Some good comments on the earlier post, better than it deserved.
I regret writing that mortgage lenders and owners are on the opposite end of a transaction. It is more apt to say, as Kevin Erdmann pointed out, that the house is financed with debt and equity. Both can earn a return.
Another commenter offered a numerical example. Let me riff off some of the numbers.
Suppose the house costs $200,000, it is 100 percent financed, and the mortgage rate is 4.0 percent. Then you can think of the interest expense as $8000. Pretend that it is the same for the owner-occupant as it would be for a landlord. Both the owner-occupant and the landlord can deduct the interest expense for tax purposes. They also can both deduct property taxes. I think that 3 percent is high, so I would go with something like 1.5 percent, or $3000.
If depreciation is 2 percent per year, it amounts to $4000, which is what the commenter suggested for repairs. Depreciation is tax deductible for the landlord but not for the owner-occupant. The commenter suggests that insurance is $1200, which again the landlord could deduct as an expense. If the landlord pays for utilities, then the landlord can deduct those as an expense. That might be another $2400 in deductions. Condo fees or Homeowners’ Association fees, if any, would work similarly.
If the price/rent ratio is 10, then annual rent is $20,000. If the price/rent ratio is 20 (high by historical standards), then the annual rent is $10,000. In any case, that is income to the landlord, who has to pay taxes on it. So overall, the owner comes out ahead.
Erdmann offers an interesting take on cities where supply is clearly constrained by regulation.
political obstacles to the allocation of capital into new residential housing has caused market prices to be wholly unmoored from replacement cost in those cities. In those cities, buying a house is like buying a taxi medallion. It is not so much a claim on shelter as it is a claim on political exclusion.
His point is the return on investing in housing would be more predictable, and much of the speculative aspect of home purchase would go away, if house prices were more closely tied to construction costs. And they would be more closely tied to construction costs if development were less constrained by regulatory restrictions.
I would think just the opposite, supply constraints increase predictability and this predictability is reflected in the very high price to rent ratios (low cap rates) that you see in places like Northern California. If you were buying a house outside of Orlando, then you would need a lower price to rent ratio (higher cap rate) to compensate you for the risk that there will be further development that drives down the price of your house.
North of San Francisco, there is a small town of Bolinas. In the 1970s, the hippies froze the number of water meters to control “growth.” No water meter, no construction.
A few years ago, a house got torn down and the water meter was put up for sale. The meter (not a house, not a lot) sold for $300,000. Yes, a lot like taxi medallions. Capitalized value of scarcity rents. Except there is no Uber to fix the housing market.
Shouldn’t you be apprehensive that lowering housing costs will make family formation affordable and turn whites more Republican?
Thanks for the shout out, Arnold.
Another analogy that I think might be useful is to think of urban density as a limited resource. We live in a time and place where the technological and cultural context has made dense urban centers very valuable for innovation and production in fields that are heavily dependent on human capital. But we also live in a time and place that for aesthetic and cultural reasons is not capable of creating urban density. So, the dense urban centers we have are sort of grandfathered in. It’s like having mines in a rare but important commodity. It’s OPEC for housing. The frustrating thing is that this resource doesn’t have to be limited. If we could adjust the cultural obstacles, we would be like Midas. But in the meantime, places with urban density capture economic rents. And other cities don’t attract those markets away from them because no city today can create the residential density necessary to unlock that value.
Of course, regarding your recent post, it could be that the competitive moats around these markets along with the natural winner take all landscape they are in allows firms like Google and Apple to invest in long term projects like monopolists.