Foreword
Housing is a touchy subject. On the one hand, nobody likes to hear about homeless children, or elderly retirees forced out of their homes. On the other hand, nobody seems particularly obliged to go out of their way to help those in need obtain and retain housing. So what then?
For full disclosure, I have a fairly large portfolio of real estate investments, of which a majority are residential. Obviously, I am not an impartial observer. At the same time, having been both a tenant and an (indirect) landlord for multiple years and in many different locales, while also keeping constant tabs on the managers who oversee my investments, I feel I can provide a perspective that is often lacking in the media.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
Costs of building a home
According to RocketMortgage, the average cost to build a home is about $282,299 in 2022. Granted that a portion of those homes are larger, luxury homes, so the actual cost of building a “starter home” for someone of more modest means is probably lower. On the same article, the average cost to build a 1 bedroom is about $80,000 on the low end — much better!
But let’s dig a little more — according to BusinessInsider, the median American family has a net worth of around $121,700. Suddenly, that $80,000 looks a lot tighter. Also, recall that the $80,000 figure is at the low end of the scale — in most parts of the country, it may not even be a feasible number. At the same time, the $80,000 cost doesn’t even include the cost of the land which, depending on location and size, can easily cost $100,000 or more.
Next, building a home takes time, from a few months to a year or more, depending on the location and scope of the project. During this time, the new owners will need a place to live, likely rented which means monthly rent payments.
Finally, home insurers and mortgage lenders typically do not service new builds. A new build is much more risky for the insurer, as there is active work being done and thus more chances for accidents. At the same time, if the borrower defaults on their mortgage, the lender has no real collateral (i.e. the house) to foreclose on to recoup their money. As a result, both insurance premiums and mortgage rates for a new build tend to be much, much higher than for a regular home.
Why is building so expensive?
A large part of the reason why building new housing is so expensive is because of existing rules and laws. Modern day housing units must fulfil a myriad of rules and laws built over decades of experience. Unfortunately, these necessarily add to the costs of building.
For example, in practically everywhere in the USA, all homes must have proper heating and cooling depending on the local climate, bedrooms must have an exterior wall and have exterior facing windows for safety reasons, wall paint must be lead free for health reasons, bathrooms must have proper plumbing, etc.
For the most part, I personally believe these to be sensible and reasonable — no one should be poisoned by lead paint just because of their financial situation.
Separately, the craftspeople who build our homes deserve to be compensated fairly — theirs is a job involving manual labor and, often, very real risks to their bodies and health. They should also be protected by adequate insurance policies so that them and their families are taken care of if the worst were to happen.
Finally, to ensure that all the proper building rules were adhered to, and that nobody made a mistake that might lead to potential disaster, most counties in the USA have enforced inspections by local engineers and experts, to ensure that buildings are “up to code”. While overall a good thing, these inspections do add to the overhead both in terms of costs (inspections typically are not free) and time (and they take a while to schedule, while any issues found need to be remedied).
And remember, we’ve just discussed the cost of building the home. Maintaining a home incurs another set of expenses such as property taxes, utility bills, etc.
Grim reality
When you put together all the requirements a modern home needs, and the costs of building that home, you arrive at a very grim conclusion — for a very large portion of the country, buying a home is simply an expense they cannot afford.
Renting
Given that so many people cannot afford to buy a home, yet still require a roof over their heads, it’s no wonder that many people choose the next option, which is to rent a home from a landlord.
Unfortunately, the facts that renters tend to be less affluent, housing costs are high, and investors (landlords) need to make profits result in some very contentious relationships. In particular, landlords tend to be portrayed in the media as unscrupulous capitalists, out to suck up every last cent from their hapless tenants.
While clearly not every landlord is a saint, it seems unduly combative to assume every landlord is the devil. While there are certain valid criticisms, there’s also a lot of just simple misunderstandings and well poisoning.
Houses are for living, not for investing
On the surface, this seems like a valid complaint, but is it really?
For better or for worse, in the USA, the government has decided that it is incapable of providing housing for the people. As such, this critical role has been outsourced to the private sector, with incentives such as tax advantages for real estate investments, etc. to encourage development.
The private sector, being capitalistic in nature, is incentivized by profits — private individuals and entities simply do not, in general, offer up their resources for free.
Given that the country has a general lack of housing, in order to correct that imbalance, housing prices need to rise, essentially increasing profit margins and incentivizing investment, so that enough housing will be built for everyone who needs it.
Until the government’s stance on the matter is changed (see below), the only real way to ensure enough housing units being built annually to accommodate new household formation is, unfortunately, higher home prices.
Investors push up the price of homes, forcing others to rent
There is some truth to this — real estate investors are driven by the profit motive, and as long as the numbers work, they will willingly bid up the price of homes, sometimes beyond the means of Regular Joe’s.
But that’s just one side of the equation. The investors clearly needed to buy the homes from someone else (in order to push up the prices) — someone who benefitted from the increase in home prices. Someone who, too, maybe a Regular Joe. What then? Are real estate investors now Santa Clauses handing out bags of money?
The fact is that this is a more nuanced issue — investors benefit existing homeowners, while hurting new ones. In more concrete terms, baby boomers and Gen X’ers tend to benefit from real estate investors, while millennials and Gen Z’ers tend to suffer.
Whether this is desirable, then, likely depends a lot on whether you already own your home.
Landlords raising rent is predatory
Tenants tend to complain that landlords seem to raise rents every year, and at rates that tenants generally feel are unfair. So let’s break it down.
