"If house prices rise, the value of your house (the hedge) increases but so does the cost of shelter."
What about the ability to rent? As demand for purchasing housing goes up, demand for renting typically goes down (ie. either levels off or regresses). Sure over time both go up, but at a particular slice of time, usually on a cost of living basis one is advantageous over the other. And while you're renting at a cheaper cost than it would be to essentially rent money (let's not kid ourselves, you don't own a house if you have a mortgage), you have liquidity to place in other investment vehicles.
Small observation... maybe there's something to it, maybe not, but it seems I'm 2/2 on calling when market swings happen here in downtown San Diego over the past 10 years. Take a look at the delta in rental prices in properties in various classes and compare verses actual selling prices. Just like a P/E for a company, if you can't at least turn a profit on owning a piece of property as a rental, it is likely overpriced. As much as people love to talk about various market factors much of this is emotionally driven.
For instance, last year I observed an entry level condo complex in a marginal area rent 1 beds in the $1800-1900 range. The latest comps for that building were $150k for like properties. About 5 blocks away 1 beds in a luxury high-rise were renting in the $2200-2300 area. Comps? High $300k. At the height of the market comps for the luxury high-rise were in the mid $500k area and the marginal property were in the upper $300k area. Back when that was happening, the luxury high-rise unit was renting just shy of $2k. The marginal unit? About $1400. I took another 4-5 other buildings in the area of varying quality and this trend was intact. To be fair this is a small, insular market and these swings are largely driven by speculation from the bubble-tastic situation many overheated markets found themselves in (ie. people owning and flipping multiple properties found the bottom of the market being rented cheaply).
> As demand for purchasing housing goes up, demand for renting typically goes down (ie. either levels off or regresses)
While it's true that we had a rather large anomaly 2004-2009 (a.k.a. the housing bubble), and that there are tiny boom/bust cycles in which it is possible to get a little leverage to cover switching costs, prices and rents seem to be mostly linearly correlated [1]. This means that as prices go up, rent goes up.
In order for prices to be divorced from rents, you have to hypothesize some weird market externality, like a major recession, or crazy incentives for mortgages, city suddenly becomes a tourist destination, etc.
It would behoove you to read beyond the sentence you quoted.
"In order for prices to be divorced from rents, you have to hypothesize some weird market externality,"
There are always externalities at play with an asset, and many times they are irrational. Sometimes people just want a place to put their money because a particular asset class appears to be more performant at a given time than the alternatives.
[1] Isn't applicable as this is a regional phenomena. Looking at this at a national or global level absorbs localized hysteris.
While it's true that there are regional price/rent divergence phenomena, the transactional costs exceed the profits and effectively segment owner-occupied and renter-occupied housing into noninterchangeable goods. Quoting from a BLS meta-study [1] who cites an earlier BLS manuscript by the same author (original paper unavailable):
> Despite this novel divergence finding, the third novel finding is that there were evidently no unexploited profit opportunities. The detached-unit rental market is surprisingly thick, and detached housing is readily moved between owner and renter markets, so the capital specificity issue highlighted by Ramey and Shapiro (2001) should not play a big role. However, the large costs associated with real estate transactions would have prevented risk-neutral investors from earning expected profits by using the transaction sequence buy–earn rent on property–sell, and would have prevented risk-neutral homeowners from earning expected profits by using the transaction sequence sell–rent for one year–repurchase. The large wedges offer a partial explanation of the significant divergences: rents and user costs might evolve somewhat independently until their divergence becomes large. Another way to put this is that the owner-occupied and rental markets are segmented.
Those transaction costs are going down to the point where they will be a non-issue. Technology is making it happen. 1%/flat fee brokers were common during the last cycle as well as all sorts of tools to buy/sell your property. Check out something called homecoin.com. Additionally, did you know you can become a licensed broker for less than $1000?
BTW, I am both a landlord and a homeowner, have been since 2003.
I also have known 5 gentlemen/families over the years who have made 8 and 9 figure fortunes solely from real estate. No, it didn't happen over night, it took several boom/bust cycles and leveraging up. I'm just echoing largely what I've been told.
I'll take practical experience over studies any day.
