16 Part Series on Housing Affordability

In 2019, I wrote a 16 part series of posts for the Mercatus Center that laid out a way of thinking about housing affordability.  Here are the links to those posts.

1. Thinking Clearly About Housing Affordability:  "Here is the core analytical error: housing affordability should be measured in terms of rent, but our understanding and policies have erroneously focused on price—to disastrous ends.  From monetary policy to credit policy to regulations on local development, responses to the housing bubble have consistently and explicitly aimed for less residential investment, fewer buyers, and fewer homes.  Limiting the supply of homes has had a predictable effect of increasing rents.  In other words, the problem of affordability, in terms of price, was “solved” after 2007.  Affordability in terms of rent was not.  Understanding the difference between these two measures will be an important factor in correcting the policy errors that led to the crisis and creating better, more equitable, more stable economic outcomes in the future.
   I argue in my book, Shut Out, that the housing collapse and the financial crisis were not inevitable.  They weren’t even useful.  In fact, their very purpose was mistaken.  The fundamental measure for housing affordability is rent, not price.  And, trying to bring down prices instead of bringing down rents inevitably will fail on its own terms.  In the long run, prices will be determined by rents anyway."
2. What Are Landlords Good For?:  "More efficient markets lead to higher real estate transaction productivity. The resulting higher prices convey that information: owning a home is more valuable now, because it can be done with less hassle. Landlords would be less necessary because transaction costs would be a smaller problem, making homeownership more valuable.  Only focusing on price might tempt one to suggest that transaction cost-reducing innovation should be avoided because it would only increase prices."
3. Homeowners Make the Best Landlords:  "When considering the benefits of home ownership on the margin, the focus should be on capturing the excess yield that seems to be widely available to owners.  It is this yield that is most important to marginal potential owners, not capital gains... It may be more accurate to think of that excess yield as a form of patronage.  A lucrative wage available to those with access to ownership.  The wage is earned by performing the duties and taking the risks of a landlord. Upon becoming the owner, the wage remains, but the duties of the job can be shirked.  There is no problem tenant to evict.  No vacancies to fill.  No complaints to manage.  It’s a cushy job you can get because your Uncle Sam pulled some strings down at the bank."
4. Real Estate Investment Doesn’t Increase Spending:  "The housing bust is creating more excess capital income than a housing bubble ever could have."
5. Rising Prices, Lower Rents; Rising Rents, Rising Prices: "The suppression of credit has lowered Closed Access prices, but they are still high because rents are high. Open access housing has been pushed to a level well below previous norms. But attempting to solve the price problem in Open Access cities has created a rent problem...Where building new homes is permitted, rising prices lead to declining rents. But, rising rents lead to rising prices. In the long run, even the solution to rising prices begins with a focus on lowering rents."
6. "The Myth About Bubble Buyers": (F)or households 45 to 54 years in age, the homeownership rate in 1982, when the Census Bureau started tracking it annually, was 77.4 percent. It bottomed out at 74.8 percent in 1991 and then recovered to 77.2 percent at the peak in 2004. By 2017, it was down to 69.3 percent!…..Rental expenses as a proportion of incomes (Figure 1), belie the conventional wisdom. The rental value of owned homes was more stable as a portion of owner income than the rental value of rented homes from the late 1990s to the mid-2000s. In other words, if there was an increase in relative spending on housing, it was among renters. The rental value of homeowners was rising in line with their incomes. There is no sign of marginal homebuyers being induced into homeownership and overconsumption.
7. Squeezing Unqualified Borrowers: "Considering this set of circumstances, the idea that housing affordability is getting worse because prices are high and that the solution is even higher interest rates or tighter credit access is a disastrous misreading. It will lead to a vicious cycle of segregation between households that can qualify under today’s standards (and who then can buy ample units at favorable terms) and households that cannot qualify (and who must keep economizing while a large portion of their wages is transferred as rent to the ownership class). There are two options. Re-opening credit markets to entry-level buyers will return the market to a more equitable equilibrium. Maintaining the market as it is will continue down the path of settling at a new equilibrium where certain households live in smaller, less adequate units, either because of size, amenities, or location."