As we’ve discussed before, housing is expensive, and maintaining them is also expensive. At the same time, landlords (investors) are capitalists and out to make a profit. Which means that whatever costs the landlord bear, must eventually be passed on to the renter, along with a markup for profits.
Yes, that means renters tend to pay more in rent than the landlord pays in costs. And as we’ve discussed earlier in order for the supply of housing to meet the demands of new households, this must necessarily remain true.
Given that the landlord’s costs increase every year due to inflation, so too must the rent. At the same time, in order to stimulate more housing to be built, areas with a severe lack of housing must necessarily see rents rise faster than inflation — the temporary supernormal profits incentivizes new housing to be built, which then will increase competition amongst landlords, which in turn reduce future rents.
But if renters are paying for the cost of the homes to begin with, what are landlords for? As it turns out, a lot.
Recall that renters tend to be less affluent. As a result, they tend to have trouble getting the necessary financing for building or buying homes. Landlords step in here, as an intermediary between the banks and the renters — the landlord puts up their reputation and assets as collateral to the bank to obtain the financing needed, and they then charge the renter for the “lease” of their balance sheet.
If you’ve worked in finance, you’ll know that while financing rates for the first ~75% of a project is relatively cheap, rates jump dramatically as the loan to value increases — the lender naturally assumes more risk as the equity cushion is reduced.
Similarly, the cost of borrowing 100% of the cost of a home needs to be much higher than borrowing 80% of the cost of the same home — the higher rates compensate for the higher risk assumed by the lender + landlord.
Secondly, landlords tend to manage more than 1 home. This often translates into savings in terms of maintenance costs via economies of scale — it is fairly common for landlords to build relationships with local craftspeople in a win-win relationship — the landlord provides the craftsperson a steady stream of jobs and income, while the craftsperson gives the landlord a discount for their services. This discount can then be passed on to the tenant.
Next, the landlord, by virtue of having to deal with constant maintenance issues across their tenants, will naturally build up a rolodex of known and trustworthy craftspeople, saving the tenant time and potential costs of engaging a less skilled or even outright fraudulent contractor.
Finally, the landlord also provides a service — essentially a 24 hours contact for maintenance issues, as well as aggregation of various expenses into a single, tidy monthly rent payment.
Solutions
Personally, I believe strongly that everyone benefits if everyone has proper housing — homelessness tends to bring with it many social problems.
However, and I say this as a beneficiary of the current system (being a real estate investor), the private sector is simply not equipped nor incentivized to achieve that goal. The most profits can be extracted when relative demand is high, since as supply increases marginal profits fall. So given a free market, supply will likely never ever rise enough for everyone to be suitably accommodated.
Given that the benefits of 100% housing is a benefit shared by all, basic economics then suggest that affordable housing, as opposed to luxury housing for those more affluent, should really be provided or subsidized by the government in some way. Forcing the private sector to subsidize housing for the less affluent such as the use of rent control, rent stabilization or other coercive means will just lead to less investment and thus even worse problems in the future.
Section 8 housing
As a start, section 8 housing, I feel, is a pretty good program. Its main issues are 2 fold. First of all, the program is severely underfunded, and really needs to be a much bigger priority of the government’s budget, so that everyone those in need can reliably qualify and get the assistance they need.
Secondly, the stigma associated with it must be eliminated. That can likely be achieved with a bigger budget, so that more graduated assistance can be provided to more people — those who are living in poverty may get, say, 99% of their rents covered, while those much above the poverty line but are still struggling can get, say, 10% of their rents covered.
With an expanded program aimed at everyone from those in dire need up to those in, say, the lower 85 percentile in terms of income, the program can conceivably be seen as just as social benefit, and not “aid for the poor”, and hopefully that will remove the stigma, allowing more people to benefit.
Along with the above, enforcement of the rules to prevent abuse should also be strengthened. Those receiving aid should be required to show actual need, while landlords should be on the hook for providing quality housing at a reasonable price, and not just taking advantage of desperate people who don’t have much of a choice.
Government built housing
Section 8 housing works by engaging with the private sector via subsidies. It is, however, not the only way, and to be honest, the fact that the private sector is involved necessarily means that the overall costs are higher to account for private profits.
As an alternative to section 8 housing, the government can also opt to just do-it-itself so as to save on costs. As we know from examples around the world, large scale public housing programs can work, though like section 8 housing, it needs to be properly funded and managed, while also at a scale large enough to overcome the stigma of receiving government aid.
Not that long ago, the US government used to build and sell subsidized housing to those in need. Technically, remnants of this program and its offshoots still exist around the country, though the scale is at a level that’s much too small to really address actual needs. A dramatic expansion of that program, with adequate funding, proper oversight and management may revitalize the program enough to help address the housing issues faced by those most financially vulnerable.
Altruism?
Ultimately, I think it is important to acknowledge a few basic facts:
- A lot of people, with their own means, simply cannot afford to own a home. Some may not even be able to afford to rent.
- Homelessness is a social problem which affects everyone, even those who are not homeless. As such, everyone benefits if homelessness is reduced or eliminated.
- To a lesser extent, giving everyone a stake in society, via home ownership, has benefits too. People who feel that they have a stake tend to behave better, leading to less social issues.
- To bootstrap these programs will likely involve large public programs and associated large public spending. Yes, that means those who are financially better off necessarily must take on some temporary discomfort. But if we can get it right, the future benefits should outweigh the current costs.
Janky Thoughts 