The high cost of promoting homeownership

It's individually rational, but collectively dysfunctional

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According to the Federal Reserve’s Survey of Consumer Finances, the median American household had a net worth of $192,700 in 2022, only $38,840 of which were financial assets.

A typical family’s net worth is mostly real estate, and those investments are dominated by owner-occupied real estate. People have good reasons for wanting to own a home and for prioritizing that over other forms of saving. But those reasons are driven by public policy that encourages people to make owner-occupied housing their primary means of saving and wealth-building.

The fact that public policy prioritizes homeownership means that homeownership is widespread in a way that makes it a kind of cultural signifier of adulthood and middle-class stability. And that means that any dip in the homeownership rate or any barriers to attaining homeownership strike the public (and the elected officials who respond to them) as a crisis that merits a policy response.

But a lot of this is pretty dysfunctional.

Suppose you’re a dentist in a mid-sized town that includes one large factory. Nobody would advise you to invest your savings specifically in the company that owns that factory. After all, if the factory closes down, that’s going to be bad for your dental practice. What you want to do is balance risks by owning a diverse portfolio of financial assets. If you own the house that you live in, you’re facing the same problem of lack of diversification. If the factory closes, that’s bad for your dental practice and bad for the value of your home. If anything, from a pure investment standpoint, the ideal move would be to own a home on the other side of the country.

There are obviously some offsetting reasons why it’s congenial to own your own home. But precisely because it seems like something a lot of people would want to do anyway, it doesn’t seem like we need to go out of our way to encourage it. And precisely because a world of owner-occupants involves so much exposure to idiosyncratic risks, it encourages people to adopt other risk-averse policy preferences that hurt growth. I know that the “you’ll own nothing and you’ll be happy” guy has sparked a ton of paranoid reactions, so I want to be clear that I’m not against people owning things.

But I think the world would be better if people owned a much more diversified portfolio of assets that was much more robust to risks, and allowed for more professional management of real estate and an overall attitude to local politics that is less dominated by risk-aversion.

Homeownership has pros … and cons

Discussion of this topic tends to be confusing because people end up discussing several different issues simultaneously, and I think it’s worth trying to disentangle them.

One question is whether you, a person living in the actually existing United States of America, should either own a home or have a clear aspiration to become a homeowner. And here I think the answer for most people is pretty clearly yes. Now, of course, if you don’t have the means or the opportunity, then you don’t have the means or the opportunity. But if you do have good credit history and enough savings to make a downpayment, then buying a house is generally the smart move. This is in part because of the home mortgage interest tax deduction. But the bigger deal, in my view, is that you can get a government subsidized loan to purchase owner occupied housing and turn your modest savings into the seed of a larger leveraged investment. There is no equivalent to Fannie Mae for buying a diversified portfolio of stocks. So even though the diversified portfolio of stocks would be a better investment all else being equal, the availability of a loan on generous terms is a big advantage to buying a house.

Another issue is that owner occupied housing gets very favorable treatment for the purposes of capital gains taxation, so after tax investment gains in owner occupied housing are larger than they appear at first glance.

Over and above that, outside of New York City, the market for rental housing for grown-ass adults is pretty limited. A lot of rental housing targets lower-income people, along with some nicer, professionally managed “luxury” apartments aimed at single young professionals. But people in the market for dwellings for middle class, middle aged families will find that this is only sporadically available, often as a somewhat irregular case where an owner-occupant has to move suddenly or temporarily and puts a place on the market. In fact, civilians and politicians alike get really weird when investors try to move into the single-family housing market and operate professionalized landlording operations (more on this later).

So, most people in the US own homes over the course of their life because that mostly makes sense, and this raises the question of whether the government should address barriers to homeownership. It mostly seems like we should. Homeownership is advantageous for most people, so if some people are making down payments with the help of family money and others can’t, that becomes a source of compounding financial disadvantage that we might want to address.

But note that one of the main reasons why homeownership is almost always a worthwhile goal is that public policy specifically makes it financially advantageous. The bigger question, I think, is whether it makes sense to have so much policy effort to encourage this specific form of investment.

The answer is “no it does not”

This seems like a reasonably easy question to me.

Absent subsidy, most financial advice would suggest that the most useful thing about homeownership is that it’s an effective psychological trick to get people to save money.

But as an actual investment vehicle, owning the home that you live in is just terribly flawed. There are, of course, non-financial reasons that you might want to do this. The people who sell expensive jewelry will tell you that you should think of it as an investment, but that’s obviously terrible advice if you’re thinking purely about investment. What’s true is that jewelry is highly durable and has nontrivial resale potential, and those investment attributes are relevant to jewelry’s merit as a consumption item. Absent policy favoritism toward it, homeownership would be similar to that: You do need a place to live, and owning your home rather than renting it provides some additional value to the consumption aspect of housing. And, of course, a home is a valuable object that can be resold in a pinch.

Buying a house is not a crazy thing to do. The point is that absent subsidy, it wouldn’t be a particularly optimal thing to do.

And if you were starting from scratch designing savings and investment policy for the middle class, I don’t think you would want to design policy that specifically encourages that form of investment.

For example, instead of exempting sales of owner-occupied housing from capital gains taxation, you could have a lower threshold for when capital gains taxation kicks in. You could get really ambitious and create a sovereign wealth fund with mandatory contributions (like in Singapore) that you’d also be allowed to make voluntary additional contributions to. Or, you could have something like “Fannie Mae for index funds,” where the government would re-insure loans made by banks to middle class people who want to make leveraged investments in diversified pools of stock.