8. "Tight Lending Regulations are a Wealth Subsidy": Thinking in terms of rental value, public policies and market innovations that lower mortgage interest rates can be broadly beneficial to consumers, even if those benefits don’t accrue to the actual borrowers who use those low rates.  That is because higher mortgage interest rates have a similar effect on price as exclusionary lending standards.  Downward pressure on price creates a rental subsidy for home buyers who don’t require a mortgage.
9. "Property Taxes Are Rent to a Public Landlord": If there is concern that the net effects of government policies, in total, favor housing and lead to market volatility, a return to higher levels of property taxation can be a useful tool for countering it.
10. Property Taxes Can Be a Tax on Monopoly Power.: "If politically maintained monopoly power is going to remain, claiming monopolist profits through taxes is an improvement. The fact that the tax doesn’t affect rents is a sign of efficiency. If rents must be elevated, better that they go to local public services than to the real estate cartel."
11. Low Property Taxes and Obstructed Housing Supply Are a Bad Mix "It would seem that raising property taxes would make housing more expensive.  They are, effectively, a tax on materials to build homes.  But the binding constraint to affordable and reasonable housing in twenty-first century America isn’t material.  It isn’t a lack of affordable physical space.  It is the political obstruction to placing those materials in dense urban centers."
12. Are Property Taxes Regressive?: "A region that allows ample new supply and imposes higher property taxes is friendlier to households with lower incomes than a region with obstructed housing supply and low property taxes."
13. Income Tax Benefits to Homeowners Are Regressive: "Two of the most important changes to the tax code made by the Tax Cuts and Jobs Act of 2017 (TCJA) relate to housing: a reduction in the deductibility of state and local taxes and a reduction in the mortgage interest deduction."
14.  "Because of Housing, All Taxes on Capital Tend to Be Regressive".: "(T)he income tax code, as it exists, has regressive effects regarding housing affordability.Given those effects, it is inaccurate to treat capital taxation in general as a progressive tax. Corporate taxation, in general, creates a regressive rent subsidy. A different tax regime that focused on property taxation rather than generalized capital taxation could plausibly produce public revenue in a way that would be more progressive than a tax code that taxes capital income more generally. This should cast doubt on common presumptions about how and why to change the tax code."
15. Does Homeownership Really Increase Household Liabilities?: "The idea that paying $700 in rent is preferable to a $300 mortgage payment comes from the idea that a potential home buyer would be adding a new liability to their household balance sheet. It would involve leverage, and leverage is dangerous. But this idea is, itself, a product of mental framing. There are assets and liabilities that we explicitly include on balance sheets, like the value of a home and a mortgage, or the market value of a corporation’s future profits. And there are assets and liabilities that we don’t explicitly include, like future rental expenses or the market value of a laborer’s future wages. ------The explicit financial engineering that spread before the financial crisis has taken on a lot of criticism over the past decade.  That financial engineering, ironically, created risks and costs that were more transparent and visible than the implicit financial engineering that has been an unwitting side effect of deleveraging Americans’ explicit balance sheets. A significant part of corporate financial analysts’ academic training is to properly account for the liability of the rents corporations have committed to paying.  Wouldn’t it be prudent for mortgage regulators to account for this liability also when evaluating the benefits and costs of the lending standards applied to households?"
16. A conceptual starting point for housing affordability and public policy: "Understanding this value and the systematic returns that homes provide leads to a somewhat paradoxical conclusion that (1) homeownership is usually a good investment, and (2) the smaller the investment, the better. In other words, an owner-occupied home with a low rental value can be a great investment, but the downside is that it requires living in a home with a low rental value. The various posts in this series have considered housing affordability with a focus on rent. This focus has led me to the following policy suggestions: we should (1) maintain relatively high property taxes, (2) reduce or eliminate income tax benefits of homeownership, including the non-taxability of the rental value of owned units, (3) eliminate urban supply constraints, (4) reduce regulatory barriers to mortgage lending, especially in low tier markets, and (5) encourage innovation in real estate markets that reduces transaction costs."

