87,000 Hours or: Thoughts on Home Ownership

Edited to add epistemic sta­tus and sum­mary:

The ba­sic the­sis of this post is that, for many rea­sons, the volatility (risk­i­ness) of buy­ing a house are sig­nifi­cantly higher than gen­er­ally be­lieved.

The con­sid­er­a­tions ex­plored here are the re­sult of dis­cus­sions with a fi­nan­cial ad­vi­sor and plug­ging var­i­ous pieces of pub­li­cly available data about hous­ing mar­kets into ad­hoc mod­els of long run perfor­mance. Ul­ti­mately, pre­dic­tions about as­set classes usu­ally come down to refer­ence class fore­cast­ing, as any ap­peal to ‘over’ or ‘un­der’ priced is rel­a­tive to some trend, and choice of the timescale on which trend fol­low­ing is ex­pected can be cho­sen to tell a story. E.g. two peo­ple ar­gu­ing can have one ar­gu­ing for a re­ver­sion to a long run his­tor­i­cal trend while the other ar­gues for a re­ver­sion to a short run trend. They may both be right on differ­ent time scales go­ing for­ward too. This post at­tempts to sur­face rea­sons why buy­ing may be more ex­pen­sive than a pop­u­lar model one might en­counter, which may have been gen­er­ated by peo­ple in the pro real es­tate camp. Thus it ar­gues that peo­ple’s con­fi­dence in­ter­vals, es­pe­cially to the down­side, are too nar­row when mod­el­ing home buy­ing. Losses in the hous­ing mar­ket are hard to get quan­tified data on since they are pri­vate and of­ten vary enor­mously due to im­puted rents and op­por­tu­nity cost be­ing idiosyn­cratic be­tween in­di­vi­d­u­als. A small thumb on the sale at each step in a mul­ti­plica­tive plan­ning space can add up to a lot by the time you reach the out­put of your model.

The main pa­ram­e­ters looked at in this post if you want to do you your own home­work (which ob­vi­ously you should for an in­di­vi­d­ual pur­chas­ing de­ci­sion) are as fol­lows:

Rent-to-Buy ra­tio (see linked post at bot­tom for prob­lems with the de­fault pa­ram­e­ters of pop­u­lar rent to buy calcu­la­tors)

Aver­age time spent in pur­chased homes

His­tor­i­cal house price indexes

His­tor­i­cal rent price indexes

Van­guard’s Balanced In­dex in­vest­ment fund (lev­er­ag­ing a bal­anced fund hand­ily beats all-stock al­lo­ca­tions btw)

Salary and sav­ings con­sid­er­a­tions over a career

Home own­er­ship tax benefit calculators

I’ll add any more that oc­cur to me.

Be­ware ex­trap­o­lat­ing av­er­ages to un­usual situ­a­tions. Out­lier mar­kets usu­ally have var­i­ous rea­sons that have driven met­rics to ex­tremes. Failure to un­der­stand the ca­sual mechanisms will pre­vent one from pre­dict­ing when such trends might re­verse.

Origi­nal post:

The av­er­age per­son spends about 10 years (87k hours) in a house be­fore mov­ing, which already goes against peo­ple’s tacit mod­els. This post is about the var­i­ous rea­sons why buy­ing a house is a bad idea.

First let’s ad­dress the idea that rent­ing is ‘throw­ing money away’. This ig­nores the op­por­tu­nity cost of in­vest­ing ex­tra in­come and the lump sum of the down pay­ment into a house in­stead of the stock mar­ket. Peo­ple spend on av­er­age 50% more money on mort­gages, taxes, and fees than they spend on rent. If that money were in­vested in the mar­ket it would be earn­ing you a re­turn. Peo­ple very of­ten re­port be­ing sur­prised how much more a home wound up cost­ing them than they had ex­pected. You can plug in the num­bers for your­self in a rent to buy calcu­la­tor (and should do so do get a sense of which num­bers mat­ter, but keep in mind they tend to have de­faults set that are crazy and home buy­ing tilted). A fi­nan­cial plan­ner goes into more de­tails about rent to buy ra­tios here(link be­low). Sum­mary: buy­ing makes sense in grow­ing mar­kets where the rent to buy ra­tio is un­der 20. But the mar­kets in which the rent to buy ra­tio is un­der 20 are the same mar­kets that you *don’t* want to live in. The ra­tios are low pre­cisely for the rea­sons you don’t want to live there, var­i­ous qual­ity of life and job prospects.

