Dr. Eli Beracha is the co-founder of The Beracha Team serving as the real estate consultant of the firm and advising clients on their acquisition and disposition decisions. Dr. Beracha has over 20 years of practical real estate experience. Over the years, he served as a consultant for real estate funds that manage billions of dollars, advised on development projects, investment decisions, portfolio allocation and wealth management.
In the academic world, Dr. Beracha is a Professor, Department Chair and the Director of The Hollo School of Real Estate, at Florida International University. He earned his Ph.D. in Finance with concentration in Real Estate Investment and has published dozens of academic papers in leading journals and featured in the popular press including the WSJ, The Economist, CNBC, Bloomberg, The NY Times and Forbes, among many others. In a recently published report by the Journal of Real Estate Literature, Dr. Beracha was ranked 3rd in the world for his real estate research productivity.
Dr. Eli Beracha has recently been recognized by The Journal of Real Estate Literature as the world’s third best in research productivity, and today, we are honoured to be joined by this top industry expert to bring more clarity to the renting versus buying debate. We use Dr. Beracha’s ‘Lessons from Over 30 Years of Buy Versus Rent Decisions: Is the American Dream Always Wise?’ and ‘Housing Ownership Decision-Making in the Framework of Household Portfolio Choice’ papers as the basis for most of today’s conversation, beginning with why owning a home is deeply rooted in the perception of the American dream. Then, we discover how to measure the true price of home ownership, how the American dream and other psychological factors influence one’s decision-making, how hard assets perform compared to stocks and bonds, and why renting comes out ahead of buying nine times out of ten. We also learn why owning is for the inherently wealthy, the ins and outs of Dr. Beracha’s rent versus buy index, the rate of property appreciation versus stock appreciation, and how renting influences saving habits compared to owning a home. To end, we dive deeper into the risk-adjusted wealth accumulation of home ownership versus renting, and Dr. Beracha compares the efficiency of the real estate market to the stock market while detailing everything to take into account to be fully-equipped to make your decision to rent or buy.
Key Points From This Episode:
(0:00:00) Why Dr. Eli Beracha is one of the world’s best to discuss renting vs buying a home.
(0:05:32) Understanding why owning a home is deeply entrenched in the American dream.
(0:06:10) The various aspects to consider when measuring the price of home ownership.
(0:07:57) Weather Dr. Beracha agrees with the adage “renting is throwing money away.”
(0:09:36) What the price of a home should represent, and how psychology influences decisions.
(0:16:48) Unpacking Dr. Beracha’s 2012 paper subtitled, ‘Is the American Dream Always Wise?’
(0:19:51) Hard assets versus stocks and bonds, and why renting pips buying most of the time.
(0:26:00) Why many still choose to own a home despite long-term financial discrepancies.
(0:30:53) The ins and outs of Dr. Beracha’s rent versus buy index.
(0:39:46) Why homeowners are usually wealthier than renters even though renting is “cheaper.”
(0:42:03) Property appreciation, stock appreciation, and the renter’s savings rate.
(0:47:41) How home ownership influences saving habits compared to renting.
(0:49:46) The risk-adjusted wealth accumulation of home ownership versus renting.
(0:58:40) Dr. Beracha compares the efficiency of the real estate market to the stock market.
(1:03:22) Everything you need to take into account to make your decision to rent or buy.
Read The Transcript:
Ben Felix: This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix, Chief Investment Officer at PWL Capital, and Dan Bortolotti, Portfolio Manager at PWL Capital.
Dan Bortolotti: Good to be back.
Ben Felix: We had a very interesting guest today. We're joined by Dr. Eli Beracha. He studies real estate. He's a finance professor, but his main research focus is on real estate. We talked to him about one aspect of his real estate research, which is renting versus buying a home. He's got a bunch of papers on that. He's got a bunch of papers on other real estate topics too, but we focused on this one. He's been in his field for 20 years, both academically and with practical experience as well, serving as a consultant for large real estate funds. He's advised on development projects. He's been in there studying it academically, but he's also been in the field in a practical sense.
