Saturday, September 22, 2018

Are we in a housing bubble?

The term "bubble" means that prices are too high.  But the question is difficult to understand unless we know what to compare them to.  We can use the ideas of Chapter 9 to measure housing prices relative to the cost of renting.  Because renters can buy, and owners can sell and rent, in the long run the prices should be comparable (a mobile asset should be indifferent about where it is used).  Here is the Fed data on the relative costs of owning relative to renting.  

Many people (some economists) think that there was a housing bubble in 2006 whose bursting lead to the subsequent recession (shaded blue area).  Currently owning is 30% more expensive than renting.  In 2006, owning was 70% more expensive than renting.  


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  2. Hi Luke! Consider this problem:
    John is considering either buying or renting a house. He has $50k in a savings account with a compounded interest rate of 3% monthly. John sees a house he really likes for $250k. If he puts down $50k on the house, he can borrow the remaining $200k at 4% interest over 30 years. His mortgage would be $1000/month (not including insurance and property taxes). He then sees a house for rent down the street for $1000/month (identical in size and quality to the $250k house). John decides to buy the $250k house since the monthly payment is the same as renting.

    a. What is John's opportunity cost of buying the house in the first year?

    b. What is John’s total cost of owning the $250k house over 30 years? Include the additional cost of $300/month to account for insurance, taxes, and maintenance.

    c. If John rented the house for 30 years instead, what would it cost? Assume an annual rent increase of 2% after the first year.

    d. If John rented, how much would he have in his savings account after 30 years if he made monthly deposits of $300?