Monday, June 11, 2018

Housing: Part 304 - The problem of the displacement of long-term renters.

One of the dilemmas of in-fill housing expansion is that some existing tenants are usually displaced.  That can happen directly because units are taken down to make room for new development, or it can happen indirectly because rents will rise in a "hot" area, leading to a reconstitution of the local population - "gentrification".

A primary cause of this problem is the existence of long-term renters.  These are households who have deep roots in the local community and ties related, very locally, to place, who do not own the properties they reside in, and therefore lack control over these changes.

Frequently, tenants rights policies are advocated for to try to solve this problem, but those sorts of frictions in the dynamics of local housing markets are a big part of the problem that has prevented urban housing markets from shifting to meet new demand for urban tenancy.  The better solution would be for these households to be owners in the first place, and the fact that they are not owners is a sign that our financial and housing markets are underdeveloped.

Landlords provide two sorts of liquidity services.  First, they provide liquidity for frequent movers.  Many frictions exist in the market for transacting real property, which make it quite expensive.  Thinking of homeownership as an ownership stake in a flow of rental income, this makes homeownership unprofitable for tenants who cannot commit to a long tenancy.  This service is very valuable.  Landlords allow tenants to move without incurring all of the costs of buying and selling real property, so that households who might move often are not burdened by the cost.

Second, they provide liquidity through access to capital.  Some households might be able to commit to a long-term tenancy, but they don't have the access to capital markets that would allow them to purchase a property.  In the real estate market that exists, this is a valuable service, also.  But, the goal of housing and financial public policy should be to eliminate the need for this service.  In a fully functional market, households that can commit to long-term tenancy should be able to be owners.  There should be financial products available to them that allow that to happen.

So, the fact that there are long-term tenants in some urban neighborhoods who can be evicted because they are not owners is a sign of a suboptimal system.  If there are a large number of residents in an area who have developed a sense of endowment about the area, but who are renters, then the solution we should seek for them is to find a way for them to be owners.

This is why I really don't like the focus on affordability, whether in terms of debt payments to income or price to income.  If a household can afford to rent a home, they can afford to own a home.  The transactional frictions may be harder to solve, so it is reasonable at this point in time for short term tenants to opt out of ownership.  But, that isn't really so much of a problem, because short-term tenants will not tend to have as much of an endowment effect about the neighborhood they currently live in.

On the other hand, there should be a financial product that allows a long-term tenant to own their home, and the fact that some can't is a problem, because they do feel more of a spiritual ownership of their location.  It does hurt them more to be forced to move.  But, many long term tenants can't be owners because the only financial products we have for ownership involve down payments, amortization, and a mismatch between the asset, which is real, and the typical mortgage product, which is nominal.

Actually, since the crisis, even with the inflation premium embedded in mortgage payments, most tenants - especially those for whom affordability is most difficult - could purchase their homes with a mortgage that would have a monthly payment that is less than their rental payment.  In many cases, it is much less.  This is the case, because in our errant haste to solve what was presumed to be a credit-bubble induced affordability crisis, we have done the opposite of what we should have done.  Instead of finding more ways for households to access ownership, we have eliminated the option of ownership for a large portion of the country.

Our financial system has failed, but the failure wasn't in making too many households homeowners before 2007.  The failure was in preventing households from becoming owners after 2007.

The problem that tenants in gentrifying neighborhoods have is that the financial market has not developed enough to give them a true ownership stake in their properties, so some advocates try to give them second-best ownership stakes through tenants rights.  It would be better if those households could benefit by selling into a hot market, or by borrowing from rising home equity, and choose individually how to capture those gains.

That doesn't solve all of the problems.  From white flight in the 20th century to NIMBYs in today's coastal urban centers, homeowners have never reacted well to any sort of change in their neighborhoods.  And, why should they?  Change is difficult, and when change encroaches on an area, it induces the need for compromise which is a sort of bad luck for those who would prefer that their neighborhoods remain the same.  Some of the reasons for disliking that change may be more morally justifiable than others, but all of those households are reacting to the same human desire - that the world we live in should stay just the way we like it.  But, these compromises are a fact of life.  We currently are missing some dear neighbors who recently have moved away.  Isn't it funny how flexible our sense of political privilege can be?  In this case, it would be absurd of us to demand that our neighbors remain in this house in order to keep our neighborhood intact.  Our sense of political assertiveness comes mostly from our sense of who are outsiders and, thus, who we can boss around.  So, of course it would be ludicrous of us to demand that our dear neighbors stay.  But, it doesn't seem so ludicrous to try to stop strangers from some other social class from moving into our neighrborhoods.  The reason that doesn't seem ludicrous is because they are outsiders and so we feel more comfortable asserting control over them.*