He is the department chair and director of the Hollo School of Real Estate at Florida International University. He's got his PhD from the University of Kansas in finance with a concentration in real estate investment. He's got a huge resume of published papers in academic journals. He was recently recognized by the Journal of Real Estate Literature as the third ranked in the world for his real estate research productivity. In terms of interesting people to talk to about the rent versus own decision for housing, he's got to be up there in the top one or two people in the world to ask about this.
Dan Bortolotti: It's such a hot topic with our listeners, right? I mean, it's something that we've talked about a number of times and it always attracts a lot of reader interest. It's great to have them on to provide some actual empirical data on the discussion.
Ben Felix: Dan, you and I had a pretty good conversation about this topic back in episode 325, which we do reference during this conversation. If people want to go and check that out, that's the episode number. I don't know, Dan. I thought this is a great conversation. Eli's research spans analytical studies of rent versus own outcomes. He shows, as we've talked about, that renters can come out ahead. He's also got a really interesting buy versus rent index that him and co-authors have published. It's like a barometer that shows a point in time for different areas in the United States, whether ex ante, looking at the information that we have now looking forward, whether it makes more sense to rent her own in that specific place. We talked about how that model has actually been pretty good at predicting future price movements for real estate.
Then the other thing that I really appreciate with the whole conversation about Eli's research in general is that he's not saying renting is better. He's just saying, hey, look, renters can have similar wealth outcomes, but he also acknowledges that they don't. We spent quite a bit of time talking about why that is.
Dan Bortolotti: We talked about it quite a bit on our original podcast that you referenced, this idea that in theory, it absolutely makes sense that if you spend less money on housing by renting and you invest the difference wisely, you could come out ahead, or at least very comparable. Most people just quite simply do not do that. In practical terms, it actually makes sense to advise people as a parent advising your young adult, son, or daughter, should you rent or should you buy. It's very limited just to present some academic evidence. I think, let's look around. What do people actually do is vet to rent and spend the difference. That's going to have a dramatically different result than rent and save the difference. We all know which one most people do.
Ben Felix: I mentioned this during the conversation with Eli too, but he says something along these lines in one of his papers that the general advice to buy instead of rent is good advice, but it's given for the wrong reasons.
Dan Bortolotti: That's right. People, I think when they give that advice, say things like, houses always go up in value, they're not risky and things like this, or other investments are more risky and likely to result in lower returns. None of which is true. But if you look at his reasoning, why homeownership can make a lot of sense, as you said, it's the same conclusion. It's just for different reasons.
Ben Felix: The other really interesting paper of his that we talked about is how an owned home fits into a portfolio of other assets. I mentioned this during the conversation too, but especially for our world then, where we're dealing with people who do have sufficient wealth outside of their home, they actually have a portfolio of assets. They own stocks, bonds, and a home. In those cases, when you adjust for risk because of the hedging properties of the home, it's actually gives you a better risk adjusted outcome in a lot of cases. For people who have wealth and have other assets, owning a home actually looks really good in a model. But then for people who only own a house, it doesn't look so good. There's a lot of nuance and really interesting points that we talked about.
Dan Bortolotti: It's a very important point, because as we know, in Canada, there's a very large number of people for whom their house is the vast majority of their net worth. As homes are so expensive, that isn't surprising. But it does help to look at that from a risk perspective. If something were to happen to affect the value of your home, it devastates your net worth, in a way that it wouldn't be if it represented a quarter of your net worth.
Ben Felix: Interesting stuff. Any other thoughts or comments before we go?
Dan Bortolotti: No, let's get to it.
Ben Felix: Okay, here we go. Episode 354 with Eli Beracha.
[INTERVIEW]
Ben Felix: Eli Beracha, welcome to the Rational Reminder Podcast.
