Econ Duel: Rent or Buy?

Owning a home is a huge part of the American Dream. But is the dream of homeownership really all it’s cracked up to be?

In this new Econ Duel from Marginal Revolution University, Professors Tyler Cowen and Alex Tabarrok weigh in on the issue. Each representing a side of the home ownership debate, the two professors ask what’s smarter—to rent, or to buy?

On the “buy” side, Tyler Cowen shares the tax advantages of buying a home as well as the effect homeownership has on one’s stability and savings regimen. Does buying a home force us into better savings habits?

Against those arguments, we have Alex Tabarrok, coming down on the “rent” side of the equation.

Among other points, he talks about the real beneficiary of tax breaks (hint: It may not be you!). Along with that, Alex tackles the trials and tribulations of home-buying, in places like San Francisco, New York, or Boston, where a combination of scarce building permits and increased demand drive up home prices. Plus, doesn’t owning a home -- and committing a 20% down payment -- break the diversification rule of good investing?

All that said, though, here’s the real question that matters—which side are YOU on? Watch and let us know in the comments!

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♪ (opening music) ♪

So Alex, we're economists.
Often people ask me,

well what is it that we know about
investment and investment advice anyway?

Now, we've already talked about equities,

but as economists do we have
anything else to tell people?

Let's talk a little bit about housing,

because housing is one of these areas
where there's a lot of myths around it.

People in America,
it's part of the American Dream.

And one thing I think people don't
realize is that over the long run,

house prices are certainly
not guaranteed to go up.

I mean we saw in the financial crisis
that house prices came way down.

But there's still this kind of idea
that people have in their heads

that they're not making any more land,

so in the long run
house prices have to go up.

And we know from our
understanding of assets

that you should not expect your house
to be a great financial investment.

But isn't there a tax reason
to buy a home?

So if I borrow money for a mortgage,

and I'm paying income tax
and itemizing my deductions,

I can write off a lot of that mortgage
interest and get some of the money back.

And that means

it could be cheaper or more advantageous
to buy the home because of taxes.

But don't forget,

a lot of that tax advantage is going
to be captured not by the buyer,

but by the seller.

What the tax advantage means is
it pushes up the prices of homes.

It's already built into a higher price,

so you, as the buyer, don't always
get that gain. Often it's the seller.

Well, but think of this
in terms of elasticity.

Say I live in an area, like
many parts of Texas or Florida,

where I get this tax break that
increases the demand for homes, yes.

But then suppliers build more homes and
they drive the price back down again.

And it seems that
in a lot of states actually,

the buyer should be reaping a lot
of that tax break. Yes, No?

If only there were more places
in the United States like that,

I would tend to agree.

But one of the big problems we have
in the United States today is that

the demand for housing goes up
and you're in some place

like San Francisco, or New York, or Boston

whereit's impossible
to get permits to build more housing.

And when the demand goes up,

all that means is
the price of the house goes up.

So all of those gains, whether
it's from the tax system,

or whether it's from people
wanting to move to San Francisco,

all of those gains go to the land owners.

And that's actually a big problem
we have in the United States today.

- [Tyler] But I do see a stability reason
to own a home. Say you're 37 years old,

you have 2 kids in school, you want them
to go to a good high school district.

You don't want to be told, "You're going
to have to move." You want to arrange your

backyard the way you see fit. And you
don't want to have to renegotiate a rent

contract. All of those factors
militate in favor of buying a home.

- [Alex] So I think you're right for those
people. But one thing you've got to keep

in mind, is that on average, houses are
not going to be a great financial

investment. So you have to be exactly one
of those people who wants extra stability,

more stability than the average person.
That's when you're going to gain from

buying a house. And, keep in mind, that
when you buy a house and that heating

system collapses and you've got to
repair that, that's a big problem.

When you're hit by a lightning strike
and you've got to repair the roof,

that's a big expense as well. So when
people say, "I'm only worried about the

rent going up." Well that's fine.
They may be worried about that,

but don't forget, you've got to be worried
about replacing the roof every 20 years, as well.

- [Tyler] So it's really a marginal question,
you're saying. Like at the margin,

do you need the tax break more than
the typical buyer? At the margin,

do you value the good high school district
more than the typical buyer?

And at the margin, are you better at
fixing the broken roof or hiring someone

to do it than the average buyer? And those
things may or may not apply to you,

but that's the right way
to think about it?

- [Alex] Exactly right, so if you want that
tax advantage, you've got to be earning more

income than average. You've got to
be itemizing your deductions.

If you're not one of those people in the
upper middle class, you're not going to

get that tax advantage. If you've got one
kid, maybe the school is not so important.

Maybe you have to have two before you
really get that advantage from the

schooling. So yeah, you've got to be
thinking about how you're different from

the average. If you really want to buy a
home, you've got to love buying a home.

- [Tyler] I think of people as needing to save
more typically. That we're programmed to

think about the here and now, we're a bit
impatient. Perhaps we haven't evolved to

think well enough about the more
distant future. If you buy a home,

pay off your mortgage at the end of 30,
or one hopes 15 years,

you own something. In the meantime, you're
saving. And you get into a routine that

doesn't even feel like saving. It's more
savings than if you're writing a rent

check every month. So maybe it's our own
imperfections. We need to lock ourselves

into a higher savings regime, and that's
another possible reason to buy a home.

- [Alex] Yeah, I do think the forth
savings argument has got something to it.

But there's a big problem, especially
in the United States today,

and that is there's such an encouragement
to buy houses with no money down,

even after the financial crisis. If you
really are concerned about savings,

the key point is to have a 20%
down payment. So save up for that

down payment. And that is really what is
going to be the forth savings aspect

of buying the house.

- [Tyler] You know, I think the biggest piece
of advice I'd give to people is just to be on

that wealthier side of the equation, so
that owning a home makes sense for you.

- [Alex] Don't forget our earlier investment
rule. Diversify, diversify, diversify.

And yet, when it comes to housing,
people are encouraged to put a

huge amount of their wealth into one
asset, in one place in the country.

That could be a terrible decision. If
you're in a small town with only one

employer, and you have a house and that
employer goes bust, well your house price

is going to fall, you might lose your job,
your income is all going to fall,

and it's all going to be
happening concentrated,

all in one place all at one time.

(narrator) What do you think? To see
previous episodes of Econ Duel,

check out our playlists. Or if you're
craving more financial advice,

click to find out if mutual funds
are a good investment.

♪ [music] ♪