your model.
The main parameters looked at in this post if you want to do you your own homework (which obviously you should for an individual purchasing decision) are as follows:
Rent-to-Buy ratio (see linked post at bottom for problems with the default parameters of popular rent to buy calculators)
Average time spent in purchased homes
Historical house price indexes
Historical rent price indexes
Vanguard’s Balanced Index investment fund (leveraging a balanced fund handily beats all-stock allocations btw)
Salary and savings considerations over a career
Home ownership tax benefit calculators
I’ll add any more that occur to me.
Beware extrapolating averages to unusual situations. Outlier markets usually have various reasons that have driven metrics to extremes. Failure to understand the casual mechanisms will prevent one from predicting when such trends might reverse.
Original post:
The average person spends about 10 years (87k hours) in a house before moving, which already goes against people’s tacit models. This post is about the various reasons why buying a house is a bad idea.
First let’s address the idea that renting is ‘throwing money away’. This ignores the opportunity cost of investing extra income and the lump sum of the down payment into a house instead of the stock market. People spend on average 50% more money on mortgages, taxes, and fees than they spend on rent. If that money were invested in the market it would be earning you a return. People very often report being surprised how much more a home wound up costing them than they had expected. You can plug in the numbers for yourself in a rent to buy calculator (and should do so do get a sense of which numbers matter, but keep in mind they tend to have defaults set that are crazy and home buying tilted). A financial planner goes into more details about rent to buy ratios here(link below). Summary: buying makes sense in growing markets where the rent to buy ratio is under 20. But the markets in which the rent to buy ratio is under 20 are the same markets that you *don’t* want to live in. The ratios are low precisely for the reasons you don’t want to live there, various quality of life and job prospects.
Second let’s address the fear that ‘rents keep going up so it becomes a better deal over time.’ Rents can’t go up relative to house prices or vice versa for very long because eventually people will arbitrage the difference away. When renting is cheap, demand for purchasing homes drops. When renting is expensive demand for purchasing homes goes up. But we’d expect small persistent distortions in the direction of buying being more expensive because so many people default to buying even when it doesn’t make sense. But what about the Bay Area? Compound annual growth in housing prices over the last couple decades has been around 7.5% while growth for rent has been around 4.6%. But this is exactly why I expect regression to the mean. Overall rent to buy ratios in the Bay have been overheated and are now dropping, and it’s prices that are getting pulled down faster than rent is going up. Additionally, rents have historically appreciated much more slowly than the stock market, meaning renting should get cheaper for you over time if you’re investing.
Isn’t that all moot if the home you buy keeps appreciating in price since you get to buy with leverage? (A down payment is typically 20% so a home purchase is leveraged 5:1). In the fastest appreciating housing markets, this has been true. But buying a single house is like buying a single stock. The volatility you should expect is going to be much higher than a diversified stock portfolio. Essentially, any claims made about predicting future housing returns boil down to momentum based reasoning vs regression to the mean based reasoning. Either could turn out to be true, and you shouldn’t assume that you’re going to out guess the market. And with all those wins you hear about you have to account for survivorship bias. All the people who didn’t make out so great aren’t bragging about it.
Take housing the in the Bay Area for instance. Apparently more than half of home sales are going to Chinese buyers. If there is a substantial crack down on the various schemes these buyers are using to get money out of China, or if a different city becomes a hotter investment market, or unforeseen things cause this to change, a lot of speculative money that was piggybacking on this cash flow might leave. This has happened in other times and places. Indeed, the price index in some of these super hot markets like SF and Seattle have seen sharp declines the last few months. You may hand wave this away by claiming that ‘it always comes back’ but that again doesn’t actually calculate through how much opportunity cost you are paying by not pumping money into the market during down turns.
Another source of volatility is the inherent linkage between house prices and employment in the area. By buying a house close to where you are currently making a high salary (which you would want to since commute times disproportionately affect happiness) you are making a long term bet which, if it doesn’t pan out, will simultaneously leave you without that high paying job, either forcing you into a long commute or selling the house and moving to a different city. This is extraordinarily common. Labor mobility boosts earnings, and it is difficult to account for this in a calculator, but the younger you are the more wary you should be of locking yourself out of major career moves that move you geographically.
‘But the market is expensive too!’ there are a couple important points about that. The first is that none of the typically cited measures that people tout to claim the market is expensive have historically been very good predictors. Remember, if you can make a confident prediction about the market you can make gigabucks, so anyone claiming this who isn’t sitting on top of a mountain of money should be considered suspect. Second, let’s look at three examples of people trying to time the market. All three people invest at a rate of $200/mo. Person A has the absolute worst luck in the world and invests on the eve of all the worst stock market crashes over the last 40 years. Person B has the best luck in the world and invests exactly at the bottom of all the crashes. Person C believes it is hard to out predict the market and just puts some of their savings into the market each month. Maybe you’re guessing that person B and C do about the same even though C’s strategy is way easier. Nope, it’s even worse than that. Person A, the unlucky one wound up with 660k. Person B, the lucky one made 950k. But Person C, who just plugs $200 in rain or shine made...1.38 million. What? How is that possible? Person B still misses out on gains over time by waiting around with cash in hand trying to time things.
So let’s plug this back into the housing situation. If a mere $200 a month over time in the market generated 1.38 million...well that puts a big damper on the stories of people making millions from holding a house for a long time. If you were to sit down and carefully go over the numbers with such happy folk they usually did worse than they would have putting similar amounts away into the market (people will get very mad at you if you do this). Again, people who happened to buy into the hottest markets before they sharply appreciated may have outperformed, but you shouldn’t expect to be able to predict that ahead of time.
