Who cares about future house prices?

By Felix Salmon
July 17, 2009

James Kwak wonders about the housing market, and price-to-rent ratios:

The fact is that most people buying houses aren’t going to be renting them out, and what they care about is the price at which they will be able to sell that house in 10 years.

Has anybody ever quantified this? Let’s say that you have a choice between renting and buying. If you rent, you just pay $1,000 a month. Alternatively, you can buy a house for $200,000, with a $40,000 downpayment, and pay that same $1,000 a month to service your $160,000 mortgage. (Let’s keep things simple and ignore things like property taxes and mortgage-interest tax relief and maintenance costs and what have you.)

Which do you choose? That’s up to you, of course, and will probably be related to the amount of money you have, and your desire to spend or invest that $40,000 on something other than a house downpayment. But to what degree does the value of the house in ten years’ time affect your decision? After all, you may or may not have any desire to sell in ten years’ time. And even if you do sell, there’s a very good chance that you’ll just end up buying another house elsewhere, which will be similarly more expensive. In that sense buying a house isn’t an investment, so much as it’s a way of permanently covering your built-in short position when it comes to the shelter market.

Similarly, if you’re inclined to rent, the key number you’re worried about when it comes to the future is not house prices in ten years, but rather prevailing rents in ten years. Buying a house can be thought of as paying $40,000 up front to lock in that $1,000-a-month rent in perpetuity. You don’t particularly mind if house prices go up, so long as that’s a function of rising price-to-rent ratios, and not a function of rising rents with a constant price-to-rent ratio.

The point is that in a normal market, the only people who really care about the nominal value of their house in ten years are the people who are essentially timing the market: buying now, with the intention of cashing out in ten years, making lots of money in capital gains, and then going back to renting. That’s a tiny proportion of the housing market. Everybody else is just paying whatever they can reasonably afford.

In a bubble, of course, things change. Then you get a much larger number of speculators, and you also get an added advantage to rising house prices: the ability to refinance your mortgage on a regular basis, taking out cash each time. In general, when a very large number of people think of houses as an investment, that’s a good sign that you’re in a bubble. When most people think of houses just as somewhere you need to pay money to live, either in rent or in mortgage payments, then that’s a much more normal housing market.

Update: Great minds, etc. Karl Smith:

When people asked me about the wisdom of home buying during the bubble my stock response was, “think of your house as a place to live.”

That is, overwhelming the returns that come from owning a home are going to come from the “real dividend” of actually living in the house. In the long run prices may rise and prices may fall but your primary concern has to be keeping your family warm and dry.


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The only way I’ve ever seen housing as an investment is in the sense that after the kids leave home, we move into a smaller (cheaper) house and get back the money we’ve been putting into the larger one. And while the difference between the prices will flucutate, there will always be one, so it will always pay off. Renting a larger home and then a smaller one pays off with lower rent, but we wouldn’t get any of our rent payments back.

But you do care about the long-run expected return on your investment in housing even if your are not trying to time the market as there is an opportunity cost associated with the down payment. The choice: rent and invest $X in mutual funds/money market/etc., or invest the $X to invest in the local housing market.

The discussion relating to the bubble is how much of the increase in the price/rent ratio was due to the greater availability and lower cost of mortgage funds versus how much was due to unrealistic expectations about future returns to housing.

Without making too many unfounded assumptions, you can actually back out a rough estimate of the excess return to housing using a simple rent versus own model. When we moved to New York two years ago, my estimate of the spread over the 10-year Treasury, based on rentals and sales in the same buildings, was about 20%. Needless to say, we’re renters and will be until prices fall to the point where the spread comes much closer to zero.

There is a large literature in economics analyzing just this type of problem conveniently disguised under a variety of different names. If you have a subscription to JSTOR, search on housing combined with user cost or tenure choice or asset-market approach.

The classic reference is Poterba’s paper in the Quarterly Journal of Economics in 1984, “Tax subsidies to owner-occupied housing: An asset-market approach.” Mayer, Himmelberg, and Sinai provide an overview of the literature in the Fall, 2005 issue of the Journal of Economic Perspectives.

Posted by framed | Report as abusive


I generally agree with you but not on this one.

Well, the answer to your question is: Almost everybody who bought a house in the last 8 or so years cares about price appreciation. Lets frame the question differently: If I were to tell you 8 years back that house prices will remain stagnant for the next ten years, would you have bought a house? A large majority of Americans wouldn’t have. Surely, not those folks who took out interest only mortgages they couldn’t afford but did anyway because they were told the could always sell the house at a higher price if they couldn’t make the upwardly adjusted payments.

