IANA-econmist, but I think some of the reasons for renting instead of buying include the following,

- Lifestyle - e.g. single in 1BR apt, plan to marry later and have kids
- Transient - college, job relocation, etc.
- Bad credit - unable to get a mortgage
- No savings - unable to put down the required 20%

Why shouldn't rental rates and home prices track each other?

How about the huge tax subsidy (the mortgage interest deduction) for home ownership!!!! What kind of economist wouldn't identify that as a major factor for a bouyant housing market regardless of the rental market.

Krugman's thesis is only right if every agent (buyers, sellers, renters, rentors) are wrong and wrong-headed. Soft rental rates can be evidence of strong property values. There is no evidence that the supply and demand of real estate is out-of-whack. Thus, even in the short-term, rental levels would have been determined by the carrying costs and expected appreciation potential of the underlying property. Both factors have been exerting a downward pressure on rents. The first effect is obvious. In an environment where carying costs are stable and low, owners need not pass as much cost to renters. Less obvious, but as significantly, market expectations that property is undervalued and/or that is likely to experience future appreciation should drive rents lower. (Owners just want to own the asset, and throw away the rent; renters really want to own, and need to be induced to rent.)

Renting is essentially being short real estate. Most pundits have been (conceptually) short real estate (especally the chicken-littles like Krugman). What is amazing is that they see the evidence that they have been wrong for a decade as evidence that they may be right sometime.

Krugman will always jump at the chance to back handedly bash Bush policies or anything that might be construed to be a Bush-policy based positive.

There will always be folks, as Gideon points out, that will find renting a better choice for whatever reason. If people ARE, as Krugman suggests, buying homes purely on speculation what are the potential outcomes? If the property is owner-occupied and you don't have to move, then falling home values has little effect on you - much like a bear stock market. The way you turn a temporary decline into a permanent loss is to sell. If it's income propery and you bought it even though rents are low speculating it would appreciate, it may become a cash flow problem - but that's what spreadsheets are for before you sign the papers. Nobody intelligent buys a single-family dwelling to rent if it doesn't cash flow. And the spectacular home ownership numbers aren't about non-owner occupied residences anyway.

OJ, your point about rental prices is intuitively correct. Although, generally, a home's value as an income-producing investment is determined by a multiple of what it would rent for. By that formula, implied rents SHOULD track higher as home values go up. But, in a low interest rate environment, the inverse relationship becomes less true -- i.e. a home now valued at $200k doesn't pull the market rent price UP for it because it's easier and more tax advantaged simply to buy it.

I don't have the data, but would be surprised if a similar relationship weren't true 40 years ago when rates were this low.

>- No savings - unable to put down the required 20%

This may not be that big a factor. I was able to buy my first place at around 3% down (and my current place at around 10%) using an FHA loan.

My current place (bought in 1997 when the last real-estate bust hit bottom) has appreciated 240% since then (around 30% a year); some of the surge to buy might be "Buy while rates are low and before the price can go up any more!"; when mortgage interest rates rise again, we'll probably see the end of the sales boom.

"What drives most appreciation in housing prices is the universal human desire to own a slightly larger and more expensive place than one can really afford; a desire restrained in normal times by the universal desire of those who lend money to get paid back."

For the past six-and-a-half years, my wife and I have rented in the Rockaway Peninsula of Queens, New York. For the past three months we have been house and (as "Plan B") apartment-hunting. Rents have jumped considerably over the past two years, but housing prices have jumped much more. That universal human desire #1 is nonsense, from what I see: In the Rockaways, much of the home-buying is by first-timers like us, who see their first chance to get out of paying someone else's mortgage, and instead pay for their own. (The condo we are now in contract to buy, is actually smaller than the apartment we've rented for the past two-and-a-half years.)

Oddly enough, much of the Rockaway Peninsula is a hellhole, and yet prices are shooting up in slum, middle-class, and upper-middle-class neighborhoods alike.

The first and most obvious reason for heightened demand is low interest rates, which can cut the total cost over the course of a 30-year mortgage by tens of thousands of dollars. (However, I have also read that lower-interest rates can cause prices to rise, though I may have seen that as a headline to a story I never got around to reading, since I don't recall the reasoning behind the claim. My hunch is that sellers raise asking prices, to erase the savings caused by the lower interest rates.)

Another factor in rising housing prices, is government intervention, through programs like Fannie Mae, Freddie Mac, and HUD's selloff of defaulted houses in poor neighborhoods for way- below-market prices. For instance, last year, black friends of ours bought a home from HUD for $65,000, perhaps 70% below its market value. It is essential to note that they are black, because the neighborhood in question is extremely racist. (Our friends have nothing to fear, but we would have plenty to worry about.) It is also germane, because such programs were designed in the first place for minority home-buyers.