Aren’t I doing the same thing from the other end by predicting that the stock market will do well over the next 40 years? It’s very different because, as mentioned before, a single house is more like a single stock than it is like a globally diversified portfolio. When you look at a stock index over the long term, even things as catastrophic as the World Wars is just a blip. Betting on the world economy is just a much different bet than betting on a single house in a single market.
What about if I do something clever like buy a big house with my friends? Bigger houses cost less per room etc. A few problems. Going in on a house with multiple people also means splitting the tax advantages of home ownership. More luxurious homes are subject to bigger swings in home valuation during downturns than single family houses since that’s where most of the demand is. Second, this situation multiplies the opportunity cost of not being mobile. The chance that at least some of the people will wind up needing to move sooner than expected is high. Which leads to the third thing which is that this is a much bigger hassle to coordinate both immediately and ongoing and it may end your friendships, which is going to be painful if you are living together for years.
What if I time the housing market? This doesn’t work for the same reason that timing the stock market doesn’t work. Pretend it is right after a crash and you’re thinking of making an offer on a house. Where does the down payment come from? You can bet that lending standards have gone up in a crash and you’re not going to get a zero down loan. The money will have to come from your investment portfolio, which means you’re pulling money out of the market at the worst possible time to gamble on a particular house outpacing the market. This is a bad plan.
Come on! There has to be some situations in which buying makes sense! I did manage to find two situations where you can have a reasonable expectation of coming out ahead, or at least not doing too badly if things turn south. These scenarios are still highly reliant on you being sure you want to stay in a particular spot for at least 10 years, so there’s opportunity cost and risk there. 3 Bedroom, 2 bath houses are in highest demand, leaving 2 and 4 bedroom places slightly better deals. If you buy either a 2 bedroom condo and rent the second bedroom to someone reliable, or rent a 3 bed/2 bath with a fourth bedroom converted garage and live in the converted unit while renting the house to a family, both of these can pay off while giving you future flexibility to not need to move if family planning comes along. In either case you just stop renting the extra room. In the case of the 4 bedroom you’d start renting the garage unit when you moved into the house until you needed it as well. If you want to pull off this strat in a crazy housing market you’ll still need to find a good deal and run the numbers yourself. And you’ll have a tendency to put your thumb on the scale to get the outcome you want, so you have to be pretty careful about that. Also, trying to convert a garage yourself can be a real time and money sink without guarantee of success due to insane zoning laws, so that kind of setup is rare. Using a strat similar to this you can stretch to maybe make rent to buy ratios of 25-30 close to break even i.e. in cities you’d actually want to live. The Bay Area is probably still out though unless you want to live far from your job which is a terrible misery inducing decision.
‘I still think I should go in on a house with someone else’. One of the reasons the above scenarios work is that they don’t introduce the complications of multiple stake holders. Having renters vs owners means the friction is relatively low if (more like when) things change.
Gambling on hot housing markets isn’t a free lunch. It takes up a lot of your time (both before and after the purchase) and encourages poor emotionally driven decisions. And then it exposes you to a bunch of politics that will further degrade your quality of life as you now have a huge proportion of your net worth tied up in this scheme. The realtor market is oriented around juicing whatever misconceptions you have that will encourage you to buy whatever you can afford, and the politics around trying to force homes to be ‘good investments’ are toxic.
Okay so this is a lot of doom and gloom. Gee thanks, Romeo. Well, the reason I went to the trouble of writing all this is because there’s a massive upside to being aware of these issues. And that’s freedom from worrying that renting is bad! This pays huge dividends over time as you don’t need to ever worry about locking anything down. Combine with having few enough belongings that moving is no longer a huge chore and the ability to move once every few years becomes a real boost not only to your career potential but also to not calcifying into routines that make your life seem shorter and less varied.
- My guess for why I was wrong about US housing by (14 Jun 2023 0:37 UTC; 110 points)
- 's comment on [Site Meta] Feature Update: More Tags! (Experimental) by (25 Apr 2020 22:38 UTC; 31 points)
- Request for stories of when quantitative reasoning was practically useful for you. by (13 Sep 2019 7:21 UTC; 10 points)
Mind if I reeeee real quick?
I have a feeling this explanation is misleading.
Investing in the stock market and in the real estate market are two different things, different risk profiles etc. Correctly, this should read, “This ignores the opportunity cost of investing extra income and the lump sum of the down payment into a house instead of the exact same house, but renting it out to someone and collecting the rent.”
This points to a better explanation: You always “pay rent”. You being alive and taking up space always costs something, because space just costs something. Either you live in someone else’s space, in which case the cost for you of taking up that space is the rent you’re paying them; or you live in your own space, in which case the cost for you is the rent that you could collect from someone else if you didn’t take up the space.
When you effectively “pay rent to yourself” in this manner, economists call it “imputed rent”. Treat it like you would treat any other rent in your calculation.
When thinking about whether to invest your money into a house or something else, typically you want to decouple that decision from your living situation and see if it still makes sense. Regardless of where I live—given my net worth, does it make sense for $XXX,000 of my investment portfolio to be tied into this specific piece of real estate?
Then the standard investing advice applies:
you can only systematically make money in a market if you know more than other people who participate in that market know (e.g. maybe you have a friend in the zoning comittee);
don’t put most (or God forbid, all) of your wealth into a very specific asset (like real estate in a specific city);
etc.
See, you’re conflating land ownership and tenancy here. You can absolutely move wherever you want while owning and renting out a house somewhere else.
Same issue here.
