Rent or buy?

By R.A. | WASHINGTON

GOING into the housing bust, I would have accepted David Leonhardt's general framing in this piece: that the decision to rent or buy one's home is primarily about the relative costs, and that most people should at least consider buying if the price to rent ratio hits a certain threshold. These days, I think that's not at all the right way to think about the choice. Homeownership, let's recall, is in most cases a highly leveraged, undiversified, relatively illiquid bet, with a return that is highly correlated to local labour market conditions. In general, responsible financial planners would warn their clients away from such an investment. Sure, you get a roof over your head as part of the bargain, but the potential downside is enormous, as should be blindingly obvious to us all.

But Mr Leonhardt sets most of that aside and suggests that, hey, maybe you should play around with the New York Times' mortgage calculator, and think about buying. Problem one is that said calculator asks you to fill in the about by which "you expect home prices to go up each year". The correct assumption should be zero. Strikingly, the calculator gives you the option to estimate annual appreciation as high as 30%. It doesn't let you enter an annual decline of value of greater than 10%, despite the fact that over the past year, several markets have seen price declines of at least that much. The latest Case-Shiller index has Las Vegas showing a 17.4% annual drop in value. Given how leveraged home purchases are (even the responsible ones that involve 10% to 20% down payments), the danger of declining home values should be given significant weight.

Especially given the problem of illiquidity and the correlation of returns with local labour market conditions. Mr Leonhardt writes:

In some once bubbly markets, prices have fallen so far that buying a home appears to be a bargain, based on a New York Times analysis of prices and rents in 54 metropolitan areas. In South Florida, Phoenix and Las Vegas, house prices — relative to rents — are as low as in places that never experienced a bubble, like Indianapolis and St. Louis.

Well that's lovely, but what is the value of having the option to pick up and leave these metropolitan areas at no cost? As of February, Las Vegas' unemployment rate was 13.9%. Should we be encouraging people to chain themselves to labour markets like this for at least five to seven years? One of the great virtues of the American labour market is its flexibility, and especially its geographic flexibility. In good times, homeownership doesn't reduce this flexibility by all that much, but good times aren't when you need a labour market that can rapidly adjust to uneven economic conditions. I would hope that most Americans would have more sense than to look at the enormous declines in home prices over the past few years and see a buying opportunity, rather than a cautionary tale.