Se­cond let’s ad­dress the fear that ‘rents keep go­ing up so it be­comes a bet­ter deal over time.’ Rents can’t go up rel­a­tive to house prices or vice versa for very long be­cause even­tu­ally peo­ple will ar­bi­trage the differ­ence away. When rent­ing is cheap, de­mand for pur­chas­ing homes drops. When rent­ing is ex­pen­sive de­mand for pur­chas­ing homes goes up. But we’d ex­pect small per­sis­tent dis­tor­tions in the di­rec­tion of buy­ing be­ing more ex­pen­sive be­cause so many peo­ple de­fault to buy­ing even when it doesn’t make sense. But what about the Bay Area? Com­pound an­nual growth in hous­ing prices over the last cou­ple decades has been around 7.5% while growth for rent has been around 4.6%. But this is ex­actly why I ex­pect re­gres­sion to the mean. Over­all rent to buy ra­tios in the Bay have been over­heated and are now drop­ping, and it’s prices that are get­ting pul­led down faster than rent is go­ing up. Ad­di­tion­ally, rents have his­tor­i­cally ap­pre­ci­ated much more slowly than the stock mar­ket, mean­ing rent­ing should get cheaper for you over time if you’re in­vest­ing.

Isn’t that all moot if the home you buy keeps ap­pre­ci­at­ing in price since you get to buy with lev­er­age? (A down pay­ment is typ­i­cally 20% so a home pur­chase is lev­er­aged 5:1). In the fastest ap­pre­ci­at­ing hous­ing mar­kets, this has been true. But buy­ing a sin­gle house is like buy­ing a sin­gle stock. The volatility you should ex­pect is go­ing to be much higher than a di­ver­sified stock port­fo­lio. Essen­tially, any claims made about pre­dict­ing fu­ture hous­ing re­turns boil down to mo­men­tum based rea­son­ing vs re­gres­sion to the mean based rea­son­ing. Either could turn out to be true, and you shouldn’t as­sume that you’re go­ing to out guess the mar­ket. And with all those wins you hear about you have to ac­count for sur­vivor­ship bias. All the peo­ple who didn’t make out so great aren’t brag­ging about it.

Take hous­ing the in the Bay Area for in­stance. Ap­par­ently more than half of home sales are go­ing to Chi­nese buy­ers. If there is a sub­stan­tial crack down on the var­i­ous schemes these buy­ers are us­ing to get money out of China, or if a differ­ent city be­comes a hot­ter in­vest­ment mar­ket, or un­fore­seen things cause this to change, a lot of spec­u­la­tive money that was pig­gy­back­ing on this cash flow might leave. This has hap­pened in other times and places. In­deed, the price in­dex in some of these su­per hot mar­kets like SF and Seat­tle have seen sharp de­clines the last few months. You may hand wave this away by claiming that ‘it always comes back’ but that again doesn’t ac­tu­ally calcu­late through how much op­por­tu­nity cost you are pay­ing by not pump­ing money into the mar­ket dur­ing down turns.