There is of course a reason to own a place: so that you can refurbish it to your liking—or you might even want to build a house to your liking, if,like me, you think there just aren’t any existing buildings designed in a sane way. You just can’t rent a place from someone else and start tearing down walls and installing gadgets—and even if you were allowed to, you don’t wanna invest into improving someone else’s place.
(ETA: Just to clarify, even if you’re buying/building a place for the reasons mentioned in the previous paragraph, you should still be aware of the tradeoffs; the price you pay for the ability to customize your living space is that most of the value can disappear with a particularly shitty election outcome, war, immigration, the collapse of the financial system in that country—anything you can’t get insurance for.)
The usual financial justification for owning a house is that you are “naturally short housing.” If you expect to live in the same place your whole life, then you’ll owe more money when rent goes up. So you want investments that go up in money when rent goes up and down when rent goes down. Being 100% exposed to the local real estate market is roughly optimal (though less if you aren’t certain you are living there, or if you are more likely to move neighborhoods and you don’t want exposure to this particular house). I don’t think you can decouple these two.
100% exposure to local real estate is different than 100% exposure to a particular house.
>Being 100% exposed to the local real estate market is roughly optimal
I only think this was true in the era before arbitrary portfolio construction for minimal fees. It might be the best hedge available due to taxes and leverage for some individuals but only once they have enough money that they won’t be screwed if their housing investment goes sideways. People sometimes think of this as a good asymmetric bet due to it being the only highly leveraged investment available to younger people, but between deficiency judgments, the expiration of the mortgage forgiveness act (meaning cancelled debt counts as income), and the hassles involved with potentially needing to file for bankruptcy, it’s actually a pretty bad deal to the downside.
So basically if you are going to buy a house anyway, putting it off is almost certain to be better because things swing more in your favor the older you get: less likely to move, have put more money into markets while young so that your nest egg is growing, total assets are larger making the house smaller proportionately, know more about your preferences for housing, have observed the local market for longer, loss of career flexibility is a smaller loss. Probably others as well.
Sure. If you are happy living in that house it doesn’t seem like a big deal. Maybe you could do better by being willing to move out of that house and into another house if this one became more expensive, but for lots of people that’s a pain in the ass (and the idiosyncratic volatility is a small enough deal) that they wouldn’t want to do it and would prefer just hedge against the risk.
If you can make your mortgage payments, how do you end up screwed if the investment goes sideways? In general, how does this change the basic calculus: I need to pay rent in this house, so I want to hedge against changes in rent?
I agree we can have a quantitative discussion about what’s optimal, but to do that you have to actually engage with the quantitative question.
If the house goes sideways your opportunity cost is going way up. Needing to move is also correlated with the value of your house going down meaning you get forced to sell low. I agree that a guesstimate model with bounds would be ideal. I think it’s actually guesstimate’s killer app to give real estate predictions much better than point estimate calculators.
Hedging against changes in rent is fine. I think that if people were to look at the total cost of the rent hedge as a straightforward insurance contract many fewer would pay it due to the very high costs. I think ownership implies less risk to people than they’re actually getting over long time spans.
Speaking from my “N = 1” perspective: Yes, there is the disadvantage that if something bad happens, e.g. some idiots win the election and decide that my country leaves EU, the value of my lifetime savings could drop dramatically overnight. Same thing if there is e.g. a terrorist attack and my lifetime savings become a cloud of smoke and a heap of rubble, in even shorter time interval.
However, if the above described things do not happen, then I live in a middle of a city with job opportunities left and right (since I have moved here my commute means walking on feet), and I am a boss of what happens inside my place. New buildings growing around me increase the value of my property (it makes my place closer to even more job opportunities), while inflation reduces my mortgage payments to peanuts. The rent collected from the other place I own (where I lived previously) increases. At this very moment the rent I collect from one place (much smaller and further away from the city center) equals the mortgage payment at the other place, so this cancels out; I am looking forward to the surplus in the future.
I am not saying this is a proof that owning the place is better. As Moses said, this is a different risk profile; different advantages, different disadvantages, different probability distribution. I am just saying that from inside, for me, having invested in buying my place feels good. I do not regret not renting my place in the past instead.
In theory, the parallel-universe me could have rented the places, and invested the extra money instead. In practice, I shiver when I imagine what kind of investment the 15 years younger me would have made. Because my 15 years younger me actually had some extra money, invested them, and the money just evaporated. In my defense, it was before I ever heard about passively managed index funds. I live in a post-communist country, where people do not know how to handle having extra money, because in the past this kind of problem simply did not exist. All financial advice you can get here, is scam, regardless of the source (the bank I have money in regularly offers me “opportunities” that are obvious shit). Today I understand this; 15 years ago I didn’t. I am really happy that I bought my first place instead. This lesson may not generalize for you; but I think that investing in your place can make sense for people who are not financial experts, because the situation is relatively more legible. (Unlike with various funds, a scammer just cannot sell you a cardboard house pretending it was build from concrete; and the house you bought won’t keep changing its shape and address during the next years.)
I somewhat agree about bad financial advice but people also do get bamboozled by real estate investment all the time.
When I bought my current place, I learned that “partial reconstruction” means last-minute changes that look pretty when you are inspecting the place, but start falling apart when you actually use it for a few months. Still, the position in the center of the city and the area in square meters remain the same; and those make about 80% of the value.
With funds, the real deal being 80% of what I was promised, would be much better than I ever got.
Agree with most of what you said
mostly because tax implications and managing a property both make the returns lower than REITs on average.
