I am compelled to respond to a recent comment, about why one would purchase a home now, knowing the purchase will be worth less in the future, and still feel good about said purchase. The person called this behavior non-coherent and illogical. I thought I would explore this concept a bit. My reasoning may not be solid, but I think I can make a bit of a case.
If one thinks about a home purely as an investment, I somewhat agree with the commenter. I say “somewhat”, because this line of thinking can lead to irrational behavior (bubbles), based on current expectations of future value. It is hard to predict the future, there are many variables and actors involved. This summer everyone thought oil was headed for $150 a barrel….now it’s less than $40.
On the other hand, almost everything we purchase is a depreciating asset (cars, electronics, computers, clothing, furniture etc.) In theory, just as I currently rent my home, I could also lease a car, electronics and furniture. Taken to its extreme, one would never purchase anything given the above logic (except perhaps food and jewelry).
If I do not plan to use an asset for most of its useful life, then leasing makes more sense. But in reality, we typically purchase most items (weighing utility versus price). It’s often a matter of convenience, not having to worry about preserving the condition of the item, less billing etc. Sometimes our life circumstances change, and force us to sell things earlier than we would like. However, Craigslist is an excellent tool for recouping some of the residual value.
That said, I still try to be prudent in my purchasing of depreciating assets. Do I buy the latest and greatest electronics/computers when they first debut? No. I typically wait until I feel they are reasonably priced. Do I have time to shop around at every possible store to make sure I am getting the best deal possible? No. I usually check consumer reports to make sure I am getting a good value, and often purchase at Costco.
Of course some assets lose all value, but people still buy them. I bought a computer at Incredible Universe (now Fry’s) to use for grad school applications back in 1997. It cost me $2000 for the setup, and 6 years later was worth almost nothing. That computer was an enormous purchase for me, as I was only making $10.50 an hour (ah the joys of working for a not-for-profit in the public interest). Yes there were alternatives (library perhaps), but I chose to purchase the computer.
Given current macro/micro economic factors, are home prices where I live likely to depreciate. Yes. Do I feel making a purchase now is a good alternative to leasing given our current time horizon. Yes. Did I do much more homework and due diligence for my home purchase, since it is likely the largest purchase I will ever make? Once could argue either way. Is this illogical and non-coherent behavior? Perhaps, but humans are not always the rational actors economists assume (although some of that is changing).
P.S. I spend a disproportionate amount of time in my home (as a full time teleworker) so my utility of a home is perhaps greater than most.
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"Why one would purchase a home now, knowing the purchase will be worth less in the future."
I wonder about the "knowing" and "future" aspects of this comment. I guess that in current environment it is reasonable to expect that the purchase would be worth less, but knowing for sure... I don't know... And how far in "future" can we expect the worth to remain lower: 1 year, 5 years, 10 years?
I also think that the home prices are still heading down, but they have already dropped significantly (well, maybe not as much as I would want in the nicer areas). I haven't found a house I like for the price I would be able to afford, but if I did, I would not be waiting. Yes, I know that the prices can keep dropping, but nobody knows exactly when they hit the bottom until the prices start climbing back, but at this point, I would be upset for not buying earlier, and maybe at the time when prices bottom out, there wouldn't be any worthy houses on the market.
BTW, congratulations on your new home. Hope you'll enjoy it. Love your blog.
I think you're probably correct to assume that a long time horizon irons out some of the wrinkles of likely continued depreciation.
Obviously past a certain point of fast and steep depreciation you start kicking yourself, but within a reasonable band (when the drops are either low or slow or some combination), then a long time horizon and the high utility of just finally feeling settled and being able to customize (and whatever else you're getting out of it) probably outweigh the rankling reductions in the comps around you.
Maybe. Hehe.
Assuming no rent increases, we would spend almost 130k in rent over 5 years. That is a huge chunk of change to kiss goodbye.
If home prices are flat, we still come out ahead (since we are paying off principle). If prices decline, we can reduce our tax base.
BTW - I am not trying to convince anyone to buy a home. Everyone's circumstances are different. I'm just saying, it's not necessarily a completely irrational thing to do.
Well, for some I'm sure renting has been bliss and bordering on euphoria.
As for my wife & I, the stories of renting could be either comical or a nightmare.
Now we no longer have an 83 year old 4'3" Japanese Samurai landlord banging on our door and (entering!)demanding to know where the generator was hidden in the one bedroom apt. This happened more than once. (Her hearing aid was set too sensitive & we found the source of the noise to be the washing machine that was directly over her beedroom) Not our fault. Her 60 year old son had to take her out of the duplex.
