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It's possible that housing prices are much higher for good, because real estate was historically undervalued.

I know, I know, hear me out ;)

I remember reading an article during the housing boom that made a very interesting argument in defense of the high prices. It was wrong, of course, but it was different from the usual "there's never been a better time to buy... or sell!" crap you heard from the real estate PR machine. It was a pretty sober look at the numbers.

The argument boiled down to this - if you're going to compare current prices to the historical trend, you need to exclude the possibility that real estate was undervalued before you can conclude that current values are overvalued purely based on divergence from historical trends.

The paper argued that housing was historically undervalued because creditworthy people didn't have good access to credit. A house required a 20% down payment, and banks (back when banks held a loan for the entire life of the loan) wouldn't allow income to debt ratios to exceed a certain threshold. They argued that new methods to spread risk across larger pools allowed the extension of larger amounts of credit without a huge jump in risk.

An example was a loan made to two nurses with excellent credit earning a combined income of well over $200k, but who only had about 20K in down payment. In the past, this 10K would have limited their purchase price to 100K. Now, they could bid much higher - without, as the article described, a massive increase in risk to the lender, especially if that risk could be spread.

It was a well-reasoned argument, and I think what it missed was the profound level of corruption and dishonesty going on in the industry at the time. As we all know now, and as our wise leaders like Greenspan should and could have learned while they were reassuring everyone things were just peachy, is that the "two nurses" example was not at all typical of these "higher risk" loans, and the "spreading of risk" was in fact a way of dividing up and obscuring risk to make horrendous loans look better (and package them up and sell them, and then bet against them).

But this phenomenon will probably continue. Yes, housing prices are higher, but I suspect that once the dust settles, some of these "innovations" (my disgust with the industry makes it hard to use that word) may actually come into play.

In short, we may pay more for houses than our elders did, but we may actually have better, more efficient access to credit in the long run (I want to make sure nobody thinks I'm defending the antics of the banking sector during the bubble with this argument).

Oh lastly - I do apologize for no cite. Can't really remember where I read this...

The fact that the majority of people buy their homes though loans leads to a wide range of price distortions.

I would argue housing increased in price faster than inflation in large part because the FED was so effective at reducing inflation which reduced interest rates. A 30 year loan could see the borrower paying 2x the houses initial value as interest, so if you drop that down to 1x suddenly people can afford to pay significantly more for a house.

This, lead to people being easily able to afford the house, but unable to make the 20% down payment. Which lead to 'risky' loans being safe for a while. Thus, a lot of automated risk systems only had good data for during a historically long period of increasing housing prices and decreasing interest rates.

That's an interesting theory.

Comparing purchase to rental prices pretty much blows it out of the water, however.

I'm interested in hearing more on this point.

Briefly, look at a "buy vs. rent" calculator.

If the costs of renting, inclusive of any possible foregone appreciation gains from real estate, are lower than of buying, then the economically rational choice is to rent, not buy.

In urban economics, the value of housing is largely dictated by the potential income one can acquire by virtue of holding it. That is: housing reflects the local prevailing wage.

It makes zero sense to rent a property (as a wage earner) for more than one can make in income living in the area. Hence, rents tend to be much more responsive to wage inflation/deflation than housing prices (student and retirement housing would be exceptions, but they're constrained by similar functions ultimately).

With real estate, there is the potential for appreciation gains. This presumes, however, that there's someone willing to buy at the appreciated property later. Housing prices cannot inflate indefinitely over other assets. And the long-term historical return on housing (since the 1880s or so in the US -- period for which data are available) are in fact lower than most forms of investment. Housing carries heavy costs: taxes, maintenance, improvements, etc. And it's largely an illiquid asset, particularly for the small investor (I may have many of a smaller investment to sell, I generally only transact in a single house at a time).

There are other tweaks on this: rental/owner-occupied housing aren't perfectly substitutable (covenants, HOA restrictions, etc.), there are non-financial returns to housing (or at least longer-term returns), notably school district access and crime/safety rates. In markets with low vacancy rates, rental values may fluctuate more broadly. Bank lending practices may make buying easier (2000s) or harder (2010s) at any given time.

But the upshot is still: rental prices in a given market tend to be a better guide to local economic conditions than real estate prices.

The theory wouldn't hold to justify the run up in prices during the housing boom, or the rent/purchase disparity now. But in the long run, I do think that pooling could be used to allow larger amounts of credit to be extended to people without a huge increase in risk. I could see this leading to a one time, permanent increase in the value of leveraged assets like real estate.

Keep in mind - it might have been a plausible explanation for why real estate jumped 25% when historical trends would only have forecast a 10% rise. It wouldn't explain a massive run up (2-3 fold increases in housing prices over the course of 5 years). The housing boom was eventually driven by irrationality and corruption, which may have completely obscured a smaller but more rational increase in prices resulting from a legitimate technique to pool risk.