Book News

 Lots of book stuff happening.

Scott Sumner's "The Money Illusion" is coming out.  This is an important account of the 2008 recession.  It is the framework for viewing the economy that drew me into my housing work.

Rowman & Littlefield is releasing a paperback version of my first book "Shut Out" this month!  And here is a code you can use to get it for only $18.90.

Use code:  RLFANDF30

Here: https://rowman.com/ISBN/9781538163009/Shut-Out-How-a-Housing-Shortage-Caused-the-Great-Recession-and-Crippled-Our-Economy

And, in January,  my followup book "Building from the Ground Up: Reclaiming the American Housing Boom" will be out.

Should be an exciting few months ahead!

The curious sine curve of equity returns

 Occasionally, I take a new look at how equities are doing compared to a long-term sine wave.  Over the course of the last century or so, real total returns on the S&P 500 follow a sine curve pattern in a surprisingly regular way.  I'm just fitting curves here, so I don't want to say too much about it, but it is interesting.

The positive performance of the stock market over the last few years is actually right in line with the long-term trends.

Here are charts comparing real total returns to the sine curve, fitted to 20th century results, with the last 21 years out of sample.

More on Interest Rates and Home Prices

Some follow-up thoughts on yesterday's post.

There might be some more to think about regarding interest rate sensitivity and local supply constraints.  I asserted yesterday that the decline in yields from 2000 to 2005 was concentrated among the more expensive cities, but that yields remained relatively stable in other cities during that time.  One implication is that expensive cities may be more rate sensitive.  I am unusually flummoxed by the patterns here for some reason.  But, digging around some more, I think I have become less sure of my intuition about sensitivity to interest rates and about relative housing yields across metros.

This first chart suggests the reason for expecting more yield volatility in expensive cities and possibly more sensitivity to interest rates.  Clearly, over time, high rents have become an increasingly important factor in housing markets.  Systematically, where rents are higher, gross yields are lower.  And, where rents are low, yields seem to remain relatively stable over time. The relationship between rent levels and yields moves up and down through hot and cold markets.  In other words, a bit counterintuitively, where rents rise, the rent/price ratio declines and becomes more volatile.

Data from Zillow.com affordability measures

But, when I look more closely at cyclical changes, I just don't see the pattern that this suggests there should be.  During the 2000-2005 boom, the Closed Access cities and the Contagion cities experienced anomalous declines in gross yields.  Long term interest rates also declined during that time, but I think the decline in yields in those markets was a result almost purely of these anomalies.  In the Closed Access cities, the anomaly was mostly continued strong rent inflation, and in the Contagion cities, it was from short-term price surges having to do with big shifts in migration that stressed their local markets.  Taking the Closed Access and Contagion cities out of the mix, in the rest of the country, if anything, housing in cities with higher yields was somewhat more sensitive to changing interest rates than housing in cities with lower yields.

As housing has moved through the aftershocks of the boom and the crisis, this seems to continue to be the case.  Once those anomalies from 2002-2006 worked their way out of the system, housing seems to be only somewhat sensitive to long term rates, and it is more sensitive to rates where housing is less expensive.

Zillow has detailed rent data going back to 2014.  Looking very broadly at the numbers up to 2014, gross rent/price was in the same range that it had been in the 1990s, and that this was more or less the case across MSAs.  Over that time, 30 year TIPS rates had declined from about 3.5-4% to around 1%.  One could suppose that this is because housing yields are not rate sensitive or because shifts to very tight lending had added a premium to housing yields, counteracting the change in TIPS rates.

I'm working very broadly here, but it appears that there could be three general forces at work here. (1) expected rent inflation, (2) long-term real rates, (3) tight lending since 2007.

In "Shut Out", being a little more thorough, I suggested that expected rent inflation could explain differences in home prices across cities, plus about a 20% price increase due to declining rates. Rates have declined about that much again, since the boom.  These two factors may be correlated, because if low rates trigger more home buying demand, that should lower rents where supply is elastic and raise rents where supply is inelastic.  It's complicated.

From 2014 to about September 2019, housing yields appear to have declined the most in metros with higher yields.  This changed after September 2019, and maybe this has mostly been due to Covid issues, but since then, yields have declined across the board.  I suspect that part of what is going on is that there has been a temporary decline in rents in the expensive, low yield cities, which has temporarily lowered their yields.  As those rents recover, yields in those cities will move back up.  So, it appears that there is a systematic change since 2014 of yield compression.  Yields in low-yield cities are staying about the same and yields in high-yield cities are declining.