The variable delta between rent and purchase price/mortgage cost doesn't break the premise that purchasing a house is a hedge against future requirements. You might do better renting but you don't have the future right to occupy that house at any cost. Rents might go up more than your investments and leave you needing to look elsewhere but if you have bought it you have a secure tenancy (subject to mortgage conditions).
I think you are very right about a large delta being a signal of an unsustainable market though. Steve Keen (http://www.debtdeflation.com/blogs/) describes investment in assets where the profit won't cover the interest as 'Ponzi' investment as you are hoping to pay it off from rising asset prices and points out that these are unsustainable in the long term, someone is going to get caught out. He thinks that loans should be capped to a multiple of rental value which should reduce the tendency to drive up prices by purchasers competing to take on the most leverage and mean that competing purchasers compete on who can commit the most equity.
"The variable delta between rent and purchase price/mortgage cost doesn't break the premise that purchasing a house is a hedge against future requirements."
But it does break the premise "but so does the cost of shelter." There is an advantage to sell while it's a seller's market and rent, while doing the opposite while it's a buyer's market. That's leverage that breaks this premise.
"You might do better renting but you don't have the future right to occupy that house at any cost."
This thinking is one of the key reasons why it's possible to systematically make money off of real estate. It's pervasive crowd-think, at least in the more impacted markets. It seems sound and logical, but it's fear based and irrational. There is clearly an upwards trend in real estate, yes that is true. But there are peaks and valleys along that mean.
"Steve Keen (http://www.debtdeflation.com/blogs/) describes investment in assets where the profit won't cover the interest as 'Ponzi' investment as you are hoping to pay it off from rising asset prices and points out that these are unsustainable in the long term, someone is going to get caught out. "
Yes, that's speculative action at work - as I mentioned in my original post with actual examples toward the end with my theory of how to detect the switchover. It's fun to talk about and how to solve it but it doesn't change that it actually occurs. The recent housing bubble exacerbated it but it is a phenomena of active markets during boom/bust cycles.
> But it does break the premise "but so does the cost of shelter." There is an advantage to sell while it's a seller's market and rent, while doing the opposite while it's a buyer's market. That's leverage that breaks this premise.
Hedged is never optimal but it should never be disastrous either.
You can often profit from unhedged speculation. If you can successfully predict the market you have nothing to gain from hedging. That you can do it profitably and possibly reliably doesn't make it hedged.
>> "You might do better renting but you don't have the future right to occupy that house at any cost."
> This thinking is one of the key reasons why it's so easy to make money off of real estate. It seems sound and logical, but it's fear based and irrational.
This thinking may be based on fear and suboptimal in terms of dollar wealth outcome but that doesn't necessarily make it irrational (stability and security have real value to some people) but you are right that it creates opportunities for those seeking profit.
The Steve Keen / Ponzi finance comment was in agreement with you.
What about the ability to rent? As demand for purchasing housing goes up, demand for renting typically goes down (ie. either levels off or regresses). Sure over time both go up, but at a particular slice of time, usually on a cost of living basis one is advantageous over the other. And while you're renting at a cheaper cost than it would be to essentially rent money (let's not kid ourselves, you don't own a house if you have a mortgage), you have liquidity to place in other investment vehicles.
Small observation... maybe there's something to it, maybe not, but it seems I'm 2/2 on calling when market swings happen here in downtown San Diego over the past 10 years. Take a look at the delta in rental prices in properties in various classes and compare verses actual selling prices. Just like a P/E for a company, if you can't at least turn a profit on owning a piece of property as a rental, it is likely overpriced. As much as people love to talk about various market factors much of this is emotionally driven.
For instance, last year I observed an entry level condo complex in a marginal area rent 1 beds in the $1800-1900 range. The latest comps for that building were $150k for like properties. About 5 blocks away 1 beds in a luxury high-rise were renting in the $2200-2300 area. Comps? High $300k. At the height of the market comps for the luxury high-rise were in the mid $500k area and the marginal property were in the upper $300k area. Back when that was happening, the luxury high-rise unit was renting just shy of $2k. The marginal unit? About $1400. I took another 4-5 other buildings in the area of varying quality and this trend was intact. To be fair this is a small, insular market and these swings are largely driven by speculation from the bubble-tastic situation many overheated markets found themselves in (ie. people owning and flipping multiple properties found the bottom of the market being rented cheaply).