So, even neighborhoods full of owners frequently prefer stability over change, and are willing to assert control over outsiders in order to maintain it.  But, if we focused on access over affordability, and developed tools and products that provided that access, at least we would marry actual ownership with the legitimate sense of ownership that households feel about their long-term homes.  Next time you witness a debate about how new developments will displace longtime tenants, instead of wondering how to protect that class of households, you should wonder why they exist at all, and think of solutions that make them owners, in law, in a way that matches their sense of ownership, in practice.

Edit: a commenter makes the great point that in cities where prices reflect political exclusion, ownership carries more risks and isn't such an obvious improvement in today's environment.

* This is not entirely explanatory.  While there is a strong social norm against preventing our neighbors from moving away, there are many cases of neighbors preventing each other from making aesthetic changes to their properties.  So, there are selected contexts where legal or social norms allow us to obstruct the activities of our existing neighbors.


  1. > If a household can afford to rent a home, they can afford to own a home.

    Damn this is smart analysis, and so simple. Thanks Kevin.

    1. The irony is that we need more (or better) financial engineering to create means for qualified tenants to be owners, and instead there has been a backlash against financial engineering. But, it's basically semantic. I mean, if you get some equity and debt funding, build a big building, put a bunch of units in it, divide them into "tranches" like one bedroom, two bedrooms, three bedrooms, etc., collect monthly cash flows from those tranches of units, then pay all the expenses, then divide up what is left and pay it out to various tranches of debt and equity investors, etc. Isn't that financial engineering? That's a lot more complicated than just having one family fund a single unit. And it's vulnerable to cyclical upheavals, too. The local economy goes south, the equity investors can't cover the bills any more, and now suddenly every tenant might get booted out of a bankrupt building. Systematic risk. Too big to fail.

  2. Obviously I agree, but I think you are somewhat sidestepping the centrality of zoning, at least along the West Coast, More than half of Seattle and LA are zoned for single-family detached (way more than half). San Jose too. You know the story.

    Of course, an intelligent financial system should arrange sensible financing of detached house and condo-buying. Especially given the US tax code.

    But right now most those swathes of single-family detached housing are owned---and they don't want any high-rises in "their" neighborhoods.

    Homeowner groups are the zoning nazis of the universe!

    I hate to say it, but higher homeownership rates might actually exacerbate the zoning problem.

    Some renters must figure, "Meh, I can move out. I am not married to this hole."

    Homeowners? "This is my neighborhood, and local school, local stores, and it is all sacred! When I bought this house, it was zoned this way, and that was the deal. I have an unalienable right to keep this zoning!"

    I think property zoning has to be phased out. Other than a Supreme Court ruling, I do not see how it can be done.

    1. You're right. The politics are messy, and the solution probably would come from reducing the rights of current owners to obstruct change.

      Here, I'm just thinking about the benefits of ownership in terms of being able to be a fully engaged agent in the effects on your life. The post ignores other problems, too. There is risk associated with equity ownership. If a neighborhood unexpectedly declines, then being a tenant is better than being an owner because leaving would be easier. Ownership of real estate creates a significant exposure to very local economic and social conditions, and that cuts both ways. But, in financial terms, there is a lot of "alpha" in home ownership, which seems like it is more than enough to overcome the risks.

  3. Agreed.

    Homeowners believe they have an inalienable right to maintain or tighten neighborhood property zoning.

  4. Price to rent ratios are quite high in closed access cities, so I don't think it is the case that owning is just as affordable as renting, even with relaxed lending standards. When I look around in my own West Coast city, it would cost substantially more for me to buy (all costs considered) than rent.

    Probably what is driving higher prices for buying is the prospect of higher rents in the future, given the secular increase in housing prices in closed access cities. But rents aren't higher yet, which means many people are currently renting houses they couldn't buy. This is especially the case considering that many landlords don't raise rent much on long-term good tenants.

    1. Excellent point that I should have mentioned in the post. In most of the country, owners are buying shelter, but in Closed Access cities, ownership comes with a lot of complex risk exposure. Where we are today, that's not such an obviously good financial decision.