In any case, there is a striking difference between this recent move in home prices and the 2000-2005 move.  There are no anomalous cities here.  The changes in yields are relatively similar across cities, and, apparently, correlated with existing yields.

This shift could reflect at least three factors:

1) Unsustainable bubble activity.  This is always a popular choice.  I am skeptical, of course, because in general the whole existence of this project of mine owes itself to discovering evidence, time after time, that has contradicted these types of explanations.  Also, as with so much housing data, the difference between cities dwarfs the changes within them.  Should we call a decline from a 10% yield to a 8% yield a bubble when the country is full of cities with 6% yields?  This would call for tight monetary and/or lending policies.  Of course, I think that is likely the continuation of a wrong perception that has been knee-capping our economy for 15 years now.

2) Maybe prices in high-yield markets are more sensitive to interest rates.  In that case, rising rates (if they ever come) might be associated with declining prices.  I don't see much sign of loosening lending standards.  Most of the activity is still among those with high credit scores.  If that is the case, loosening regulations on mortgage lending could be a useful countermeasure to help keep prices from collapsing if prices are sensitive to rising interest rates.

3) Maybe the convergence in yields is happening because all cities are becoming supply-deprived.  In that case, strong growth and generous lending will be key.  Why might this be the case?  Building has been much lower in affordable, high-yield cities since 2005.  In this chart, there are a few outliers well below the regression line.  Those are Contagion cities who were especially walloped by the financial crisis (Phoenix, Las Vegas, Orlando, etc.).  Other cities have a quite high correlation.  Building has been low in affordable cities.  I attribute this to tight lending.  These cities tend to have lower incomes.  And, because of this, rents have been rising broadly across MSAs.  Recently, rents have moderated or fallen in the low-yield cities because of Covid migration.  In any case, less building could mean that buyers in all metros expect rents to be strong.  This can be seen in vacancy rates, too.  Vacancy rates have always been low in the low-yield cities.  Vacancies in other cities are declining too, because of the lack of building.

https://fred.stlouisfed.org/graph/?g=EU8h

Of course, I would expect some combination of 2 & 3.  Surely there is some sensitivity to real long-term interest rates.  The questions are how sensitive home prices are to interest rates, how that sensitivity might differ across cities with different supply elasticities, and how much tight lending standards may have altered that sensitivity.

I thought there might be more anomalous movement among MSAs in the recent market activity.  Austin, for instance, might have seen an unsustainable decline in yields, as the Contagion cities had before 2006, because of a big migration shift.  I suspect that tight lending plays a role here.  In 2003-2005, migration led to more building.  And, possibly the migration was more targeted at certain cities than it is today.  But, because entry level housing is greatly obstructed by tight lending (and because of supply chain issues related to Covid), there hasn't been as much of a supply response in these markets recently.  So, rents have been rising in cities that tend to take in more migration in recent years.  Migration is pushing up prices, but more so than in 2005, it is pushing up rents, so the Contagion cities aren't anomalies in terms of yield.  And, since the migration is related to lower demand for Closed Access residency, the Closed Access cities are experiencing some anomalous decline in yields, but this is coming more from declining rents than from rising prices, and will likely reverse or moderate as Covid passes.

Interest Rates and Home Prices

 A couple of quick thoughts on recent home price appreciation.

In graph 1, I estimate a national median gross rent/price yield from Zillow rent and price data.  I compare it to the 30 year TIPS (real) interest rate (plus 8%).  Certainly a case can be made that some of the recent price movement has been related to declining real long term yields.  However, without more historical data, this doesn't tell us much.  Two measures both moved in a certain direction over a period of time, and so it's easy to match them up on the y-axis.

Here is a longer series with similar measures.  Here, I estimate the national average gross rent/price level with total rent/total residential real estate value for owned homes.  I also used the CPI rent inflation measure with the Case-Shiller national home price index, with a scaling constant as a second version of the estimate.  Both estimates of rent/price yields follow similar trends.