> The world would be a much better placed if the most highly taxed form of income was rent profits in all its forms. Non-productive income is responsible for perpetuating a lot of income disparity.

In other words, you want to totally change the system.

One of the most important rent profits is plain old loans. Just because you have money, you can have even more, later. They justify interest rates with the risks they take, but that's most probably a lie. They want a cut. But the actual costs only lies in bookkeeping, which should not be charged with interest rates, but flat rates. (Interest rates are still justified up to actual risks, but no more.)

Now for the real fun: in Europe (and probably most of the world), for about 40 years, our central banks are "independents". The states cannot directly borrow from them any more. Now, we have to borrow from private banks, who themselves borrow from the central banks at a lower interest rate, or produce money out of thin air, like a state, or a forger. (The main actual mechanisms are Fractional Reserve Banking, tax havens, and derivatives).

A world-wide conspiracy wouldn't have done better.

This is by far the best comment I've seen in a while.

Loans to individuals today are account to little more than taxes paid to private individuals, who will obviously spend the money on themselves instead of the commons.

It would be awesome if a system were established that allows individuals to borrow from the central bank the same way private banks do. If JP Morgan can borrow from the Fed, then I as an individual should be able to borrow from the Fed, with an adjustment for actual risk and no more. In aggregate, I bet you that 300 million Americans pose a far lesser risk than do a couple of major banks.

Like you said, a world-wide conspiracy would not have succeeded in creating a system that allows private banks access to a nationalized bank but only allow individuals to borrow from those banks.

The technology is there or almost there to automate lending the entire lending process enough to make direct government-to-citizen lending possible. All that is needed is a way to implement this such that it results less systemic risk than our current system by fostering greater diversity in lending strategies and risk assessment than a few large banks. All you do is plug in lending strategies that are sufficiently vague and considered in aggregate at each level that gaming the system in a way that unfairly favors certain individuals.

The cost of taking the money from a government loan institution and putting in the hand of an individual should cost almost zero and the lending decisions should be made as close to the community level (as in the state or county level) as possible on a per capita basis with any incidental returns accruing to the level at which it was lent at. e.g. a county would lend money to its constituents in a way where they balance returns to the city coffers with the growth from lending at lower rates.

i.e. the federal government automates the writing of loan checks and collecting them, amount lent is proportional to local population, excess returns go to taxes, counties can levy taxes to make up a deficit (failure to properly assess risk and rates), but who gets loans and the rates are determined locally.

We'd essentially end up with 2992 entities that resemble the small local banks we used to have before the banking market consolidated, but that are essentially charged with ensuring the goodwill of their own community and not shareholders living elsewhere.

Private banks would still exist, but would have to compete with such a system and would probably compete in areas where such a system could not, such as corporate loans.

"If any government really wants to promote sustainable home ownership for all their citizens, they'd make homes a financial deadweight for people that aren't fully utilizing the home themselves."

This! In Portugal it is common for rich people to buy apartments near universities just to rent to students. The thing is, people who are rich enough buy several at once and get nice discounts on them (investor discounts they call them) and they will use the houses to make money with the rents. If you are just a regular person looking for a place to live you might negotiate a bit on the price but you always start at full price, not discounted.

I wouldn't go to the extreme of making every home you possess, except the one you live in, a financial deadweight but make it increase steeply after maybe 2 or 3 places.

I just don't know if this can happen... buying real estate is one of those American ideals that everyone seems to aspire to. Hell, I even do basically because its a favored form of relatively safe investment here and you get tax incentives for it. I think we are at a bit of a crossroads where a lot of things need to be re-thought, however, as investing, as a whole, needs to be re-examined to figure out what truly is sustainable and good for the future. Maybe new opportunities like investing in asteroid mining, etc are what we need to start putting capital into something more productive and good for humanity than just inflating real estate prices.

My opinion is that rent seeking has probably been fairly constant (relative to the size of the economy). I think the bigger issue at play is the effect of the baby boomers. As they reached their peak earning potential in the late 90's and early 00's, their spending power had an impact on the broader economy, raising demand and prices across a wide range of services and goods. While the recession has had an impact, I don't think it is a coincidence that as the Baby Boomers retire, the economy feels like it is entering a long period of stagnation.

Possible, but anecdotally I know tons of boomers with multiple properties, but I cannot say the same for previous generations and generations that came after the boomers. This is why I suspect that novel research in the area would show that rent seeking, especially from housing has risen.

Another issue that may be contributory to rising house prices are divorce rates, which skyrocketed since the early 80s. A divorce almost always results in the occupancy of two residencies per family.

"I don't think it is a coincidence that as the Baby Boomers retire, the economy feels like it is entering a long period of stagnation."

Coupled specifically with everything else that happened over those 20 years.

An ever increasing workforce, with an ever increasing productivity rate, employing an ever increasing amount of financial leverage, purchased at an ever decreasing cost.

It's certainly a recipe for a peppy feeling decade or two, and a well deserved hangover later on.

