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.
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.
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.
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.
These scenarios are still highly reliant on you being sure you want to stay in a particular spot for at least 10 years
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.)
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?
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.
100% exposure to local real estate is different than 100% exposure to a particular house
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.
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.
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.)
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.
See, you’re conflating land ownership and tenancy here.
mostly because tax implications and managing a property both make the returns lower than REITs on average.
There is of course a reason to own a place
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.
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 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.
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.