Now, economics aside, such government programs can have very beneficial effects for a neighborhood, if the proportion of non-working families (TANF, SSI-disability, etc.) is kept below a certain critical mass. (Otherwise, those families will simply terrorize homeowners and destroy their property.) Homeowners are bound to take better care of property than would renters. And my experience is that owners do a poor job of maintaining rental properties.

Economically, however, such programs weak havoc with the price mechanism, and cause those homes remaining in the same area, whose prices were not artificially reduced, to rise above what they otherwise would have sold for, as homes in the area become more scarce.

And since the low interest rates themselves are due to government intervention at the Fed, much of the entire scenario of exploding home prices is due to government action. But not all. Government inaction plays a role, too.

Homes in neighborhoods with that increasingly rare service, good public schools, have exploded at rates of up to three times the increases of the rest of the housing market. This is due largely to illegal immigrants, whose children (and the programs such as bilingual education, which are designed to ruin them) have destroyed thousands of public school districts. We have 9 million-13 million illegal immigrants in America, due to government officials' refusal to enfocre the immigration laws.

Note that many urban school districts have been destroyed by the combination of the children of illegal immigrants and the violent children of racist blacks, who have made the schools intolerable for white and Asian children, whom the blacks routinely terrorize. Thus, do white and Asian families have ever fewer, more expensive options as to where to buy a home, if they wish to send their children to the public schools.

Having contemplated buying a home in the Bay area, there is a compelling financial reason to rent. You can have more money!

If you add the hidden cost in purchasing a home in the Bay area it is greater than renting. This does not even include having to pay the actual mortgage.

For example, a 2 bedroom apartment rents for $1,800 per month. You can buy the equivalent home for about $4,000/month.

When I went to purchase a home the HOA was going to be about $400/month. I estimated maintenace around $100/month. I had to pay for a place to put my car for another $300/month. The interest on the loan was about $800/month. That doesn't even include state and local property taxes.

In my over all calculations I decided that I would make more money by investing the excess money I had each month instead of buying a home.

(I have recalled the numbers to the best of my ability, I may be off a little bit on some of them. I don't feel like breaking out the spread sheet.)

Also, I have friends in the Bay area who sold homes and started renting for reason that I have quickly laid out above.

BTW, I am certainly no fan of Krugman but in some market I see a housing bubble.

I had a long discussion yesterday with a commercial broker. In the course of looking for something else I discovered that in my county -- which is weird for lots of reasons and not a good place to look for generalities -- rents are way up, prices are way up -- except that you can buy apartments that rent for $1100/mo. for $100K! (In bulk, minimum 6.)

The reasons for this are complicated, but bottom line is that what you can expense on investments has a big impact.

I don't know the current figure, but as of 3 weeks ago the lowest asking price for any house on the island was $425,000. That explains why some people rent; unless your income is over $90K, you cannot buy.

Interest rates are low. But then so is inflation which means it'll take longer to pay off any mortgage.

But payments haven't generally been the limit on home ownership--access to loans has, no?

I don't think Krugman bashes Bush's policies because he doesn't like Bush. He bashes Bush because he hates Bush's policies.

Many people are buying homes because interest rates are so low, but many of my friends are currently in the home/condo market, and I can tell the expectation of buyers and the real estate agents (at least in the PHX, AZ market) is that housing prices will continue to go up. I've read various articles which state the same things - always buy houses because they'll go up in price. You can always sell later and get a bigger, better home.

I do think there is speculation (a therefore a bubble), but I don't know how much. Once stocks were priced not on securing the profits of the company, but on future stock prices, the bubble happened. People lost 30-50% of their portfolio on average, I think. People derided those who warned of a bubble as chicken littles as well. But who wouldn't have liked to have kept the value they lost?

People who ignore Krugman because there is an alternate explanation for housing prices (low interest rates make houses more affordable, drawing in cash which raises their value) seem to forget the interest rates will not remain low forever. Once they rise, that money will stop flowing in. And once that money stops, prices will plateau or decline.

Unlike stocks, houses are intrinsically valuable. But the decline of their home's value is going to demoralize a lot of people regardless.

The question is how big is the bubble? It may only be a slight bubble and once popped not be too bad. But even a moderately sized bubble would severely affect a person's sense of financial worth.

Housing prices may always go up in the long run -- I bought my house 14 years ago at the top of a speculative market, watched it lose about 15% in assessed value during the '90s and now it's worth about 250% of what I paid for it. (Since I bought it to live in, I don't care what's its market value is.)

But in the short run, housing prices can fluctuate violently. If you bought in a town where outsourcing just closed the major employer, you're stuck and stuck big -- worse than any halfway prudent investor in stocks would be.

I am old enough to remember when thousands of former house owners in the Houston area just walked away. They would leave the doors open behind them as a small token of their disgust.

Is there a bubble? There sure is in some parts of the country.

Chris:

Is AZ going to stop growing?