In practice I don’t find people’s reasoning for owning very convincing. It feels like people buy houses because it’s just the thing you do and the reasons are mostly post hoc. People don’t customize their houses all that much, to the degree they do it doesn’t get them very good returns on well being per dollar spent, and they pay larger well being costs from the aforementioned commute and career inflexibility problems. I can definitely imagine stumbling into a really good ownership deal, but I don’t expect it and don’t waste time looking. I can definitely sympathize with the inclination. Every once in a while I look around on zillow on what I could theoretically afford, which is a fun exercise. Fortunately the thing doing this reinforces for me is that housing is getting cheaper for me relative to my portfolio over time. So whatever I can afford now I can do even better in the future (and as a smaller proportion of net worth, which makes it more attractive hedge wise). Of course, the fact that that *will always hold true* at any given instant means I’ll likely never buy. But that’s fine. Changing my mind in the future is cheaper than changing my mind now.
I feel conflicting desires here, to point out that this sometimes happens, and to worry that this is justifying a bias instead of correcting it. For example, I switched from ‘wanting to rent’ to ‘wanting to buy’ when I realized that I would benefit a lot from having an Endless Pool in my house, and that this wasn’t compatible with renting (unless I could find a place that already had one, or whose owner wanted one, or so on). But also that this convinced me doesn’t mean that most people who are convinced are correctly convinced. It might be better for me to do whatever ‘looking seriously at the price differential’ and deciding to invest in the policy of walking to the local pool more instead; but I think actually money isn’t the main thing here. (Like, for a while I thought it was better to be in Austin than in the Bay because a software engineer would earn about $10k/yr more all things considered, and then after thinking about it realized that I was happy paying $10k/yr to be in the Bay instead.)
closely examining aversion to other forms of exercise might be the move, but in general I agree, there can be large gains (well being and productivity) from idiosyncratic amenities. I do much better when I can walk to the woods for instance, which winds up heavily informing my ‘fuck big cities’ attitude.
I also think this class of argument can easily cut the other way. Many wind up with golden handcuffs needing to maintain cash flow to build equity in their nest egg whereas their counterfactual selves might be retired and traveling the world.
I’m pretty surprised this entire argument goes without using any amount of quantitive modeling or data analysis.
I do think it presents a bunch of persuasive and philosophical arguments in the direction of your conclusions, but it’s easy to imagine (and find, searching on the internet) persuasive and philosophical arguments in the opposite direction.
(Caveat: I’m a bit new to this forum and how things work, but surely for folks here this is better answered by building a model and incorporating uncertainty?)
A few of the specifics you give I’ve found are not borne out in the research I’ve done (e.g. price sensitivity has more to do with location/centrality than it does with luxury, though more luxurious homes tend to be built farther from city centers). This could just be from different sources, but I’m noticing want to wave several large [CITATION NEEDED] flags.
Also maybe it’d be useful to share the quantitative analysis I’ve done? Basically “modeling the financial, legal, and social implications of buying a house together” has been the biggest project of mine for 2019 outside of work, but I’m not an expert (most of us in my house, myself included, are first time home buyers). I’d consider myself better informed than the average person who has not owned a house for an extended period of time, but would be very interested in learning more and learning where my models are bad.
For interested folks I found Shiller’s Irrational Exuberance to give a bunch of nice solid models (backed with data!) on speculative pricing bubbles in ways that seem to apply to SF bay area housing in particular.
I’d be extremely interested in the quantitative analysis you’ve done so far.
2 years later, I’d still be interested in your model if you’re willing to share it.
People who rent houses make money from doing it—landlords aren’t in it out of the goodness of their hearts. I guess maybe you can get this kind of gap if you use nominal rather than real interest rates? But that doesn’t seem financially relevant.
To first order you are going to be paying the same amount whether you buy or rent, unless the market is irrational. The most important corrections are (i) you’ll be making a big investment in housing and the sales price will incorporate the value of that investment, so you need to think about whether you want that investment, (ii) there are transaction costs and frictions from both buying and renting, and the buying transaction costs will be larger unless you are living in one place for a reasonably long time.
(Maybe 10 years is the right ballpark for amortizing out transaction costs of buying—e.g. if those costs are 10% per sale, then over ten years that’s 1% of the value of the house per year. At rent to buy of 30, that’s about one third of rent. Some of the buying overhead will be embedded in rent, since landlords need to break even. And I’d bet the total inefficiencies of renting are in the ballpark of 10-20% of rent.)
So if you are living long enough to amortize out the buying transaction costs, now we are comparing the investment in housing to the investment in the stock market. The most important argument here is that if rent goes up your obligations go up, so you want investments that go up in that case as well. If you are staying in one place, owning a house is basically the optimal hedge against future rent obligations (since an increase in expected future rents will increased your wealth by exactly the same amount). I think there are a lot of caveats to that argument, but it’s a reasonable first order approximation and it’s a mistake to think about the finances of buying a house without considering it. This depends mostly on living in the same real estate market for a long time, not living in exactly the same house (though it’s even better if you are living in the exact same house).
This assumes rational markets. It’s like buying a bar because you assume bar owners are making money, or buying an airline because you assume airline owners are making money. Neither do on average. Intuitively it makes sense that an investment that ‘everyone knows is a good idea’ wouldn’t be all that great. Why do landlords do it if they aren’t building meaningful equity at super high rent to buy ratios? Leveraged speculation (aka high stakes gambling). This is dangerous for the average buyer since it means the market is less reliant on fundamentals than you might guess.
