Who Needs Home Ownership?
Tuesday, October 30, 2012
Home ownership subsidies have imposed costs that are large and clear. The benefits of such subsidies are, at best, small and vague.
In the wake of the financial crisis, U.S. housing policy is in need of overhaul. In this series of essays, I will look at the issues involved.
This first essay will set the stage by looking at the economic fundamentals of home ownership. For those who do not have time to read this entire essay, it can be summarized simply: if you want good housing policy, then you should listen to the recommendations of the National Association of Realtors®, the Mortgage Bankers Association, and their allies… and do the opposite.
What If We Were All Renters?
As a thought experiment, suppose that all households were renters. Picture a scenario in which all types of housing, including single-family detached homes, are owned by various real estate mutual funds and managed by competitive property management companies.
What would this mean for individual investment in real estate? Ultimately, assets belong to households. As individuals, we would own residential real estate; however, we would own it in the form of shares in mutual funds rather than in the form of title to the house in which we live.
One positive aspect of this scenario is that our real estate holdings would be diversified. Our wealth would be less subject to the whims of our local housing markets and the evolution of our local neighborhoods.
The flip side of diversification is that, with renting, there emerge principal-agent problems. The tenant may not act in the interest of the owner, and vice-versa.
For example, when it comes to maintenance, the tenant may be negligent — or worse. To address this, property management companies would have to use security deposits and other contractual terms, just as they do now.
The tenant faces a similar problem. Suppose that you would like an upgrade to your kitchen that costs $40,000. If this raises the market value of the home by more than $40,000, there should be no problem. The owners, too, will want to make the upgrade.
We could have a democratic distribution of wealth without widespread home ownership.
However, suppose that the upgrade you want raises the market value of the home by only $25,000. That is, the most that any other household would be willing to pay in rent for the upgraded kitchen would translate into an increase of the value of the home of just $25,000. Does this mean that, as a renter, you cannot get the upgrade you want?
In such a situation, the appropriate bargain to strike would be for the renter to pay $15,000 and the owners to pay $25,000 in order to get the $40,000 kitchen upgrade. The renter pays the difference between how much he values the upgrade and the amount that the upgrade is valued by other households.
The process of arriving at this bargain might be difficult. The owners would have an incentive to understate the market value of the upgrade. The tenant would want to overstate the value of the upgrade. Only if there were enough competition on both sides of the market would the two sides be likely to settle on the fair price. Thus, we see that one advantage of home ownership is that it eliminates the need for bargaining over home improvements.
It is important to think about what the alternative to widespread home ownership would mean for the distribution of wealth. In my thought experiment, I described a scenario in which everyone has real estate assets, but they are in the form of shares in mutual funds. Thus, inequality is not affected. An alternative scenario is one in which the real estate assets end up concentrated in just a few hands, perhaps because as renters people become profligate and ignore the need to accumulate wealth. Clearly, the latter scenario would be much less democratic in terms of wealth distribution than the one that we have today.
I would argue that the distribution of wealth does not have to depend on the rate of home ownership. We could have a democratic distribution of wealth without widespread home ownership. If we think that public policy should promote saving and wealth accumulation, then there are ways of doing that other than through home ownership.
Perhaps home owners are better citizens. One argument is that owning property makes you a better libertarian, because you appreciate property rights. Another argument is that owning property makes you a better collectivist, because with a long-term stake in the area you appreciate the importance of neighborhood amenities. Which of these arguments holds sway?
If there is a tendency for property owners to become libertarians, I find this difficult to observe. Clearly, most home owners are not libertarians. Some owners, in fact, become decidedly unlibertarian NIMBYs, where “not in my backyard” becomes their byword for infringing on the liberties of others.
Even if owning your home makes you more inclined to be libertarian, that does not necessarily imply that libertarians should want to subsidize home ownership. Households that receive subsidies for home ownership may or may not develop an appreciation for property rights. But they will surely develop an appreciation for subsidies!
If you own your home, then a lot of your wealth is tied in with the quality of your neighborhood. In theory, this should motivate you to vote more carefully in local elections. On the other hand, if you are a renter, and the neighborhood goes downhill, you will simply leave.
If you own your home, then a lot of your wealth is tied in with the quality of your neighborhood.
Collectivists prefer to trap households within specific government service areas. Their thinking is that with the “exit” option foreclosed, households will be forced to exercise their “voice” option, to everyone's benefit. This is an argument against private schools. It goes back at least as far as A.O. Hirschman's classic book, Exit, Voice, and Loyalty.
In my view, the “exit” option works much better than the “voice” option. If a local grocery store does not carry the produce I prefer, the best solution is for me to go to a competing grocer. I feel the same way about schools and local governments. Compared with choosing a competing supplier, it strikes me that writing complaint letters and participating in elections is a feeble way to try to bring about change.
A tradition in the economic literature, going back to a classic article by Charles Tiebout, argues that competition among local jurisdictions, promoted by the exit option, is the best way to stimulate governments to provide a desirable mix of services in a cost-effective manner.
Overall, I think that the collectivist case for home ownership makes sense — provided that you are a collectivist. However, the way I look at it, if being a renter weakens your commitment to local government and helps to facilitate Tiebout competition, then that is a good thing.
I am not saying that we should aim for the scenario in which everyone is a renter. However, we certainly should not be keeping a national scorecard in which a rise in the home ownership rate fills us with joy and a drop in that rate fills us with dismay. Home ownership subsidies have imposed costs that are large and clear. The benefits of such subsidies are, at best, small and vague. Of course, the calculation looks different to real estate agents, mortgage bankers, and their allies in the housing lobby. That is why good public policy is to do the opposite of what they recommend.
Arnold Kling is a member of the Financial Markets Working Group at the Mercatus Center of George Mason University. He writes for econlog, part of the Library of Economics and Liberty.
FURTHER READING: Kling also writes “How to Think about QE3,” “Many-to-One vs. One-to-Many: An Opinionated Guide to Educational Technology,” and “The Economics of Pepco.” Alex Brill contributes “Housing Finance: For Once, Please Leave It Alone.” Edward Pinto explains “Government Housing Policy: The Sine Qua Non of the Financial Crisis.” Phillip Swagel and Jim Millstein say “It’s Time to End the Bailout of Fannie and Freddie. Here’s How.”
Image by Darren Wamboldt / Bergman Group