Another source of volatility is the in­her­ent link­age be­tween house prices and em­ploy­ment in the area. By buy­ing a house close to where you are cur­rently mak­ing a high salary (which you would want to since com­mute times dis­pro­por­tionately af­fect hap­piness) you are mak­ing a long term bet which, if it doesn’t pan out, will si­mul­ta­neously leave you with­out that high pay­ing job, ei­ther forc­ing you into a long com­mute or sel­l­ing the house and mov­ing to a differ­ent city. This is ex­traor­di­nar­ily com­mon. La­bor mo­bil­ity boosts earn­ings, and it is difficult to ac­count for this in a calcu­la­tor, but the younger you are the more wary you should be of lock­ing your­self out of ma­jor ca­reer moves that move you ge­o­graph­i­cally.

‘But the mar­ket is ex­pen­sive too!’ there are a cou­ple im­por­tant points about that. The first is that none of the typ­i­cally cited mea­sures that peo­ple tout to claim the mar­ket is ex­pen­sive have his­tor­i­cally been very good pre­dic­tors. Re­mem­ber, if you can make a con­fi­dent pre­dic­tion about the mar­ket you can make gi­gabucks, so any­one claiming this who isn’t sit­ting on top of a moun­tain of money should be con­sid­ered sus­pect. Se­cond, let’s look at three ex­am­ples of peo­ple try­ing to time the mar­ket. All three peo­ple in­vest at a rate of $200/​mo. Per­son A has the ab­solute worst luck in the world and in­vests on the eve of all the worst stock mar­ket crashes over the last 40 years. Per­son B has the best luck in the world and in­vests ex­actly at the bot­tom of all the crashes. Per­son C be­lieves it is hard to out pre­dict the mar­ket and just puts some of their sav­ings into the mar­ket each month. Maybe you’re guess­ing that per­son B and C do about the same even though C’s strat­egy is way eas­ier. Nope, it’s even worse than that. Per­son A, the un­lucky one wound up with 660k. Per­son B, the lucky one made 950k. But Per­son C, who just plugs $200 in rain or shine made...1.38 mil­lion. What? How is that pos­si­ble? Per­son B still misses out on gains over time by wait­ing around with cash in hand try­ing to time things.

So let’s plug this back into the hous­ing situ­a­tion. If a mere $200 a month over time in the mar­ket gen­er­ated 1.38 mil­lion...well that puts a big damper on the sto­ries of peo­ple mak­ing mil­lions from hold­ing a house for a long time. If you were to sit down and care­fully go over the num­bers with such happy folk they usu­ally did worse than they would have putting similar amounts away into the mar­ket (peo­ple will get very mad at you if you do this). Again, peo­ple who hap­pened to buy into the hottest mar­kets be­fore they sharply ap­pre­ci­ated may have out­performed, but you shouldn’t ex­pect to be able to pre­dict that ahead of time.

Aren’t I do­ing the same thing from the other end by pre­dict­ing that the stock mar­ket will do well over the next 40 years? It’s very differ­ent be­cause, as men­tioned be­fore, a sin­gle house is more like a sin­gle stock than it is like a globally di­ver­sified port­fo­lio. When you look at a stock in­dex over the long term, even things as catas­trophic as the World Wars is just a blip. Bet­ting on the world econ­omy is just a much differ­ent bet than bet­ting on a sin­gle house in a sin­gle mar­ket.

What about if I do some­thing clever like buy a big house with my friends? Big­ger houses cost less per room etc. A few prob­lems. Go­ing in on a house with mul­ti­ple peo­ple also means split­ting the tax ad­van­tages of home own­er­ship. More lux­u­ri­ous homes are sub­ject to big­ger swings in home val­u­a­tion dur­ing down­turns than sin­gle fam­ily houses since that’s where most of the de­mand is. Se­cond, this situ­a­tion mul­ti­plies the op­por­tu­nity cost of not be­ing mo­bile. The chance that at least some of the peo­ple will wind up need­ing to move sooner than ex­pected is high. Which leads to the third thing which is that this is a much big­ger has­sle to co­or­di­nate both im­me­di­ately and on­go­ing and it may end your friend­ships, which is go­ing to be painful if you are liv­ing to­gether for years.