To be more concrete: in expensive housing markets landlords are typically losing money, cash flow wise, in order to participate in speculation. In cheaper markets landlords typically make a bit of money cash flow wise but when you price out their time and opportunity cost this doesn’t wind up being a particularly remunerative avenue. Again, people tend to point to winners of this slot machine.
in the long run averages over entire markets will approximately equilibrate. But that doesn’t matter if you’re playing against idiots with incoherent time preferences in popular markets. You’ll need to outbid someone making a poor financial decision. Cash flow wise you pay a lot more upfront (down payment plus 50% more than you would have paid in rent), which as mentioned has opportunity costs since young people are cash flow constrained (which is also why young people should be leveraged into their portfolio).
you have to multiply out by the chance that you’ll need to move sooner, raising average costs.
the optimal hedge is whatever grows your money the fastest in a way that isn’t correlated with your other cash flows + assets. A portfolio that is better hedged against local markets and less volatile than housing can be constructed and will grow faster than rent reliably.
In aggregate, the housing market is only slightly more volatile than markets, but buying a house isn’t buying into the housing market like an index, it’s buying one house. The data on private losses is really bad, but my best guess is that there is massive survivorship bias and failure to account for imputed rents and opp. cost at play.
If you want to convince the reader “it turns out most investors are getting a bad deal, and are only doing it because they are idiots” then I think the burden of proof is switched, now you are the one claiming that the reader should be convinced to disagree with investors who’ve thought about it a lot more.
(I also don’t think you are right on the object level, but it’s a bit hard to say without seeing the analysis spelled out. There’s no way that nominal rather than real interest rates are the important thing for decision-making in this case—if we just increase inflation and mortgage rates and rent increase caps by 5%, that should clearly have no impact on the buy vs. rent decision. You can convert the appreciation into more cashflow if you want to.)
The basic argument in favor is: if I want to keep living in the area, then I’m going to have to pay if the rent goes up. Not buying is more of a gamble than buying: if you buy you know that you are just going to keep making mortgage payments + taxes + maintenance, while if you don’t buy you have no idea what your expenses are going to be in twenty year’s time. (But I totally agree that buying a house depends on knowing where you want to live for a reasonably long time. I also agree that e.g. when housing prices go up your wages are likely to go up, so you don’t want to totally hedge this out.)
The optimal hedge is anticorrelated with your other cashflows, not uncorrelated. In this case, future rent is one of your biggest cashflows.
What’s better correlated with my future rent, then an asset whose value is exactly equal to my future rent payments?
It seems like your argument should come down to one of:
You don’t know where you’ll be living in the future. I think this is really the core question—how confident should you be about where you are living before buying makes sense? My guess is that it’s in the ballpark of the rent-to-buy ratio. I think people could make better decisions by (i) pinning down that number for the markets they care about, (ii) thinking more clearly about that question, e.g. correcting for overconfidence.
You may be tied down to an area, but should be willing to move out of your house if it becomes more expensive, so you shouldn’t hedge against idiosyncratic risk in this exact neighborhood. This depends on how attached people get to houses and how large is the idiosyncratic real estate risk. (Maybe this is what you mean by “hedged against local markets”?) I don’t know the numbers here, but I don’t think it’s obvious.
can I expect to beat the average professional investor by buying an index fund? Yes. I’m claiming you can beat the average house buyer by not buying, because houses are overall very overbought. This is expected of a market where the prevailing wisdom is ‘throw as much money as it as you can.’
The bounds n how well you will be doing relative to costs in twenty years time has reasonable confidence bounds whether you buy or rent, we have lots of historical data for both. Why would extrapolating from buying trends be more valid than extrapolating from renting trends? IIRC purchase prices are more volatile than rental prices overall, and this effect is stronger at the high end. To reiterate, there is a premium on buying in some markets and the premium is related to the cost of competing with other speculators.
That’s right, I was wrong.
I meant that you can get a better deal. You can get something that is only marginally more correlated but much much cheaper in the market.
also: people should expect regression to the mean in the most expensive markets and therefore want to think twice or three or four times before becoming convinced they are getting a good deal.
Hmm, I notice that we’re making exactly opposite prediction types on two different assets. Last year I made a momentum prediction on the stock market (real returns to be around 7% in line with history), you made a regression to local trends argument (<2% growth in line with recent slow growth of underlying factors). In real estate here I’m making a regression to the mean argument (I expect housing to under perform because it has been over performing by quite a bit over the last 20 years. ) and you’re making a momentum argument...
Regression to the mean arguments tend to be reference class tennis, since regression to a particular mean is just an argument for momentum on a different time scale. In either case there’s an argument to be made about ceilings on asset prices (earnings on stocks, ability to service monthly payments on mortgages). In both cases there’s a reversion to mean argument to be made when recent growth has brought the asset price much closer to a relevant ceiling.
I think in both cases people have been surprised by how much the ceiling has gone up? In stocks corporate earnings have become much larger than people would have predicted at the same time that stability was increasing which means people were willing to accept higher multiples on those earnings. Housing is somewhat downstream of this. The strongest markets have been subject to very cash rich buyers, both tech workers and foreign capital pushing mortgages up to levels that wouldn’t be affordable to most. Living in a city turned out to be a better deal (decreasing crime and pollution and increased earnings power) than thought so people are willing to accept longer payback times on houses. There’s a question about which is more constrained and likely to hit a wall sooner. If corporate earnings go down raises and new entrants will slow down, lowering the amount of cash entering these markets. Elasticity to shocks compared between asset classes might be the thing.
edit: thinking about it a bit more, it seems like corporate profits have a lot more headroom than house prices. When house prices get too high more people do in fact rent and just choose to retire elsewhere after making massive salaries. There is less political will to force people to pay more for housing than there is to maintain corporate monopolies that ensure lack of new entrants. Companies also eventually start building housing (as google is doing now) because the calculus flips on paying workers more vs giving them more benefits (esp b/c tax structuring). I guess with corporate profits eventually people start doing more illegal end runs around monopolies.
