It was damn hard to find a place to live, but I lived to tell about it (and respond to the comments on my original rant)

by pdxblake

Now that I’m done with the nightmare of finding a new place to live (yes, it is a nightmare, so much so that I am actually looking forward to moving, but that might be partly caused by the roommate I’m leaving) I can actually write the post I promised in response to the commenters on my last post.  They asked good questions so I am here to answer.

Aren’t apartments owned by someone? Isn’t that ownership usually through the form of a mortgage? Wouldn’t removing the deduction increase the cost of ownership? Wouldn’t that then increase the cost of renting at all times?

Yes, people own the apartments I rent and they do so for more than the charitable purpose of giving me a place to live.  They also tend to finance the acquisition cost with debt (through a mortgage).  They also get to deduct the cost of interest from their income (see my rant on finance and inequality).  Whether or not I agree with it, interest is a deductible expense for businesses, and that lowers the cost of debt-financing for businesses of all types (and encourages higher leverage because profits are magnified by adding more debt).

Removing the interest deduction would lower the rate of return for people who buy apartments to rent out.  That would lead to fewer apartments and higher rents (to offset the tax gift that is the deductibility of intrerest payments).  It would raise rents at all times, but I was specifically saying that the deductibility of interest payments on personal mortgages pre-crisis (as well as the easy lending standards that applied at  that time), coupled with the real estate crash had incentivized more home ownership than was optimal and led to a collapse that pushed–nearly all at once–many people who had once owned homes into renting.

While I do not disagree with the long-run outcome of eliminating the tax-deductibility of interest, there is a big difference between short-term and long-term effects (in the long-run we are all dead, and in the short-run I’m homeless).  The market will eventually clear (probably though higher homeownership by people who didn’t buy homes in the bubble, who can get the low interest rates today).  But in the interim, rents will trend higher until banks loosen lending standards back to pre-pre-crisis levels (20% down and all the rest)

So, in the end, I agree with your point and it is probably better to eliminate the mortgage interest tax deduction gradually over time when the housing market (and economy) are more ‘normal’.

Also, in your example the benefits of ownership apply to one mortgage held for thirty years. Each new home purchased requires something like 5% of the value of the house to acquire in fees, so in your example the opposite of a deduction of $10,000. This means it is cheaper to own than rent if you do not move more than once every seven years (not including inflation) (4×10=$40,000 > $36,000) but more expensive to own if you wish to move more often. Without the deduction it would never make sense to own, thus vastly increasing the cost of rent because of demand (at least in the short term) skyrocketing.

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It’s cheaper for you than owning, has less risk (you can’t lose your life savings), doesn’t require sudden outlays of cash if something breaks, and is far more flexible. Owning a house only makes sense when the appreciation of a house rises more quickly than inflation as a whole (like the stock market) and you plan on staying in that house for years.

The costs of homeownership are somewhat hidden (you can’t predict when your house will break in ways that cost you a lot of money all at once).  There also up front costs of buying the house beyond the down payment.  My friend Dan who commented on the post pointed me to a calculator from the NY Times that does a good job at showing some of these costs and shows break-even points for the investment in a house.

One of the big problems with the housing bubble was that houses ceased to be an investment and just became a trade (ask your friend in the investment industry about the difference, I’m sure you’ll get an earful).  When you are ‘trading’ houses, the defects with the house are not a problem, just a cost of doing business.  You are capitalizing on the rising price of the house to bail you out.

Now that that people are not investing in houses to try and get in on the latest trend (stricter lending standards–tighter credit–put an end to that fad), the mortgage industry has become more staid, and we are back to the same long-term decision-making between owning and renting.  But, that long-term shift has very little to do why it was so much harder to find a place to live (renting) today.

Now on to the final comment I’m going to describe in depth (God damn microeconomics still is hard for me, I like macro so much more):

In any case the mortgage interest deduction increases the marginal rate of substitution for home ownership over renting, which by definition increases the elasticity of demand for rental units and relieves pressure on their price. While it may be problematic for other reasons (hardliners argue that any government intrusion to increase liquidity in a market drives up asset prices and facilitates bubbles), the mortgage interest deduction favors renters by reducing the number of competing ‘buyers’ (the rental market actually being a market for buying/selling leases).

You are correct with the normal relationship between the  effect of the tax deduction on rental prices, but it is only in a perfectly functional market does this relationship hold.  When credit markets will not lend to borrowers of a certain credit quality (who would otherwise receive credit), the marginal rate of subsititution (MRS) between owning and renting goes to infinity for those people.  No matter the price difference, they have no choice but to rent.  Now add several million of these people who would otherwise, based on their MRS between renting and owning choose to buy a home and you have a problem.

A person may wish to pay higher than market rates of interest for a mortgage on a property, to compensate the bank for the additional risk, the bank currently will just say ‘no, you can’t have a loan at any price’.  This pushes them to rent rather than buy, and the MRS for their purposes is infinity because no matter how much they are willing to pay for a mortgage to buy a property, they cannot get it.  There have always been people whose MRS between owning and renting have been infinity, but now an important segment of the market fall into this category.  Long-term, yes, the credit markets (for mortgages) will get back to equilibrium and then we can argue about whether the MRS effect will keep rental prices at reasonable levels, but that is not the market we live in today (and indeed the MRS going to infinity for a large proportion of the population is one of the main reasons why I wrote my rant, which I will note, was much more based on facts than Rick Santelli’s rant that started the Tea Party, so can I get some credit here?).

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