Homeownership and Social Justice

I am reading and enjoying Simon Johnson and James Kwak's 13 Bankers. Like a lot of recent stuff (including an OECD report), it takes a swipe, if a mild one, at the virtues of homeownership.   If people think homeownershipp is overrated, I can live with that (even if I disagree with it. Where I do have a problem is when people argue that government "pushes" homeownership on people, whether they really want it or not.

I am not sure that the pushing matters that much--it is entirely possible that people, for reasons beyond financial reasons, want to own houses in particular and real estate in general.  Two things stick with me:

(1) I was talking yesterday with a developer here in India who is trying to building market-rate affordable housing.  He faces a number of hurdles, one of which, he said, is "Indians' obsession with homeownership."

(2) Years ago, when I was in Madison, the guy who cut my hair loved to talk about the rental property he owned in Florida.  It would, he said, be the source of his retirement income.  I asked him why he was so undiversified--why he didn't sell his place and put the money in an index fund.  His reply was that he didn't trust Wall Street, and that he needed an investment that he could "touch" as well as control.  I told him his mistrust of Wall Street was misplaced--shows what I knew at the time.

The point is that there is something about real estate that reduces agency problems,  One may not be able to control markets, but one can control the management of real estate that one owns.  I do remember when I left the rental market for the owner market, I was very happy, not because I thought I would make out financially (house prices in Madison had been stagnant for years), but because I disliked my landlord, and was relieved that I would no longer have to write a check to him. 

This is not to say putting people in houses they cannot afford is a good idea, and I have long been dubious of very low downpayment schemes (I do think homeowners who put no equity into their houses are not really owners).  But it is a little too easy for people who own houses (or have the choice to do so) to say it is not important to make the option available to others.  Freedom to some extent means the ability to take control of one's own life, and to avoid agency issues as much as possible. 

I freely confess that this is all supposition based on informal observation.  Some work has been done on how ownership solves some agency issues, but I think it is an understudied phenomenon.  If anyone wants to help me think about how to model such things formally, I would welcome the assistance.

According to an informal vote of Indian School of Business MBAs...

...the cities with the most potential for real estate investment in India are Pune and Ahmedabad. 

How much freedom to choose?

Ed Glaeser argues that the "moral heart of economics" is "freedom" and in particular the "freedom to choose:"

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.

When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.

I will leave it to others to dispute the notion that more choices are always better than fewer.  But I can't help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well, choices.  We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way of consequences.  We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer.  We can make an awful lot of choices and still be economically secure.

Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid.   The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price.  Does she really have choice?

Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground.  Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon.  Does that miner have a choice?

I could go on, but I think the point is fairly clear.  There are times when government intervention could expand the choice set up a large number of people.

Ed does point out how government can improve choice sets, and for that he deserves credit.  But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies.  Elinor Ostrom's Nobel win in 2009 shows that the economics profession is beginning to recognize this problem,  but I am not sure Ph.D. students are broadly encouraged to study it.    

Uh-oh

I met with a large developer here in India.  He told me that "rent models," (i.e., discounted cash flow models) don;t work in India--that everyone wants to own property in India, and so India is different.  I remember a Japanese real estate guy telling me the same thing about Japan in the late 1980s.

At least there isn't a lot of leverage here, so the systemic risk of a collapse in prices is lower.  But still....

Mark Thoma passes on terrible news about Maxine Udall, girl economist

To all Maxine Udall Girl Economist Readers

I didn't know who she was, but I felt like I knew her.  She was smart and wise.

Land use regulation and the cost of housing, Indian style

Mumbai is among the densest cities in the world: as a metropolitan area, it is roughly ten times denser than New York (h/t Alain Bertaud).  Yet residential zoning codes typically have FSIs (the equivalent of a floor-area ratio) of between 1 and 1.33.  This compares with typical central business district FSIs of between 5 and 15 in other cities around the world, and there are places in Hong Kong, which is a very attractive city, where it reaches 20.  

So what happens when the most crowded large city in the world forbids intense development?  Prices get very high.  The most expensive parts of Mumbai are more expensive than Manhattan; the least expensive are comparable to the American Midwest, but people's "middle-class" incomes are perhaps 1/8 as large in Mumbai.

A developer I spoke with last night told me that if FSIs were raised to 4 (still low by world standards), prices would fall by about 50 percent.  While this is not an econometrically determined elasticity, it does make a certain amount of sense.  It would be worth at least doing the policy experiment of raising FSI uniformly.

As for services, well, there are already plenty of people using services.  The average person in Mumbai consumes about 30 square meet of residential floor space, so allowing more vertical development might, if anything, alleviate crowding, both inside and out.  

The present value relationship still doesn't work in India

I had students here in Hyderabad gather data on rents, and then we put together a valuation pro forma.  We determined that the present discounted value of flats here is roughly 40 percent of their sale price.

I have been doing this sort of exercise since I first visited south Asia seven years ago, and I get about the same outcome every time.  It is not credit that is driving this market--many people buy property with cash.  People tell stories about "black money" financing property--this is untraceable, and therefore untaxed, money.    But our calculations imply an implicit tax rate of 60 percent--taxes in India are not that high (in fact, other than an eight percent transfer tax, they are fairly similar to the US).

So the story must be about expectations, and indeed, that is the story I hear.  But current yields are well under 3 percent, and if values rise faster than rents, those yields will get even lower.  Something has got to give.  I just have no idea when.