If anyone is having trouble sleeping on this Friday evening... I bring you possibly the dryest piece of writing of my career to date. Yes, it’s a careful look at why people who say that renting is actually as cheap as owning a house are wrong medium.com/@popebenedizzl…
So there’s a bit of a twitter meme, which has started to spill over into policyland, that private rental and owner-occupation are equally expensive. People claim often compare the annual costs of owning a house to rental yield, calling what’s left a normal investment return.
Clearly, the UK consumer disagrees with them: most people allocate an internationally unusual amount of their wealth to housing, and survey data shows that essentially everyone (even most social renters!) want to eventually become homeowners.
Now: when people express an overwhelming preference for a particular type of good, usually economists would agree that it’s likely to be a superior good. This is particularly interesting in housing because the major difference between renting and owning is financial.
As a result, it’d be kinda odd if it were genuinely the case that owner-occupation and private rental were equally expensive - one might expect preferences for stability and flexibility, for example, to be more finely balanced if there were no difference in cost.
The standard financial model of housing tends to regard a house as a stream of rents discounted to the present. So comparing those rents to the financing costs plus any taxes and depreciation makes a lot of sense.
However: if you own the house, and the rent goes up, you’re hedged - you don’t have to pay any increase. If you rent, however, you have to pay up. This year, next year, and for as long as you stay in the house. Or any house, as other options will also have become more expensive
So the standard model described ignores the value of the increase of this expected inflation. Once you add it back in, you find that at least for owner-occupiers (landlords are differently taxed) the return on the deposit looks to be about 40% with annualised risk of 40%
That’s MUCH higher than you’d expect from other assets. A four-times levered investment in the equity market would give you an expected return of about 20%, with at the very least 40% of volatility - and at any time your funding could be withdrawn.
You can describe that as an abnormal investment return, but it really just means that buying saves you money versus renting. This is likely because it’s landlords who are competing with owner-occupiers to buy houses, and their costs are much higher - and paid by renters.
Also, UK tax law means that any returns from a primary residence (be that in rent you don’t have to pay, or in capital gains) are entirely untaxed. So if the alternative is investing in your human capital and carrying on renting, then that disparity is even worse.
All this means is that access to a deposit to become an owner-occupier is extremely valuable for UK households, as choosing not to buy has significant annual costs. And since most wealth in the UK comes from housing, there’s a risk that we become a society of slugs and snails.
Any policy prescriptions designed to target this disparity need to keep this carefully in mind. Because those policy prescriptions which change the terms but don’t change the relative costs of renting versus buying are unlikely to have very significant outcomes.
(For disclosure, CC @ianmulheirn who wrote the initial article suggesting this, and is consistently very interesting despite being wrong in this case)
