10 Updates

No, Housing Is Not Like Food

May 7 2014, 8:16pm CDT | by

I guess it’s inevitable that in the wake of a housing bubble collapse that we should expected at least a decade of home ownership criticisms that overreach. The latest of these comes from Josh Barro...

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11 weeks ago

No, Housing Is Not Like Food

May 7 2014, 8:16pm CDT | by

I guess it’s inevitable that in the wake of a housing bubble collapse that we should expected at least a decade of home ownership criticisms that overreach. The latest of these comes from Josh Barro at the New York Times. His angle is that why should you buy long-term contracts for housing when you don’t buy long-term contracts to supply you with food? Now Josh is a very smart guy, and so are people who have been praising his piece. He’s also usually one of the best economics commentators out there. I think that just goes to show that when it comes to homeownership a lot of people have let their general negative feelings about the institution fog their thinking about the economics of it.

Here is Josh’s basic story:

Instead of buying the food you need right now, you would buy a contract giving you rights to a stream of food in perpetuity. Say, a contract entitling you to five pounds of chicken breasts, delivered to you every week, forever. That’s basically what buying a home is: securing the use of a residence, indefinitely.

He then goes on to discuss all the problems that would occur if you bought food like this, concluding:

Betting on your local real estate market isn’t all that different from betting on the price of chicken, which is why I got on my soapbox recently on MSNBC to urge people to rent their homes

Since Josh argues we should rent housing like we consume food we are left to draw the conclusion that Josh buys year long contracts to receive a stream of food. After all, most renters have leases of a year or longer. Data on this can be hard to come by, but according to the 1995 Property Owners and Managers Survey (POMS) supplement to the AHS, 85% of tenants have a lease, 43% of which are for a year, and 2.3% are for more than a year. Basically very few people buy housing on the “spot market” like Barro’s analysis suggests we should. Why should that be? If Josh dug into the reasons that people sign leases instead of buying housing on the daily spot market he’d see some of the significant differences between housing and food.

Let’s start with the fact that housing is expensive. According to the consumer expenditure survey, the average homeowner spends $7,244 on food a year, while the average renter spends $4,996. On housing, homeowners spend $9,399, including the mortgage, property taxes, and maintenance, and renters spend $8,548. So the average homeowner spends 30% more on housing than food, and the average renter spends over 70%. This doesn’t include utilities.

People also endure higher costs when the price of housing rises compared to when the price of food rises. When the price of carrots rise, for example, there are a variety of options for households to switch to that can help mitigate the effect of the prices on the household budget. As a result, if carrots are 5% of your household budget, a doubling in the price of carrots doesn’t mean a 5% increase in your budget. You can relatively easily switch to another vegetable.

In contrast, when it comes to housing there is a lack of substitutability for many households. Sure, for young, mobile, metropolitan globetrotters like Josh the notion of moving to a cheaper part of a city or even a cheaper city may sound like a pretty costless transaction. But for families with children, these moves can be much more costly, and can mean putting kids in different schools, and losing meaningful social connections that they have to the people and institutions in their neighborhood.

In general, households are also less likely to see a significant rise in the price of their current basket of food than their current housing. Housing supply is inelastic in many areas, and this means prices can rise quickly. Food is produced in what’s generally considered the closest thing to a perfectly competitive market, and while supply may be constrained for some foods, the general supply of food can easily increase to prevent significant price rises.

Thus there are several factors that combine to make household exposure to risk from local housing price inflation more significant than food price inflation:  high costs of substituting, the larger share of income, and inelastic supply in some areas. These are reasons why you’d see some demand for hedging housing price risk but not food price risk.

But the differential exposure to risk is not the whole story. There are also the high costs of locking into long-term contracts for food. The particular mix of food a person wants to consume over long periods of time isn’t exactly something you’d be good at forecasting or want to be locked into. In contrast, people tend to want to consume the same housing over long periods of time. This is because it costs money to physically move your stuff, and, as discussed above, people like to stay in one neighborhood. In general, people want to consume the same flow of housing services for years. They don’t want the same mix of food for years.

Another significant difference is that with food, there is not inherently any risk here that someone needs to bear. Food is sold a non-durable good, so they are consumed in the period they are purchased. Housing, in contrast, is a durable so someone has to bear the risk of owning the asset over long periods of time. As a result it would be more accurate to say housing is like a farm than to say housing is like food.

Or to put it another way, housing is a small business (see Matt Bruenig for more on this). After all, would anyone disagree that a landlord is a small business owner? They own assets and sell the flow of services produced by those assets. Households do the same thing except they consume the flow of services. This brings up an important point: if buying a home is a bad investment for household, then how do landlords make any money? They are, after all, basically engaged in the same business as homeowners. When you recognize housing as a small business this becomes a harder claim to make.

Given that either individuals or landlords can bear the risk and reap the return of owning the capital asset, which party should do it? There are some reasons why a landlord has a competitive advantage. For example, owner-occupied housing may be too much leverage for many individuals. However, I think most miss out that homeowners also have many competitive advantages over landlords in the housing services production industry. For example:

1) Landlords face vacancy risk, which homeowners don’t.

2) Landlords have a principle/agent problem with tenants when it comes to maintenance, homeowners don’t.

3) The rental market has imperfect information where tenants don’t necessarily know “good” landlords from “bad” ones, and vice versa. Homeowners are the tenant and the landlord.

4) Landlords don’t know the preferences of their renters with respect to upgrades, appliances, and repairs. Homeowners choices here match their preferences.

5) Homeowners have a tax advantage in the mortgage interest deduction.

6) Tenants can borrow at lower rates than landlords because of policy and because its harder to walk away from a house you live in/>/>

This last point is worth emphasizing. People usually assume that the low cost of owner-occupied mortgages are entirely due to government policy, but it’s also due to the inherently lower risk of owner-occupied borrowers. In either case, low borrowing rates provide a competitive advantage to homebuyers even if it is largely government created.

Now it is true that housing can be risky, and we shouldn’t be subsidizing homeownership like we do. But the comparison of housing to food clarifies little and confuses much. Overall the criticisms of homeownership we’re seeing are overreaching. Better to make the case against homeownership on solid economic grounds instead of tenuous analogies that clarify little and confuse much.

 
Update
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