A Flea in the Fur of the Beast

“Death, fire, and burglary make all men equals.” —Dickens

Tag: housing

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.

[…]

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?).

The Fed is not out of bullets (why QE3 will work)

by pdxblake

Paul Krugman offers an explanation on how QE3 will work, and also why it may be more effective than QE2, the last iteration, which has led many critics to conclude that the Fed is out of bullets or declare a diminishing return on successive rounds of quantitative easing.  Krugman writes:

Now, what you learned back then was that the transmission mechanism worked largely through housing. Why? Because long-lived investments are very sensitive to interest rates, short-lived investments not so much. If a company is thinking about equipping its employees with smartphones that will be antiques in three years, the interest rate isn’t going to have much bearing on its decision; and a lot of business investment is like that, if not quite that extreme. But houses last a long time and don’t become obsolete (the same is true to some extent for business structures, but in a more limited form). So Fed policy, by moving interest rates, normally exerts its effect mainly through housing.

The reason why housing is a good way to influence the direction of the economy now (and why it has become a better transmission mechanism since QE2) is that rising house prices (particularly when the home equity is positive) is that it makes people feel wealthier and thus more willing to spend on other things.  Monetary easing also (as Krugman pointed out) affects the decision around investing in new long-term investments (like housing).

The effect on spending from the wealth effect (from rising house prices) is greater than from other sources because people buy houses with borrowed money (a mortgage).  This increases the feelings of higher wealth from rising house prices more than the percentage by which they increase.  And right now, house prices are just beginning to rise after several years of decline.   The Fed’s easing will help accelerate the rise in house prices.

In addition, there have been a lot of people with negative home equity (meaning they owe more on their houses than the houses are worth).  This has negative effects like a lowering of their wealth and also making them less mobile (if they are not working) to move to take a job.  As the negative equity decreases and prices rise so that they have positive equity, the wealth effect should be even larger, and we are heading in that direction according to a recent data release from CoreLogic:

CoreLogic … today released new analysis showing that 10.8 million, or 22.3 percent, of all residential properties with a mortgage were in negative equity at the end of the second quarter of 2012. This is down from 11.4 million properties, or 23.7 percent, at the end of the first quarter of 2012. … Approximately 600,000 borrowers reached a state of positive equity at the end of the second quarter of 2012, adding to the more than 700,000 borrowers that moved into positive equity in the first quarter of this year.

And, how about new housing?  Well new house starts are going to be helped by more Fed easing and have been on the upturn as vacancy rates for both houses and apartments are declining (unfortunately the data for vacancy end in January 2011).

These factors are combining now in a way that they were not in previous iterations of QE.  We are also not in as dire straights as QE1 (Financial collapse) or QE2 (European debt crisis) so rather than just forestalling greater collapse, QE3 should be able to contribute to more economic growth, which will help to bring down the unemployment rate.

My search for a new apartment sucks more because of the mortgage interest deduction

by pdxblake

This post is going to piss off some of the people who own a house, but here goes (leave the hate mail in the comments, please).  I am searching for a new apartment and I have noticed that the market has become significantly tighter than it was the last time time before last when I was searching for a place to live, which it so happens was before the financial crisis.

The statement I am going to make that will piss off most home owners is that I feel twice screwed by the mortgage interest deduction.  The first is obvious: I don’t own a home so I don’t get the mortgage interest deduction (not to mention the ability to itemize deductions).

The second is a little more complicated, but gives me a chance to run through some economics.  The mortgage interest tax deduction is a subsidy for leveraged home ownership (it only applies if you pay interest every year on a mortgage).

This is a simple supply & demand curve.  What the mortgage interest deduction does in its most simple effect is increase demand (from the blue to the turquoise line, D’) because if you buy a $200,000 house, and pay $10,000 in interest every year (and you are in the $35% tax bracket), you save $3,500 every year in taxes, every year until you pay it off (30 years from now).

The value of $1 is higher today than getting $1 in 30 years, but it still has value in the future (the calculation for how much less that dollar is worth to you is based on the ‘discount rate’; a 10% discount rate implies that getting $1 in a year will make you just as happy as if you got $0.91 today).  So if you add up all those 30 years of savings on your taxes (discounted to the value today, the present value), it works out (with the assumptions above) to about $36,000.

Because you are going to get something (a tax cut) worth about $36,000, you are going to be able to buy more house than if you didn’t get that tax deduction.

