Well-paid economists are trying to figure out how we can back out of the situation our current set of incentives have created with respect to purchasing housing. It used to be that a 20% down payment on a home purchase was standard, and one rented until one was able to save that amount and still have something left in the "rainy day fund." Today, the concept of a rainy day fund is considered a quaint oddity, something it would be nice to have but which few seem to be able to attain, for the vast majority of Americans. And 20% down payments are apparently fairly rare, not just for first-time buyers but for those purchasing "move-up" homes, unless one is moving from a part of the country where housing is expensive to a less expensive area.
20% down payments gave way to 10% down payments, which in turn gave way to 5% and 3% and no down payment, and then to 107% financing. Homebuyer tax credits have been supplying the down payment for many people in recent months. But how do we wean ourselves from this?
It is time to start thinking outside the box. I don't yet see the full mechanics of the transition, but here's the thought process.
Houses do not rise in value. Like cars and other mechanical things, they depreciate, year in and year out. It is never worth more than what it would cost to construct today, less depreciation. At some gut level, every homeowner knows it. (And most renovation projects do not increase the value of a house by as much as they cost; the exceptions appear to be adding a 2nd bathroom to a house with only one, and adding a deck to the house. Other renovations customize the house to the preferences of the current owners, which may be something quite different from what others would be willing to pay that amount for; there's nothing wrong with that, as long as owners do it with their own money. A, say, $50,000 renovation might only increase the market value of the property by $25,000 or less.)
Let's think about what one buys when one buys a house. First of all, with very few exceptions, one is buying the piece of land on which it is built. (In a leased land situation, one does not buy the lot, but one may be buying the right to occupy it for the payment of some amount of ground rent to another party; the formula for the ground rent will affect the selling price. In a condo or co-op situation, one is buying a part of a larger entity which usually involves owning the land.) While this may be a surprise to those who have only owned land in the heartland of America, in many places the value of the land under the home represents more than half, sometimes far more than 75%, of the price of the home. These are what used to be known as "high rent districts." (You know the song, "New York, New York" -- "if you can make it here, you'll make it anywhere?" Some of that is a reference to coping in a high-rent area.)
One is buying the house that sits on that lot, which might be quite new and technologically up to date, or quite old and, despite being well maintained, somewhat out of date. One is also buying the right to replace that older building, subject to local zoning and other requirements, with something which better suits current market wants. The existing structure may be quite usable, but if it is a cottage in the middle of a city block, the building itself may actually have a negative value: it will cost you something to tear it down and remove the debris.
Here's the part we need to think about. The buyer pays the seller for the value of the land and for the value of the structure on it. The seller, or someone in the chain of previous owners of that site, created the building on it. But he didn't create the land value. The community did. The current owner, if he has owned it for more than a few years (a few months, in some places, even in 2010) has ridden the value up. He might have put down a 10% down payment, and experienced a, say, 10% increase in the value of the total property, doubling his money. In places where land is scarce or conditions are structured to discourage selling, he may have experienced a 50%, 100%, 150% increase in the value of the total property. But remember that the house itself has been depreciating while he owned it, even if he has taken good care of it. The seller is reaping something he didn't sow. The buyer must borrow from a lender to pay him for it, and will be paying it off for the next 30 years of his life.
Suppose that we started recognizing the distinction between the land and the building on it, and set things up so that our buyers were buying the building and the right to the land under it, but instead of paying the seller for something the seller didn't create, would pay the community, year in and year out over the course of his ownership, the annual value of the lot. In a place where land was quite valuable, that would be a lot of money each year -- more than local government needs, and enough to send some up to the state and federal governments, which have paid for the infrastructure in the highest-value cities. In a place with little infrastructure and few services and no natural amenities, it would be quite little. Banks would lend some percentage of the value of the house itself, while recognizing that they're financing a depreciating asset.
Here's a quick and dirty table. It hasn't caught the extremes at the top or bottom end, but perhaps it will help illustrate:
House Value | Land Value |
Land Share Real Estate Value |
Land Rent at 5% |
20%
Down Payment
|
80% Mortgage |
(Annual) Mortgage Payment at 5%, 30Y |
Property Taxes |
Annual Carrying Costs |
Annual Income Needed at 28% |
|
| Major coastal city |
150,000 |
850,000 |
85% |
$42,500 |
30,000 |
$120,000 |
$7,730 |
0 |
$50,230 |
$179,393 |
| Major coastal suburb |
150,000 |
600,000 |
80% |
$30,000 |
30,000 |
$120,000 |
$7,730 | 0 |
$37,730 |
$134,750 |
| Exurbs* |
100,000 | 100,000 |
50% |
$5,000 |
20,000 |
$80,000 |
$5,153 |
0 |
$10,153 |
$36,261 |
| Beach |
150,000 |
400,000 |
73% |
$20,000 |
30,000 |
$120,000 |
$7,730 | 0 |
$27,730 |
$99,036 |
| Ski Area |
100,000 |
600,000 |
86% |
$30,000 |
20,000 |
$80,000 |
$5,153 | 0 |
$35,153 |
$125,546 |
| Midwestern city |
100,000 |
200,000 |
66% |
$10,000 | 20,000 |
$80,000 |
$5,153 | 0 |
$15,153 |
$54,118 |
| Midwestern suburb |
100,000 |
50,000 |
33% |
$2,500 |
20,000 |
$80,000 |
$5,153 | 0 |
$7,653 |
$27,332 |
| Rural |
80,000 |
20,000 |
20% |
$1,000 |
16,000 |
$64,000 |
$4,123 |
0 |
$5,123 |
$18,296 |
| *beyond commuting distance, but perhaps weekend-accessible | ||||||||||
Incidentally, you might be surprised to learn that construction costs don't vary all that much from one part of the country to another. Based on costs in southern California, as 1.00, the range is from .73 in El Paso, .74 in Charlotte and Raleigh, .76 in Savannah, .77 in Montgomery, Jackson, St. Petersburg, .87 in Dallas, .91 in Boston, .95 in Seattle, 1.02 in Newark, 1.03 in New York City, 1.08 in San Francisco, to 1.29 in Anchorage and 1.44 in Honolulu. And, according to the same source, economy construction for a 2000 square foot, 1-story home can be as little as $86psf, or $172,200 -- in southern California -- which would equate to $126,000 in El Paso. "Luxury" construction on a 3,000 sf home would run $210 psf, or $630,000 in SoCal. The cost of the building varies much less than the cost of the land does.
This is consistent with Mason Gaffney's findings. (Search this page for the word "wine," and then go up 6 or 8 paragraphs.)
This is also consistent with Morris Davis and Michael Palumbo's May, 2006 paper, The Price of Residential Land in Large U.S. Cities, at http://www.federalreserve.gov/pubs/feds/2006/200625/index.html: average structure values vary far less than average land value does across metro markets. See, for example, Table D and Tables 6a through 6g.
See also http://www.masongaffney.org/essays/How_to_Thaw_Credit.pdf
Today a significant number of homeowners with mortgages owe more than their homes are worth. While what I am proposing would create a certain major disruption for many people who expect to live off their home equity, I think it is something we need to look at very carefully, and find a way to make an orderly transition to. A gradual shift of taxes off productive activity and onto land values is in order.
Comments