What if I time the hous­ing mar­ket? This doesn’t work for the same rea­son that timing the stock mar­ket doesn’t work. Pre­tend it is right af­ter a crash and you’re think­ing of mak­ing an offer on a house. Where does the down pay­ment come from? You can bet that lend­ing stan­dards have gone up in a crash and you’re not go­ing to get a zero down loan. The money will have to come from your in­vest­ment port­fo­lio, which means you’re pul­ling money out of the mar­ket at the worst pos­si­ble time to gam­ble on a par­tic­u­lar house out­pac­ing the mar­ket. This is a bad plan.

Come on! There has to be some situ­a­tions in which buy­ing makes sense! I did man­age to find two situ­a­tions where you can have a rea­son­able ex­pec­ta­tion of com­ing out ahead, or at least not do­ing too badly if things turn south. Th­ese sce­nar­ios are still highly re­li­ant on you be­ing sure you want to stay in a par­tic­u­lar spot for at least 10 years, so there’s op­por­tu­nity cost and risk there. 3 Be­d­room, 2 bath houses are in high­est de­mand, leav­ing 2 and 4 bed­room places slightly bet­ter deals. If you buy ei­ther a 2 bed­room condo and rent the sec­ond bed­room to some­one re­li­able, or rent a 3 bed/​2 bath with a fourth bed­room con­verted garage and live in the con­verted unit while rent­ing the house to a fam­ily, both of these can pay off while giv­ing you fu­ture flex­i­bil­ity to not need to move if fam­ily plan­ning comes along. In ei­ther case you just stop rent­ing the ex­tra room. In the case of the 4 bed­room you’d start rent­ing the garage unit when you moved into the house un­til you needed it as well. If you want to pull off this strat in a crazy hous­ing mar­ket you’ll still need to find a good deal and run the num­bers your­self. And you’ll have a ten­dency to put your thumb on the scale to get the out­come you want, so you have to be pretty care­ful about that. Also, try­ing to con­vert a garage your­self can be a real time and money sink with­out guaran­tee of suc­cess due to in­sane zon­ing laws, so that kind of setup is rare. Us­ing a strat similar to this you can stretch to maybe make rent to buy ra­tios of 25-30 close to break even i.e. in cities you’d ac­tu­ally want to live. The Bay Area is prob­a­bly still out though un­less you want to live far from your job which is a ter­rible mis­ery in­duc­ing de­ci­sion.

‘I still think I should go in on a house with some­one else’. One of the rea­sons the above sce­nar­ios work is that they don’t in­tro­duce the com­pli­ca­tions of mul­ti­ple stake hold­ers. Hav­ing renters vs own­ers means the fric­tion is rel­a­tively low if (more like when) things change.

Gam­bling on hot hous­ing mar­kets isn’t a free lunch. It takes up a lot of your time (both be­fore and af­ter the pur­chase) and en­courages poor emo­tion­ally driven de­ci­sions. And then it ex­poses you to a bunch of poli­tics that will fur­ther de­grade your qual­ity of life as you now have a huge pro­por­tion of your net worth tied up in this scheme. The re­al­tor mar­ket is ori­ented around juic­ing what­ever mis­con­cep­tions you have that will en­courage you to buy what­ever you can af­ford, and the poli­tics around try­ing to force homes to be ‘good in­vest­ments’ are toxic.

Okay so this is a lot of doom and gloom. Gee thanks, Romeo. Well, the rea­son I went to the trou­ble of writ­ing all this is be­cause there’s a mas­sive up­side to be­ing aware of these is­sues. And that’s free­dom from wor­ry­ing that rent­ing is bad! This pays huge div­i­dends over time as you don’t need to ever worry about lock­ing any­thing down. Com­bine with hav­ing few enough be­long­ings that mov­ing is no longer a huge chore and the abil­ity to move once ev­ery few years be­comes a real boost not only to your ca­reer po­ten­tial but also to not cal­cify­ing into rou­tines that make your life seem shorter and less varied.