Across the entire economy, that will push up demand for single-family homes over apartments (although apartment owners get to deduct interest as well) because more people will buy a house (in part, to get the mortgage interest deduction), and there will be more houses than apartments built in the economy.

Now, take that world, add a bunch of foreclosures and make it really hard for anyone to get a loan to build a new house or buy an existing house.  What happens?  There are going to be a lot of people who delay buying houses (because credit is tight) and a lot of people who used to own a house who are now back in an apartment (after a foreclosure or short sale), and there is an inadequate supply of apartments for the new demand.

And welcome to my world.  I am not going to be too much of a ass about it, but the people who used to own homes and used to get a tax deduction that is not available for renters make up a portion of these people now driving my rents up and making it really hard to find a reasonably priced apartment.  Thanks guys, and thank you, mortgage interest tax deduction.

Just in case you didn’t already know, it’s hard to get a mortgage

by pdxblake

The chart above (ht Jared Bernstein) shows the change in who is getting mortgages these days, compared to the go-go years, and it confirms what most anecdotal evidence suggests: it is much harder to get a mortgage without really good credit.  This is both good (we are not repeating the mistakes of the mid-2000s) but also bad news because it means that fewer people are able to get a loan to buy a house, which will slow the housing rebirth that has taken its first wobbly steps in recent months.  Housing typically makes up a relatively small share of the economy, but is important in making recoveries self-sustaining, the topic of my post earlier about how Mitt Romney doesn’t know what the problem he is supposed to be fixing.

City housing should be family, roommate, and polygamist-friendly

by drewnilsen

Having recently relocated to Washington, DC, I’ve been grappling not only with the stratopheric rents here, but also with the difficulty of renting a place. I actually wanted to live in one of DC’s larger, beautiful rowhouses — I’m 33, but I still enjoy living in a big house with roommates. However, as the process unfolded, I discovered how aggravating it was — I was competing for every 3-4 bedroom house — even those off the Metro in “transitional” neighborhoods — with 20+ other groups. The fact that I lack an income (I’m still job-hunting! Anyone? Bueller?) — though I have a great credit score and enough savings to pony up an extra-big deposit — and one of my roommates is tromping around the West African nation of Guinea, while my other is from Italy and lacks a social security number, made us untouchables to every individual landlord in town.In desperation, we went to a newer, modern condo, where we figured a larger entity might be more flexible on the financial angle. And, pending my criminal background check (DON’T LOOK IN SOUTH DAKOTA!), they were. Yet, I initially inquired about three bedrooms apartments, and I was surprised that they only had one 3 BR unit in a complex of, perhaps, 100 units.I found this odd, because plenty of 20- and 30-somethings want to live in groups — out of financial necessity or because they want to (I’m sure there’s some theory of Millennials in here somewhere). Or, if you’re doing well, you might want an extra room (or two), and still live in the city. The fierce competition for every large house in DC backs me up on that.

I hadn’t even considered the impact on families, though. Atlantic Cities — my catnip — wrote about the Toronto* Deputy Mayor opposing a requirement that at least ten percent of a new, large development be at least three bedrooms, to accommodate families.

My former colleague and neighbor in DC helpfully pointed out that it’s all about profit; you can command more per square foot from a studio or one bedroom than a 3 BR. His 60s-era urban renewal building, which I can see from my window in SW DC, is in the process of ripping out its 3 BRs to convert to smaller units.

Families and children — like all forms of diversity — are vital to the thriving energy of cities. Plenty of parents still want to live in the suburbs, but many parents my age want to raise their kids in an urban environment. Schools are usually the biggest hurdle (besides expense and space), but city policy and developer short-sightedness shouldn’t also be conspiring against them.

Yet, my own anecdotal house-hunting experience in the last month underscores that there is demand for larger housing units (not to mention the architectural tragedy of chopping up rowhouses and brownstones).

Hopefully, developers will realize this is find a way to not force everyone who wants to live in cities to live in the most little boxes, little boxes. But, cities have the leverage to force developers to build family (and group house) friendly accommodations, to ensure that cities retain a true diversity of residents and options.

*As I’ve learned from the Toronto-native boyfriend of my cousin (both of whom are moving to the thrilling urban environment of Ottawa next month), it’s pronounced “Toronno,” not “ToronTO.” Impress the next Canadian you meet!