Thursday, January 29, 2004

Are we Bostonites in a housing bubble?

Jane asks if we are in a house bubble. YES WE ARE. The implicit cost of housing calculated by treating rents as an annuity and discounting their sum back to the present generate house prices that are much lower than current house prices -- at least in Boston. This means that house owners are anticipating very rapid capital appreciation, because it is actually cheaper to rent forever than to buy (in Chicago it's the opposite, buying is cheaper than renting). There are excellent reasons to believe that house prices will no longer skyrocket -- like the fact they've been skyrocketing for the past 7 years -- which suggests that these expectations are inflated.

Remember -- buying a house instead of renting a house is just 1) a bet on real estate in your area and 2) the opportunity to consume "owning a house" (for people who are into that thing). It is not a way of saving rent, since you pay the rent in opportunity cost instead of out-of-pocket. A mortgage is just a way of financing the bet, like using a margin account to buy shares on credit.

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