Let's see. Although amusing, that same landlord almost was assaulted by a tenant who was raving drunk and decided to strip naked to prove her point and proceeded to try & break the landlords door down. She was 63. So I called 911 saving the landlord and immediatley proceeded to drink myself silly after seeing that.Ohh, the PAIN. I should have sued for mental anguish, lobotomy, anything.
So homeownership started looking REAL good after that:) My wife with her three kids had rented for years which was taking a toll on them. Since owning the home, their behavior has changed in manner, speech, and school. So yeah homeownership isn't all about comps, asset price, appreciation ect. It's all about gettting away from 4'3"......
Well the $130k rent for 5 years is only part of the stat. Now if you bought a similar type house is the rent more or less. If buying means you pay $200k in 5 years or $100k in 5 years then there is a huge difference obviously.
If rent and the mortgage are approximately the same then it might be better to own. You do get to pay down principal and you get the mortgage interest deduction.
If the home goes down 30K over the next 2 years but you would have paid more than that in rent and taxes (due to not having the mortgage deduction) then it is a wash anyway and you get a permanent home to settle into.
As for cars, if you only plan on using it for a year or two and then getting a new one, you probably should lease. You buy it so you can drive it into the ground over 10+ years.
Furniture renting is way too expensive to be cost effective over buying.
Computers, again you buy them and use them for several years. I do computer programming and can still get 3+ years out of a decent PC before the need for new tech makes me upgrade.
But to the main question, is home buying rational? Probably not, ever. It is a huge amount of debt, if you want it for retirement you would probably do better putting extra money (from renting vs buying) into a CD or the stock market. And it is a huge liability. People can get hurt and sue you or someone if you have a pool kids can tresspass and use it and drown and then the parents can sue you. So you have to spend more money on insurance, maintenance, taxes, the list goes on.
I can't really think of any rational reason to own a house. But that doesn't mean I don't want my own.
"But to the main question, is home buying rational? Probably not, ever. It is a huge amount of debt, if you want it for retirement you would probably do better putting extra money (from renting vs buying) into a CD or the stock market."
I disagree. Historically, there is not always a huge disconnect between rents and home ownership costs. Renting will typically be slightly less than owning, but cheap enough to save a large sum--I don't think so.
Let's say a person stays in a home for 30 years and pay it off at the end of the 30th year. One's living expenses have been significantly decreased and are essentially fixed until death at that point. You on the other hand have rented your entire life and have a little next egg set aside for being the prudent renter. During your retirement living expenses are going to continue to rise. You can annutize the savings to help pay for those expenses, but the income stream is fixed and will not rise with inflation. At some point you will be forced to downsize, unless of course, you want to work and earn an income for the rest of your life .
Your method also assumes everyone has the discipline to actually save the difference in rent and mortgage. Not many Americans can do that.
As a renter you can be forced to move at anytime--a large expense if done every few years.
"People can get hurt and sue you or someone if you have a pool kids can tresspass and use it and drown and then the parents can sue you."
As a renter you also pay renter's insurance. I can still sue you if my kid drowns in your rental pool because you didn't lock the gate. Tort's 101, it's called duty of care.
I suggest you find a rent/own calculator and put some realistic figures in it and see the outcome. It don't work out to the renter's favor. And again, use accurate data. Prices will not always decline. Inflation is at least 3%. Your CD's or savings account will not earn you 8% over the long run, figure about 3-4%. But beyond this, think about the retirement years and how you can have fixed costs to match fixed income.
I guess that I have made enough bad decisions in my life not to believe that I can advise everyone correctly on their choices. I did tell my friends who decided to buy houses with option-ARMs, interest only ARMS etc. that I didn't think it was a good idea. But I understood their reasons for doing it and, having said my piece, I shut up.
With our blogger, I'm sure that it's at least not a bad decision. First, she's relatively young. If she were my age, I'd tell her to rent. Second, she's planning to stay in the house for a long time, so the need to sell in a few years doesn't come into play. Third, I'm sure that she's run the numbers backward, forward, up, down and sideways, and can handle the payments in all but the most catastrophic situation. (And there's no way to plan for catastrophe.) Fourth, and most important in my estimation, is that she and her DH have determined that this is right for them in their situation. And I note that Dean Baker, who called the housing bubble in 2002, is looking to buy a house.
But it's really all about the B-B-Q.
I'll agree with RV's point generally.