Here, I use a 30 year TIPS bond issued in 1998 and then in more recent years the general estimate for 30 year TIPS yields.  Here I only added a 3% spread to the TIPS yields.  Part of the difference is that the mean yield is lower than the median yield. (Price/rent is not the same across the market.  It is systematically higher where rents and prices are higher.)  Part of the difference is that we imposed a one-time shock on housing during the financial crisis, adding a 2-3% spread on housing yields compared to other assets, so the spread in the first graph from 2014 onward is much higher than it had been before.

https://fred.stlouisfed.org/graph/?g=ESSe

When I first started looking at these things years ago, I excused the pre-2006 price increases with this relationship.  I still more or less stand by that.  It isn't controversial to say that home prices are related to interest rates. In fact, I think it helps clarify the analysis to show that it is specifically real long-term rates that seem to correlate with housing yields.  But, even in 2005, that doesn't tell the whole story.  Rent/price yields are not uniform across cities.  They decrease systematically where rents are high.  Some of that might be attributed to expectations of future rent increases.  Some of it might be attributed to lower cost of ownership where rent is a product of location rather than structures and services.  In any event, before 2000, gross housing yields had been between 6-7% for some time, and after 2000 they continued to be in that range in most cities.  In some cities like LA or NYC, they declined to more like 3-4%.  The aggregate yield around 5% was an average of a country increasingly becoming bifurcated into at least two different stories.

So, it may be that the correlation between 30 year TIPS and housing yields from 1998 to 2008 overstates the relationship.  In most places the gross housing yield didn't decline as much as the 30 year real rate.  Yet, even if one assumes that a 2% spread remains in place between long term real rates and housing yields, the recent drop in real interest rates is enough to support recent home price increases, even if the relationship is slight.

Actually, I think the causality may go both ways a bit.  In other work, I have mentioned that housing used to be cyclical in terms of quantity and now, because we have obstructed construction so much, it is cyclical in terms of price.  It is hard not to notice a similar regime shift in interest rates.  Before 2000, real interest rates were relatively stable, and changes in interest rates were largely related to inflation expectations.  Since 2000, real long term interest rates have become strangely volatile.

In the mid-20th century, housing yields remained stable because when rents increased, a lot of new homes were built until rents declined again.  All those new units required capital.  Mortgages, construction loans, home equity.  An increase in demand for investment (in generally safe assets and securities) drove GDP growth higher and put upward pressure on interest rates.

There is a lot of concern about a lack of safe assets, which is driving down interest rates.  Homes in California used to be safe assets.  They aren't any more.  They are risky investments in a cartel.  Mortgages used to be safe assets for investment, but many aren't legal any more, so the trillions of dollars worth of new homes they would have funded, which also would have been safe assets in Texas, Nebraska, and Tennessee, also don't exist.

So, there is an interesting set of interacting variables here.  If inflation rises, I don't think that will have much effect on real home prices or construction activity.  If real rates rise, which will be associated with real economic growth (and probably with a mitigation of short-run inflation), then it should have a moderating influence on home prices.  But, unless mortgages can flow, multi-unit projects can be easily approved, and construction can run hot, then rents will continue to rise and long-term real interest rates will continue to be limited.  In that case, it seems like a "hot" market is likely to remain, with housing growth (but at historically low construction rates) and high prices (low housing yields), while the "have nots" who are under the "tyranny sincerely exercised for the good of its victims" will face rising rents.

I suspect that a construction boom would both lower rents and raise real long-term interest rates.  But, the boom must come first.  In the meantime, housing is in a peculiar space, where we should expect there to be some sensitivity to rising rates if the economy continues to recover, yet also housing yields continue to retain at least a 2% spread to long-term 30 year rates, compared to pre-crisis norms, so that nobody should expect home prices to revert to earlier relative levels (especially as rents continue to rise).

Brig Burton and Carly Burton, again

I have good news, or at least not bad news, I guess.

I sold my business to Brig Burton in 2010.  He ended up defrauding me in that transaction.  I had to sue him.

I previously mentioned the Burtons here.

The key part:

I had to sue him in civil court in order to get fully paid for the business.  The judgments I was granted against him included fraud and conversion.  He appealed the rulings, and the appeals court upheld them, including the punitive damages that were assessed.  The appeals court confirmed that "based on the record in this case, the jury could have found by clear and convincing evidence that Burton’s conduct was aggravated and outrageous, evincing an evil mind. Therefore, we decline to set aside the punitive damages awards."