I’m not really making a claim about momentum, I’m just skeptical of your basic analysis.
Real 30-year interest rates are ~1%, taxes are ~1%, and I think maintenance averages ~1%. So that’s ~3%/year total cost, which seems comparable to rent in areas like SF.
On top of that I think historical appreciation is around 1% (we should expect it to be somewhere between “no growth” and “land stays a constant fraction of GDP”). So that looks like buying should ballpark 10-30% cheaper if you ignore all the transaction costs, presumably because rent prices are factoring in a bunch of frictions. That sounds plausible enough to me, but in reality I expect this is a complicated mess that you can’t easily sort out in a short blog post and varies from area to area.
If you want to argue for “buying is usually a terrible idea, investors are idiots or speculators” I think you should be getting into the actual numbers.
The actual numbers are somewhat idiosyncratic but my main point is that in the process of investigating the numbers most people don’t evaluate downsides because they don’t occur to them. Once these costs are taken into account the marginal buyer will flip on the decision. In extremely hot markets you are much more likely to be like the marginal buyer rather than the average buyer.
What’s the alternative?
I’m not claiming to have constructed as such, I’m claiming that with covariance data such a thing could be constructed. There are things like inverse real estate indexes, so whatever they do to construct their shares could be tuned for the same purpose.
edit: thinking about it more, wouldn’t a person want an asset anti correlated with their own future cash flows? You’d want to account for rent and unemployment and predictable changes in future cash flows. What else?
I’ll bet against.
So is the bet for the construction of a financial instrument that moves like a leveraged case-shiller housing index for a selected city with tracking error + fees smaller by some factor than the average frictional costs in the buying market?
edit: oh in this model we’re mostly concerned with the rent hedging value rather than the speculative value (that being seen as mostly a thing that subsidizes the rent hedge here) so we’d really want something that pays you when the rent index deviates substantially from its trend. If we were happy with just hedging the long term trend I think that could be done cheaply with fixed income levered appropriately, but I’d have to show that it won’t suddenly change correlations under various conditions.
edit 2: I think there’s some aether variable-ing going on here. Rental market are much more liquid and display lower volatility than housing markets. So in order to purchase a hedge against rental price (cash flow) appreciation we expose ourselves to much more volatile net worth swings? That only makes sense for people with poor savings (almost all ‘normal’ people. But normal people aren’t trying to buy in the most expensive markets anyway).
Housing markets move because they depend on the expectation of future rents. If I want to expose myself to future rents, I have to take on volatility in the expectation of future rents, that’s how the game goes.
It seems to me that this is the key point, which is why you made it the title and the first sentence of the original post, but I feel like it has been lost in the discussion and maybe swamped by the rest of your post. The longer the tenure, the better buying is. 10 years seems pretty short to me, maybe not a mistake for the average buyer, but definitely a mistake for the marginal buyer. I’d expect most buyers to have an explicit model of more than 10 years, not just a tacit model. But translating it into hours seems to lengthen or obfuscate it and distract from the point.
Among first time buyers[1]
33% move out within 6 years
45% move out within 10 years
keep in mind that 10 year is the average *financial break even* time which means any not-normally-counted costs (non financial benefits of renting) haven’t been accounted for. In the Bay you’ll break even in ~15 years *assuming current conditions prevail.* Which would put median Bay area houses at over double current prices in real terms. This would put mortgages in a range where only a DINK tech couple could afford the average house.
1. http://nahbclassic.org/fileUpload_details.aspx?contentTypeID=3&contentID=194717&subContentID=482084
there may be more recent data available but looking at how the numbers shift over time I don’t expect the difference to be large. Tenure went up a bit 2008-2016 but has begun going back down. It’s hard to find reports of distributional data vs means and medians, generally without even a SD.
Edit: in hot markets tenure tends to be longer, median for SF is about 16 years. So slightly more than half of people reach break even in SF, about the same in the south bay. A coin flip on financial outcomes seems bad once non-monetary costs are taken into account (time + opp.)
There is a lot of good sense in this article, but I have some problems with it. Perhaps the biggest: It appears to be written as if a house is only an investment; as if the buy-or-rent decision is made entirely on the basis of what will maximize your future overall wealth. I’m all in favour of maximizing wealth (all else being equal, at any rate) but a house is not only an investment; it is, as you point out, also a place where you are likely to be spending ~87k hours of your life, and you may reasonably choose to do something that makes you poorer overall if those 87k hours are substantially more pleasant for it.
Those non-financial factors aren’t all in favour of buying over renting. The article mentions one that goes the other way, though of course only in the context of what it means for your financial welfare: if you rent and don’t own, then it’s often easier to move. Here are some others:
Buy, because if you rent there are likely to be a ton of onerous restrictions on what you’re allowed to do. No pets! No children! No replacing the crappy kitchen appliances! No changing the horrible carpets!
Buy, if the properties available to buy (where you are) are more to your taste than the ones available for rent. Or: Rent, if the properties available to rent are more to your taste than the ones available to buy.
Buy, because if you rent then your landlord can kick you out on a whim. (Exactly how readily they can do that varies from place to place, but they always have some ability to do it and it’s a risk that basically doesn’t exist if you buy.)
Buy, if you get a sense of satisfaction or security from owning the place you live in. Or: Rent, if you find that being responsible for the maintenance of the place feels oppressive.