Moreover, if you strip out price appreciation, renting is generally cheaper than owning in most cities. Take your own example. Sure, you get deduction on the mortgage interest, (actually you can’t count all the deduction because you’d take part of it as standard deduction anyway) but then you have to pay taxes, insurance and maintenance. Besides, you lose appreciation on the $40K you paid as down payment. Sure, there are times where its better to own than rent. But it’s not been that way for a long time.

Also, saying that homeowners are indifferent to price appreciation is to imply that they would buy the house even if they were told house prices would fall significantly after they buy.

If people didn’t care about house prices, we wouldn’t have voluntary foreclosures by those who can afford the payments.

Posted by Donaldo Rodrigues | Report as abusive

I was looking to buy in Washington DC in 1998. At that point prices had been largely unchanged (if not down a bit) over the previous ten years, largely due to local factors (rotten city government).

It was common at the time for listings of apartments in relatively nice parts of the city to languish for months; brokers would encourage the occasional visitor at an open house to “just make an offer”. As a buyer there was a tremendous sense of uncertainty about getting in to something that you could not get out of. This was most certainly not an effort to time the market but a concern that should we have to move, for whatever reason, that it would be impossible to sell and we would be stuck with either an big loss or paying monthly fees for months after we left.

In the US people move all the time for different reasons; relocation due to jobs or family, changes in economic circumstance (for better or worse), changes in family size etc. It is only rational to think that you might have to move at some point and to worry that locking yourself into a series of payments that you can’t get out of is a problem.

Posted by Cole | Report as abusive

An important point in the rent vs buy decision is the size of the apartment of the house. A house u get for 1000$ is lot more than in size than apartment with 1000 $ rent. 1000 $ mortgage gives lot more comfort and convenience in terms of space.

All the other factors such as the appreciation after 10 years etc are secondary.

Posted by RN | Report as abusive

One thing no one ever mentions in the own v. rent battle is a tenant’s mental stress in dealing with any landlord. Having a landlord is not too burdensome when one is a carefree kid, but if one has had any reasonable amount of adult success in life, the thought of having a landlord “lord” it over you once again is intolerable at any price. Ending a landlord’s rule is one of the marks of real success in America that most people would never surrender if at all possible, at least until retirement and resultant downsizing.

I know I would pay a lot more money in house payments for the very same house that I could get as a rental just to not have to ever again deal with a landlord. Funny thing about it, I was a landlord for a long time, and a decent one from all reports, but I still feel that way about having one over my head.

Posted by richard | Report as abusive

Exactly the way it should be, though it hasn’t been for some time. Now that we are returning to rationality, it will be viewed for what it should be, a lifestyle choice.

You care about the sale price since you are leveraged and hope to have at least the same down-payment for the next place you buy.

Also, while you plan to stay 10 years, there are a number of reasons you may need to sell at any time during that period, (e.g. job) and again would prefer not to take too big of a hit on your principal. Plus there is the 6% transaction fees you were planning to amortize over 10 years, and the increase in monthly principal at the tail of that 10 years that now both need to be cut short.

Posted by libor | Report as abusive

As a homeowner I see couple of problems in the current downfall of the housing prices:
1) If a person has to relocate they cannot sell the house for the price they bought it for or the principal balance on the loan
2) If a person loses his job and now cant afford the mortgage payments and eventually cant sell the house on the price he bought for or the principal balance then he has to loose the house by Repo.
3) Due to negative equity its nearly impossible to refinance the house

Its all about loosing the flexibility. I dont care about the gains but the loses and having no flexibility makes things difficult for current home owners

Posted by Dan | Report as abusive

Dear framed,

I’m interested in the rent vs own model you used to back out the estimated returns to housing. Would it be possible to contact me at


Thank you,

Nadav Manham
http://www.investorsconsigliere.typepad. com

The comments re nasty landords are relevant, but it is a trade off. Career advancement is difficult without mobility. The high cost of buying or selling and the trap if local values fall (like in an area that loses it’s industry)should be considered. Also it costs 2% per year to own a house and also 1% per year of the reported gain in values is actually improvements. If you are young and high income upwardly mobile etc I suggest you look first at salary sacrificing into superannuation and then getting very well informed about how to exercise the almost globally unlimited investment choices within that. You will slash your tax and stay mobile and when you are ready to retire you can take the tax free money and buy a home that suits your situation at the time. All the capital gains made inside super convert to tax free after age 60 and there is no upper limit on how much your super can grow to. Looking back, deciding to be a tenant for a long time would change the way you went about it. You would get good at it and have the right gear to just move into anything and make it comfortable.

You could certainly see your enthusiasm in the paintings you write. The sector hopes for even more passionate writers like you who aren’t afraid to mention how they believe. Always go after your heart. “We may pass violets looking for roses. We may pass contentment looking for victory.” by Bern Williams.

Posted by traducator daneza romana | Report as abusive