A lot of the problem is local government. Rising property values benefit ~everyone who lives in a town even if they're bad for people who want to move there, but the later don't get a vote in town ordinances. Well off people who already live there also don't want poorer people moving in and "using up town resources" without "paying their fair share". So you have all sorts of zoning rules in place trying to prevent affordable housing, though there are exceptions and I'm not sure how much things look like this in places that aren't US Northeaster cities.

How do rising property values benefit people who rent?

That's why I used a '~' before 'everyone'. :)

You're right, a greater quantity of housing benefits renters, though low income people entering the community might not. Its sort of complex there, which is why the aren't effective opposition.

This is highly dependent on the region. I have lived in both the Bay Area in California and in Arizona. They are like studies in fairly extreme opposites. What you talk about is very much how the situation is in California, even in areas where more houses could be built, its always a huge political battle of attrition.

In Arizona, anything goes, they build shit literally anywhere, its flat (for the most part in Phoenix at least) and land is almost literally endless. Property is dirt cheap, houses are too and they have a huge overabundance of houses, I would say probably at least 1/5 of houses in the metro area there are currently unoccupied.

Areas that are desirable and have geographical characteristics that make usable land scarcer (which includes being near a body of water as that limits the land in one direction) are probably always going to have the characteristics of what you describe, IMO. One thing it does lead to is more valuing of older buildings, etc as these areas don't have the "tear it down and build something new" mentality of a place like Arizona.

>>I would bet that the reason housing prices have outpaced inflation is due almost entirely to the popularization of rent-seeking activities and real estate speculation (not including the relatively recent distortions due to late 1990s deregulations that led to CDS and other financial "innovations" created to derisk the asset class beyond what was rational).

We've got a heck of a housing bubble in Canada, and we don't have those fancy financial instruments. We have the CMHC, which shifts the risk of mortgage default from banks to the public, and an interest rate policy not unlike the US' ZIRP. Also, 2008's 0% down 40-year mortgages kind of propelled this thing into a frenzy.

> I would bet that the reason housing prices have outpaced inflation is due almost entirely to the popularization of rent-seeking activities and real estate speculation (not including the relatively recent distortions due to late 1990s deregulations that led to CDS and other financial "innovations" created to derisk the asset class beyond what was rational).

LOL. No. The reason real estate prices are so high is because when the central bank forces down interest rates money pours into investment class assets, driving prices up.

Our shadowy banking overlords wisely started tightening up years ago to avoid a US style disaster. CMHC (our equivalent to Fannie Mae) tightened credit to qualify requirements for mortgage insurance. As soon as these changes took effect volume of real estate transactions plummeted and price increases halted. But then they started creeping up again... and the reason has nothing to do with Canadian policy...

There is a sizable Chinese community here, particularly in Vancouver. Monetary policy in China is constantly devaluing the RMB, and Chinese citizens are scrambling to unload them. Tons of them are coming over here and buying up tons of real estate. So anyone in Vancouver thinking of using a real estate agent to sell their property: Make damn sure you choose a Chinese one who has mainland Chinese buyers. If you hire a native there's almost zero chance he will directly find a buyer and so they'll be no way to reduce the commission you will pay. I sold my condo a couple of years ago and NONE of the non-Chinese buyers whose offers I accepted were able to clear the conditions because their lenders had cut back on their borrowing limits. I ended up selling to a Chinese family moving here who paid for the $700,000 place with cash.

True, but this is the reason I said that homes need to cease to function as an investment asset if you aren't living in it.

Homes should not function as an investment asset when interest rates drop. It effectively negates the benefit of more affordable loans. "The good news is that the home loan is for your first home is 5% with no money down. The bad news is that now everyone is buying homes whether or not they are going to live in it themselves, so the home you want to buy now costs you double what it did when loans were 13% and you had to 20% down". Only banks win in this scenario.

I would guess that a large share of all those homes purchased as an investment asset when rates dropped were put to use in rent-seeking activities. Add to that the vicious cycle impact rising home prices has on rental rates and you have an environment that hurts everyone that can't or shouldn't be buying a home.

> almost entirely to the popularization of rent-seeking activities and real estate speculation

Interest rates in 1984 were 13+% for CDs, and higher to borrow money.

That should tell you everything you need to know.

I bought my first house in 1984. Banks were begging you to take out a mortgage and prices were in the tank. I bought the house with 5% down, PMI and a 14 percent, 1 year adjustable mortgage (interest rates were so high they had to go down). When rates went down property values soared and I was able to use the gain to finance most of the purchase of my next house.

My advice is take advantage of the low interest rates if you can. You have to live somewhere and the mortgage payments are a form of forced savings and partially subsidized by the US government.

Your example is the opposite of the current situation. If we assume that home prices are determined by monthly payment then that would explain why the price increased as rates dropped.

Then you had a low price to rent compared to payment to rent ratios. Today you have the opposite: low payment to rent and high price to rent ratios. If rates rise with prices drop?