Some other quibbles.
Does that include morgage repayment as well as mortgage interest? Mortgage interest, taxes, and fees are straightforwardly “lost” in the same sort of way as rent is; mortgage repayment, though, is just buying a house slowly. That money is invested, in real estate rather than in equities, and it is earning you a return. (Possibly a smaller, more volatile, and/or less diversified return, for sure; I’m not disagreeing with that bit.)
OK, let’s look. Where are the actual numbers? All I see is vague descriptions (e.g., A invests immediately before each crash, but how much do they invest on each occasion? An amount derived somehow from that $200/mo, but how? E.g., is the idea that the money sits there until a crash is about to happen and then however much is available gets invested, or what?) and final numbers with no explanation or justification or anything. For all I can tell, romeostevensit might just have made those numbers up. I bet he didn’t, but without seeing the details no one can tell anything.
Also: $200/mo 40 years ago is a very different figure from $200/mo now. Does anyone do anything at all like investing at a constant nominal rate over 40 years? It seems unlikely. If instead of “$200/month” you make it “whatever corresponds to $200/month now, according to some standard measure of inflation” then the numbers will look quite different. (For the avoidance of doubt, I expect that A,B,C would still come out in the same order.)
[EDITED to add:] Anecdotally, the people I know who have bought houses generally seem to have done OK, largely independent of when they’ve bought; the people I know who have rented seem to have had no end of problems. But (1) this is a small and doubtless unrepresentative sample, and (2) I think richer people are more likely to buy and poorer people more likely to rent (especially as I live somewhere where buying is generally assumed to be something you want to do), so I don’t think this is very strong evidence of anything.
and buying for those reasons makes more and more sense in sanely priced markets (ie a reasonable breakeven time).
> Does that include morgage repayment as well as mortgage interest? Mortgage interest, taxes, and fees are straightforwardly “lost” in the same sort of way as rent is; mortgage repayment, though, is just buying a house slowly. That money is invested, in real estate rather than in equities, and it is earning you a return. (Possibly a smaller, more volatile, and/or less diversified return, for sure; I’m not disagreeing with that bit.)
I don’t break down different costs, I look at how much money you put in over time and how much you wind up with at the end. The cash flow argument is relevant because of the opportunity cost of a compounding return in the market being stronger on average than returns to housing.
> OK, let’s look. Where are the actual numbers?
It’s based on a simple portfolio backtest (ex post) + monte carlo (ex ante). Yes the money is held. You’ll need to assume in general that I did distinguish between nominal and real dollars everywhere in the analysis that lead me to saying the things I said. I currently don’t have a definitive answer for whether future inflation variance would hurt investors or home buyers more.
> Anecdotally, the people I know who have bought houses generally seem to have done OK, largely independent of when they’ve bought; the people I know who have rented seem to have had no end of problems.
Most renters don’t actually put their money in stocks, they spend it. Which is a major consideration for normal people. House buying winds up being net positive for probably the majority of the population as forced savings. And sure, most home buyers do ‘okay’ but only if you ignore the counterfactual where they retire years earlier and are less stressed in general. People imagine buying a home will reduce stress the same way single people imagine a relationship will reduce stress...which is to say, sure, it can, but the variance is about the same.
Repayment versus interest etc.: Looking at total money in and total money out is fine so long as you do it carefully; in this case “carefully” means you can’t just say “If that money were invested in the market it would be earning you a return” as if those mortgage payments aren’t earning any return. I don’t know how a typical homeowner’s payments divide between repayment, interest, and other things, but it seems quite possible to me that more than the difference you’re talking about is repayment, in which case it could even be that the higher returns you (might hope to) get from investing the money in index funds rather than housing are more than counterbalanced by the fact that more of the money is being invested.
Of course the right way to answer this is to do the actual calculations, and you very reasonably suggest that your readers go and find a rent-versus-buy calculator and try to do them. Nothing wrong with that. But I think the way you describe the situation is no more accurate than the “if you rent you’re throwing the money away” line one hears from people arguing on the opposite side.
Stock market investors: If those numbers for hypothetical investors A,B,C come from a simulation you did then I think the article should say so, and should say something about what assumptions you made. As it stands, you’re just asking us to take them on faith. I don’t find them terribly implausible, and your simulations may be excellent, but we can’t tell that.
Anecdotal nonsense: Yup, the forced savings thing is a good point (and presumably not very applicable to anyone who’s bothering to read a lengthy article about the financial merits of renting versus buying). My suspicion is that the “poorer people rent, richer people buy” dynamic is an even bigger reason why my observations aren’t much evidence about what any given person here should do. But I don’t think the counterfactual is relevant here, because the observation I was drawing attention to wasn’t “buyers are doing OK” but “buyers are doing better than renters”.
Yes, home price appreciation is taken into account. Fraction of equity earned over time (loans being front loaded with interest payment) is taken into account.
Back testing portfolios isn’t very hard nowadays: https://www.portfoliovisualizer.com/
I’m sure you took into account things like house price appreciation. But what you said about investing the difference between what renters pay and what owners pay was misleading and wrong. You can do as careful and accurate and insightful a simulation as you please, but if what you say is “people pay more in mortgage + fees + taxes than in rent, which is bad because they could have invested the difference in the market and then they’d have got some actual returns” or “rent is bad because it’s just throwing money away” then you are making a broken argument and I think you shouldn’t do that. Not even if the conclusion of the broken argument happens to be the same as the conclusion of the careful accurate insightful simulation.
