Homeownership Revisited: An Economist's Perspective

A majority of American adults live in owner occupied housing. As an economist, I celebrate the logic of revealed preference. While many poor people are renters, many non-poor people reveal that the benefits of ownership exceed the costs. In this entry, I would like to delve into the details here. Up front, let me say that I don’t want to discuss the tax code and the nitty gritty of mortgage interest deductions, the GSEs, etc. Instead, I want to talk about why people gain life satisfaction from ownership and what are some of the hidden costs of ownership under our current “rules of the game”. As an urban economist, I want to contrast the private benefits to an adult of owning a home and the local social benefits conveyed to a community when it consists of home owners. Portfolio Risk from Home Ownership Let’s start with a personal example. Back in 2000, We purchased a home in Belmont, MA (a Boston suburb), we paid 1/2 in cash and got a loan for the rest. The cash we invested in the home had a next best alternative. We could have invested in a diversified portfolio of assets rather than making a place based bet. By buying this home, we were raising our migration costs for moving away from Boston and thus were losing some option value if the local economy performed worse than the rest of the nation. A strange feature of the housing market is that owners hold an undiversified portfolio. Imagine an alternative world where I could own 36% of my Belmont home and own 2% of 32 other homes scattered around the United States. This would be a more diversified portfolio. Of course there would be contracting issues in designing this contract. My friend and co-author Joe Tracy co-authored a MIT Press book on implementing these contracts. The Past Rate of Return on Housing for African-Americans In 2021, I released an NBER Working Paper where I use several data sets to make a simple point. Here is my paper’ abstract: “The racial and ethnic composition of home buyers varies across geographic locations. For example, Asians and Hispanics are much more likely to buy homes in California than Blacks and Blacks are more likely to buy homes in Georgia than other demographic groups. Home prices grow at different rates across geographic units such as counties or zip codes. Hedonic bundling inhibits buyers from purchasing shares of different homes and forming a spatially diversified housing portfolio. Spatial variation in purchases suggests that the average rate of return to housing varies across racial and ethnic groups. To test this claim, I construct a geographic shift-share index by combining Zillow geographic specific home price index data with HMDA micro data. The shift share calculations yield the average rate of return to home ownership by purchase year, and sale year for different demographic groups. Over the years 2007 to 2020, Blacks earned a lower rate of return on home purchases than Asians and Hispanics and the sample average. Within geographic areas, average loan differences across racial and ethnic groups are very small.” Let’s unpack this. Over the last 25 years, cities such as San Francisco, Boston, Portland, Seattle, San Jose, Malibu, and Santa Monica have boomed. None of these cities is known to be an African-American city. African-Americans tend to buy in other cities such as Baltimore, Cleveland and Detroit. What is going on here? (and of course I am telling an Average story —- LeBron James lives close to me in Los Angeles’s Brentwood). African-Americans on average have lower wealth than Whites and are less likely to be able to afford the down payment to buy housing in Superstar Cities. African-Americans are less likely to work in Tech than Whites and Asians and this reduces the likelihood that they are living in the major tech hubs. In the areas where African-Americans have ties, house prices have not appreciated much and this means that the AVERAGE African-American homeowner has earned a lower rate of return on housing over the last 25 years. Going forward (from 2023 to 2040) will Baltimore’s housing market outperform San Jose’s? This is possible. In my recent WFH Going Remote book, I present microeconomic arguments for why this is possible if Baltimore improves its quality of life. In closing this section, I want my readers thinking about opportunity cost. If an African-American family owns housing in Baltimore then that money is not invested in the SP500 stock market index. Opportunity cost for asset investments always exist. What About the Consumption Value of Home Ownership? When we teach Econ 101, we introduce our students to the utility function. This is the economist’s “thermometer” measuring how much pleasure we gain from different consumption bundles such as consuming beer or pizza. The consumer knows herself and knows her budget constraint and makes the right (affordable) consumption choice. Assuming people are consistent over time, we learn about their priorities from the choices they make as market prices and their income changes. With this preamble, why does home ownership raise one’s utility? One hypothesis is “pride of ownership”. But what do these words mean? Economists have struggled with modeling the demand for “status”. Economists have taken Veblen seriously and have sought tests of which subgroups of people seek to own and display luxury goods to signal that they are special. Here is a paper about cars and jewelry ownership. Of course, I understand the desire for status. I continue to submit papers to Top 5 journals and to track my Twitter Follower count! But, the point of this 1/2 joke is that there is an ever increasing number of strategies for producing “status”. As I age, I gain pride by reaching my Google Fit target of 10,000 steps a day. During my life time, I have lived in fancy rental housing in Manhattan, Singapore, and Baltimore. Given the changing demographics of our population, real estate suppliers will offer rental properties if there is demand. Don’t Renters Face Displacement Risk and Gentrification Risk? Yes, but if this is a serious concern then renters can sign longer term contracts up front. Scottie Pippen signed a 10 year contract with the Chicago Bulls at the start of his career because of his fear of injury. In a renter economy, there would be less support for local NIMBYism and real estate developers would build more housing and this would reduce rent rise risk. The ongoing conversion of commercial urban real estate into residential housing also reduces the likelihood of medium term rent spikes. I claim that it is time to visit this important paper by Todd and Nick. Sinai, Todd, and Nicholas S. Souleles. "Owner-occupied housing as a hedge against rent risk." The Quarterly Journal of Economics 120, no. 2 (2005): 763-789. Neighborhood Social Capital Boosts Due to Home Ownership? Ed Glaeser and Denise DiPasquale have posited a positive spillover that when real estate is owner occupied that the owner has the right incentives to maintain the property (to maintain the resale value) and to not free-ride in terms of neighborhood attributes such as safety and neighborhood greenness. Their empirical strategy in their applied research was to use panel data at the individual level and observe how the same person behaves before and after she becomes a home owner. A field experiment researcher would want to go a step further and randomly assign similar people at the baseline to renting versus owning and then observe how their home is treated and how their neighborhood’s quality of life changes over time. I greatly admire their work here but I want to be provocative and argue that their work is out of date due to technological change. I want to return to a paper by Baker, George P., and Thomas N. Hubbard. "Contractibility and asset ownership: On-board computers and governance in US trucking." The Quarterly Journal of Economics 119, no. 4 (2004): 1443-1479. These authors tell the following story. Back in the 1970s, truck drivers bringing stuff from California to Baltimore markets had private information about their routes and effort. The food company gave the truck driver a share of the profits to incentivize them to not shirk with respect to effort. The advent of cheap GPS computers meant that the food company could easily monitor the trucker and could now pay him a fixed wage. The same idea holds in 2023 for rental housing. The big data monitor era allows the property manager to have a very good sense of how the tenant is using the property and what is going on in the local neighborhood. If crime rises, the property manager can hire private guards. If litter increases, a crew can be hired to pick up the trash. Markets substitute for social capital and volunteering! Conclusion The modern Economy’s Big Data revolution and climate change risk both create incentives for more of us to be renters. Going forward if more of us are renters in the year 2040; then we gain the following adaptation benefits; #1; Our assets are less exposed to place based shocks (i.e Hurricane Ian), #2 we hold a real option to move away from areas that turn out to be at greater risk from shocks, #3 There is less lobbying for place based subsidies using national subsidies because “victims” have fewer place based assets at risk (i.e we are each holding a more diversified portfolio). If government steps back from insurance markets, the private sector will step up its game and insurance innovation will further spur the pace of climate change adaptation. If these ideas interest you, read my 2021 Yale Press book Adapting to Climate Change.