Although the problem of rising periodic costs will affect the retiree even if they own their home. Owning the house just means one item (albeit a good chunk) is removed from the budget plan. The problem of the too-small nest egg can dog the fully paid-off homeowner as easily as the properly saved-up lifetime-renter could continue living with increasing expenses (including rent) until death. Of course, such a properly saved up renter could just throw down and buy a house, if they figure they'll be around for a while.
Having said that, a thought that comes to mind from RV's point is that the problem with standard economic theory generally is that it assumes rational behavior. That's fine to the extent you want to know what that should be. But, as behavioral economists are pointing out (I recommend the book "Predictably Irrational" as an introduction to this), about certain things, people often behave in repeated, predictable, irrational patterns. Not "other people." You. One of these, as RV notes, is people's tendency not to save what they are "saving" in rent. With that in mind, buying even a slightly depreciating home (well within your means, mind you) probably should be part of a solid long-term plan, for most people.
And yet, there truly are those who save the savings as it were. I'm a Folsom renter, and our very healthy excess goes steadily into a holding account where our future downpayment is growing bi-monthly. When we've finally bought our home, the excess (it'll still mostly be there) will go to student debt. And when that's done, probably half to retirement investments (we're already putting 10% away)...and maybe half to the Bryan's-Fam-Vacation-and-Toy-Fund. If we can manage to save so much for so long, I think a little fun and rewarding will be in order. ;)
Yea I agree that if you will spend all your money anyway whether you rent or buy, then buying makes more sense since it is like a forced savings account. So long as you get a loan that will eventually let you pay off the debt.
Great discussion all.
One additional item I forgot to throw out....inflation expectations can drastically change the equation, in terms of current expectation of future asset value.
In a deflationary scenario, renting seems the wiser, as one can fairly easily renegotiate rent payments. In and inflationary scenario, buying seems the wiser, as you can lock in your payments in today's less inflated dollars.
(Monetary policy is not my realm....but I have to guess with the Fed eagerly throwing $$ at our economy we are bound to end up in an inflationary environment sooner or later).
"Monetary policy is not my realm....but I have to guess with the Fed eagerly throwing $$ at our economy we are bound to end up in an inflationary environment sooner or later".
Many of the outlier economists that DID see our current collapse coming are not at all worried about inflation. Most folks don't realize that at the beginning of the last depression, Hoover and then FDR both expanded the money supply in the same huge chunks as we are doing today but deflation still ruled the economy for a decade.
Now that deflation has turned the corner from simple commodity and real asset depreciation and completed the circle by impacting wages, the spiral will be very difficult to interrupt.
The large scale loss of jobs and wage decreases are the really scary part of what is happening today. It breaks down a huge mental and behavioral wall in people. "Sure I'll take a 10% pay cut, at least I still have a job".
Look at Japan for for a BEST case scenario, but consider that their lost decade had a floor under it; the rest world was soaring with a global economic boom. This time we are obviously not going to have the benefit of an otherwise healthy global economy to keep things from getting out of hand. This leaves us with our second best scenario; that the U.S. will not completely collapse economically or socially and we will still maintain one of the best standards of living RELATIVE to the rest of the world. If that plan doesn't pan out, from there we go straight downhill into major international civil upheaval and the wars that will follow. Worst case will be civil breakdown here at home.
After seeing what congress thinks is a stimulus plan, the California budget solution and Tim Geitner speak last week, my optimistic side thinks we're already beyond that best case lost decade and have locked into the second best scenario with a pretty fair chance that we're just plain screwed.
... or maybe the weather is just coloring my opinions. ;-)
-CD
I think AB did the right thing and shouldn't care about criticisms or potential depreciation of her house value. There is a related article on CNNMoney about purchasing a retirement home where the author asks a similar question as AB: "Were we early, buying before housing prices hit rock bottom? Almost certainly. Are we losing sleep over it? Absolutely not." His main point is that they are using the house already for detailed planning of their retirement as well as enjoying it on week ends. I myself may do the same to have an anchor where I can start building the bases of my pos corporate career life.
Congrats and good luck in your new home, AB. And thanks for creating this blog. It's been mighty useful.
AB,
Did you see the new $10,000state tax credit on new home purchases that went through with the budget? It does not go into effect until March, 1. Can you delay your purchse?
-CD
So let's see I can get $8k from the Fed and $10k from the State just for buying a home.
Sounds tempting, I wonder how long until they just pay me to take one?
60% off peak plus $18k in subsidies plus artificially low rates, and you still get the mortgage interest deduction... If this doesn't work is there anything left to offer?
The Fed could buy a bunch of GM vehicles (at marked up prices of course) and give everyone that buys a house a free car?
Or GM could offer everyone that buys a car a free house...
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