The question isn’t whether back-testing is hard, it’s how well you did it and whether whatever assumptions you made seem reasonable to any given reader. Again, my complaint isn’t that your final results are bad, it’s that we have no way of telling whether your final results are good or bad because you didn’t show us any of the information we’d need to decide.
[EDITED to add:] This is all coming out more aggressive-sounding than I would like, and I hope I’m not giving the impression that I think the OP is terrible or that you’re a bad person or any such thing. It just seems as if your responses to my comments aren’t engaging with the actual points those comments are trying to make. That may be wholly or partly because of lack of clarity in what I’ve written, in which case please accept my apologies.
I get it, I get this shape of feedback on LW and expect it. I think it’s a product of differing expectations for what sort of posts belong on LW. This post isn’t particularly concerned with the full suite of tools you’d need to deploy to rigorously show that my argument is correct. And that isn’t its intention. I wrote this because people asked me to surface all the relevant considerations I was aware of for home purchase. In my model, becoming aware of the relevant considerations is often much more important than tuning the confidence bounds of the considerations one is already aware of. The frame of the post assumes the sign flip that I think those considerations warrant, which makes it not come off as a collaborative truth seeking effort either. And I am open to having missed important things. But I’m not going to backfill all the epistemic rigor. I don’t know of a good write up that argues the opposite side of this that actually takes into account the seemingly important things.
I haven’t been following the thread here, but from a quick glance, seems like that would have been good to include an epistemic status or other preamble about your intention with the post. From my quick read, I had the impression that it was very carefully considered/rigorous.
Added some info at the top. I think some people want a degree of quantitative modeling that I’m not going to pour 10+ hours into polishing into usable form. This should ultimately really be a guesstimate model and I’d encourage someone with the relevant chops to apply to the EA funds to get a grant to create a much better rent-to-buy calculator that the entire community can then use to get better confidence bounds on individual decisions.
My own take is “it’s quite important for people to throw up ideas on LessWrong without being forced to delve into hours of rigor, but for that to really work as a norm I think it’s fairly important to have epistemic statuses spelling that out, so people know what to expect.”
(I also have not read this post or discussion, don’t have strong opinions about this particular example).
Yes, with the edit “Quite important” → “necessary”
My wife and I owned a house for about a decade, then rented for a few years, and now own another house. I don’t expect to rent again, and I do expect to move locations a few more times.
Whether it’s a good investment is … idiosyncratic. It’s a single asset in a limited market. It’s the least liquid investment I can imagine (with the possible exception of owning a business, which I’ve done and don’t intend to repeat). I’ve gotten lucky, and paid attention to location and sustainability of growth, and it’s worked out well.
If it had worked out super-poorly, like statewide crash, lost job, mortgage default bad, it would be worse than renting. If it had only worked out mildly bad, a loss in value but still able to make payments, I’d prefer it to renting, even at a financial loss.
Control is worth a lot to me. I can fix things to my liking. I can make upgrades that I like, rather than asking the landlord to make minimal repairs to protect their value. I will move out on my timeframe, not someone else’s.
And that’s fine. I just think a lot fewer people would choose ownership on the margin if they were fully aware of the costs and benefits.
Who’s that average person you are talking about and where does that number come from? Are you speaking about the mean time a US citizen spends in their house before moving or are you talking about something else?
https://www.lesswrong.com/posts/X7G3HfRuMzCSBzgbM/87-000-hours-or-thoughts-on-home-ownership#Sofu2NKFTMsT6y4it
So it’s the average US single-family household.
Higher in more expensive markets, but yes.
I did not read—so probably should not comment, but will anyway. In a very quick skimming nothing jumped out at me regarding the aspect of time horizons and particularly wealth transfer to the next generation.
Did I just miss that? If not would adding the idea of inter temporal transfers (inheritance) change any of the conclusions?
[Edit to add] While not about a house, I recently sold a trailer and truck. Given the response I was clearly under market price but as I was really interested starting to “clean up” my possessions I am not crying about the possible opportunity loss there. But was I did give some thought to was: What was a rough estimate of the rental rate on the two for the time I owned them. A very quick and crude calculation in my head came to under $400 a month easily.
That is a little deceptive in that these were not really used daily or even weekly—lots of down time. So (assuming I could even find a place to rent what I had) I might have come about better renting rather than buying. But that is only because I was not using them daily. If the house worked out the same I think I come out miles ahead buying the house in most situation. (Anecdotal to be sure and possible not a good comparison setting)
Not sure why home vs financial assets would be better or worse for inheritance. Ultra long term I’d expect old houses to become a bit of a money sink.
I don’t know how much it varies by jurisdiction, but in the USA there’s some weirdness in handling of cost basis and capital gains for inheritance of real estate that doesn’t apply to more liquid assets. Effectively, heirs can pay less taxes on the gains from real estate if they inherit rather than buying an appreciated asset.
I think one aspect is that financial assets are merely stores of wealth with potential for growth/returns as well as risks. The house has both of those as well as a direct use value in consuming the housing services. Additionally it offers something of a risk/uncertainty mitigating role. Once paid for the cost of consuming that housing services is pretty low so even if you see a bit hit to your income you still have a stable place to build from.
I think it’s really all the non-pecuniary aspects that get missed when analysis starts relying too strongly on the monetary equivalence point of view; by which I mean we start filtering those aspects out and just don’t see them.
In a booming market, buying can be valuable as a hedge against rising house prices
In a booming market your portfolio is booming as well. Viewed strictly as a hedge, houses would be egregiously expensive. Everyone is tacitly including in their mental model the idea that houses will keep increasing in price at whatever the recent rate has been. This is speculative.