Anyway, I thought I was through with them, but the Burtons sued me after I posted that post.  We were able to make them to post a bond, so that when the judge dismissed the case (which she eventually did), the Burtons would have collectible funds to use to pay my legal expenses.  Which the judge also ruled they had to do.

Brig seems busy lately. For example:

Here:  https://www.bizbuysell.com/business-broker/b-a-burton/green-tree-alliance/31184/

and

Here:  Brig Burton – Business Growth Leader Worldwide (nationaldiversified.com)

Update

December 2020 Yield Curve

 The yield curve looks pretty good.  Long term rates still are recovering.  The expected date of the first short term rate hike also appears to be coming closer.  This all seems like good news to me.  All in all, pretty good monetary management for the COVID-19 recession, I think.

It seems to me that a short position in early 2023 Eurodollar contracts has a nice risk/reward balance.  Not much room for downside (declining interest rates), but quite a bit of room to run higher (higher interest rates).

October 2020 Inflation Update

 I haven't updated the inflation numbers for a while.  Covid-19 has probably made it difficult to say too much, because there are so many compositional shifts in the demand basket.  But I think it is worth taking a look at what is happening in rent inflation.

Much of the drop in the stated core CPI number is coming from declining rent inflation (or shelter inflation).  Core inflation excluding shelter is still below 2%, so the Fed has room to goose spending within their mandate.  Trailing 12 month shelter inflation has declined from about 3.4% to 1.7% since the Covid-19 outbreak, and the run-rate may not be positive.

Real-time data suggests that much of this appears to be related to some amount of exodus from expensive cities like San Francisco and New York City.  However, declining CPI-measured rent inflation is pretty evenly distributed among the major metro areas.

There are three periods of sharply declining rents in this period, and it is interesting to compare them.  In 2002-2003, construction was hot and new supply was bringing down rents in cities with elastic supply (Dallas and Atlanta, but not New York and LA).  Then, from 2008-2010, the foreclosure crisis and the sharp tightening in lending markets created a negative demand shock for shelter, driving down rent inflation everywhere.  That was associated with very low rates of construction.

Now, the decline in rent inflation is associated with low but moderately rising construction activity.  If that continues, it would suggest that lower rent inflation is mostly due to income shocks and the specific character of the Covid-19 context, where landlords may be opting for more leniency until the market settles.  If there really is a persistent shift of housing preference into less dense cities and housing units, then that should be associated with rising demand for shelter and more construction, not lower rents.  In that case, there would be a compositional shift out of the expensive cities, and rent inflation might decline as tenants leave the expensive cities (pulling rents there down) and move to cities where new demand is met by supply rather than price inflation.  The fact that rent inflation is currently declining in cities like Phoenix, which we should expect to be the destination for some of those moving tenants, suggests that income shocks are more important now than inter-MSA migration.

October 2020 Yield Curve Update

 The yield curve has taken a strong bullish move as a result of the election and the Covid-19 vaccine progress.  The long end of the Eurodollar curve is nearly back to the pre-Covid level.

The date of the first rate hike remains in mid-2021, but the escape velocity has increased significantly.  Forward inflation breakevens remain level at about 1.6%, which suggests that the recent improvement has been due to real shocks.  The Fed probably still has room for more traditional accommodation.

September 2020 Yield Curve Update

 The yield curve continues to slowly show optimism.  The long end of the curve continues to climb.  It's now back up above the yields of early April.  This suggests that the market foresees continued relatively strong recovery in employment and that the Fed is adequately providing liquidity.  Forward inflation expectations have leveled out below 2%, but they are basically as high as they were before the Covid-19 outbreak.  That's probably reasonably good news.  And, the expected date of the first rate hike is settling in around the June 2021 contract, which is pretty bullish.  The market seems to think recovery is in the works.

Both because there is an endemic lack of adequate supply and because of some of the demand responses to Covid-19, residential investment should be strong to help with a continuation of positive trends.  This suggests to me that if there is much of a pullback in stocks, it will be from an unforeseen negative real shock.