There are a lot of possibilities. The point is that under a more neutral policy:

• Many people would still own homes, but the homeownership rate would be lower.

• The savings rate would be the same (or even higher) because middle class and working class people would own more shares of stock.

• New homes would be smaller on average, since this particular form of investment wouldn’t be subsidies, and there would be somewhat more working capital for business.

• The rental market would be less negatively-selected, with more business opportunity available in providing rental housing to middle class families.

The overall situation would be a modestly more efficient deployment of capital throughout the country, combined with a population whose savings are less exposed to correlated geographical risk. What’s really intriguing, though, is the thought that de-risking middle class people’s investment portfolio might lead to different, less risk-averse policy attitudes.

Why are homeowners NIMBYs?

You could imagine a world with tons of laws designed to make it incredibly difficult to open new branches of chain restaurants. In that world, existing successful chain restaurants like Starbucks, McDonalds, and Subway would be some of the loudest and more powerful voices against letting chains and expand. And everyone would think this was the most natural thing in the world.

After all, Starbucks, McDonald’s, and Subway are already successful, so it only hurts their business to allow more restaurants to open. Who wants competition?

In the real world, of course, companies do love to undermine competition. But they usually do not engage in that particular form of anti-competitive advocacy because they themselves would like the opportunity to expand. To Starbucks, the lure of growth outweighs the risk of allowing Dunkin or Peet’s to grow.

And that’s in part a virtuous consequence of the stock market cross-ownership issue.

Most shares of McDonald’s stock are owned by people who also own shares in other companies. Companies that are primarily controlled by an individual whose wealth is specifically tied to one company (like Tesla) tend to be relatively new, expansion-oriented startups. And even those founder-run companies need to attract investment from outside parties who are also investing in other companies. This generates a kind of collective class politics of shareholders that, while certainly encouraging bad policies in some areas, also means that “pro-business” politics generally means politics that allows businesses to grow and expand. Note that in Italy, where the landscape is much more dominated by family-owned businesses, this is not the case, and the Italian government engages in a lot of “pro-business, anti-market” policymaking.

But also note that with regard to housing, the American spirit of competition completely vanishes.

Under our current policy regime, it seems natural that shareholders would favor business expansion (because they welcome the upside), while homeowners would be anti-growth NIMBYs (because they fear the downside). YIMBY/NIMBY conflict is often envisioned as straightforwardly pitting the interests of renters against those of homeowners, but that’s wrong. YIMBY-ifying has a lot of upside value to homeowners, whose parcels of land could become much more valuable with more development rights. It just also poses downside risk because it’s hard to predict exactly which parcels of land would increase in value and which would decrease under a more abundance-oriented housing policy. If everyone owned diverse real estate portfolios, they would probably be pro-development and want to capture that upside. But instead, homeowners are exposed to a high level of idiosyncratic housing risk.

And you see empirically (Michael Hankinson, Andrew Whittimore) that homeowners have more NIMBY views than renters. Katherine Einstein, Maxwell Palmer, and David Glick also document that “community input” processes tend to be dominated by a demographically unrepresentative group that is massively tilted toward homeowners and that “overwhelmingly (and to a much greater degree than the general public) oppose[s] new housing construction.” Literally living inside your largest financial investment feels very normal precisely because it is encouraged by public policy. But it’s actually an odd way to live, one that generates bad downstream consequences.

Empty nests

A recent Redfin report looked at who owns the houses with three or more bedrooms in the United States. They found that a larger share of these houses are owned by empty nest adults with no kids at home than by middle aged families with kids.

As an abstract question of capital ownership, this is pretty banal.

People save money and accumulate capital over the course of their lifetime, meaning that on average, someone who is 65 owns more stuff than someone who is 35. A house is an example of stuff, so an older person is more likely to own a house than a younger person. And a big house is “more stuff” than a small one, so an old person is more likely to own a big house than a younger person is.

The odd thing about this isn’t really that old people own a larger share of the housing stock — it’s that’s older people are living in these large houses. Because, of course, the flip side of policy encouraging homeownership is that policy encourages owners to live in their investment. You could imagine a world in which every boomer couple vacates its three bedroom house, moves to a cheaper one bedroom, and rents the larger house out to a millennial family with kids. That would sort of make sense; the boomer couple is at or near retirement so needs to start monetizing its savings, while the millennials have current labor market income but need to consume more housing services.

People don’t do this in part for sentimental reasons and in part because it would be a logistical pain in the butt. But tax policy also discourages it. An increase in wealth obtained through passive appreciation in the price of your three bedroom home is treated much more favorably than an increase in wealth obtained by renting that home out. That creates an incentive to delay downsizing unless and until the owner truly needs the money. The result is that relative to a more neutral policy environment, we not only have more NIMBYism (because of risk-aversion), but a large share of the existing housing stock is deliberately held off the market by owner-occupants who are using unneeded bedrooms as a savings vehicle.

The housing policy discourse is haunted by the specter of devious landlords deliberately keeping units vacant to push up prices, which is largely apocryphal. But a large share of Americans who serve as their own landlords do, in fact, unconsciously behave this way. Because it really is financially advantageous to hold onto your oversized house until the last possible moment rather than make it available as soon as you don’t need it anymore.