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.
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.