Eli Beracha: Thank you. Thank you for having me.
Ben Felix: We're very excited to be talking to you. You've got some incredibly practical research that we're going to talk about, and we thank you for that. To start off, how entrenched is home ownership as the American dream?
Eli Beracha: I think it's very much entrenched. It is the American dream. Really, when people are thinking about coming to America, I think about the house, the two and a half kids, the picket fence, etc. Owning a home is almost a sign of you've made it, or at least you made it somewhat in the US. That's why I think it's so important part of the American dream.
Dan Bortolotti: Eli, when we think about the price of a home, when we're comparing it to the decision to rent, for example, frequently people only look at the purchase price of the home. What other factors are you considering when you measure the cost of home ownership?
Eli Beracha: That's a very good question, because most people, and I give this example in class a lot, so there are two homes. Let's say, they’re both the same size, same number of bedroom, bathroom, age, quality, finish, etc. One cost, let's say, $500,000, the other one is $600,000. Which one is more expensive? Of course, the answer is, well, the one that is $600,000 is more expensive. Well, maybe, maybe not. Well, what if the house that is $500,000, for example, in five years from now, when you sell it, you would sell it also for $500,000. The one that you bought for $600,000, when you sell it five years from now, you'd sell it for $800,000. Which one is more expensive? Well, now let's start thinking. This is one factor.
Basically, the future price appreciation for home, if it is higher, it makes the cost of home less expensive, so it's less costly to own it, and most people don't think about it. They're really simply thinking about the price tag. Some people think about, but probably not enough about the other costs around, of course; property taxes, maintenance, insurance, etc. Those are relatively straightforward. Unfortunately, people underestimate them quite often. But really, the one that they're missing is the fact that just because a property is less expensive in terms of the price tag, it doesn't make it less costly.
Ben Felix: Such an important point. The price appreciation piece, but also, just all the other unrecoverable costs, the things that you pay to live in a home that people don't think about makes it, I think, hard for people to compare renting and owning. Can you talk about the fact that there are these other costs to owning that are different from the price? What does that say about the general sentiment that renting is throwing money away?
Eli Beracha: If you would find a place that you would consider living in, and let's say that that place is available for rent and available for sale. Let's say, I like the place, I want to move in, but I'm not sure if I want to buy it, or rent it. I always give the example. Let's say, you're asking somebody who is wise, experienced. Let's say, your grandma, and you ask your grandma, what would you say? Should I buy it, or rent it? What would your grandma say? All the students always say, my grandma would tell me to buy it. I said, yes, she'll probably will. She will not only tell you you should buy it, she would follow it with, “Well, if you rent, you're just throwing your money away.” Or, she finish with another classical, “Well, if you rent, you’re just paying your landlords mortgage.” Some kind of an ending like this. But really, it cannot be more far truth than that.
The cost of renting, the rent amount, that is the cost of using the home for a given period of time. You pay your rent every month, and if your rent is $3,000 a month, that it was a costs you to rent it. People underestimate how much it really costs to live in your own home. Sometimes the obvious place that people look at is what is the mortgage payment, which is not the cost of the home. We can talk about it later. Even if it is, even if that is what they're comparing, they're excluding other things, like maintenance, repairs, the time you spend at Home Depot over the weekend, because you fix this, that, and the other. It makes home ownership not cheaper than renting, often more expensive. Renting is definitely a valid option for many, many individuals, many families.
Ben Felix: Can you talk about, theoretically, what the price of a home should represent?
Eli Beracha: Well, the price of anything should basically represent what is the future benefits, I guess, discounted the present. Of course, when we talk about investment property, it's easy to take cash flows, discount them, and calculate the value, which should equate to the price of the property. When we talk about a home, it's a lot more difficult, because you talk about a lot of soft things that you can't really easily discount. For example, the quality of education, the level of crime, the beauty of the neighbourhood, all the soft things that we definitely do value, but it's very hard to put a number, or a dollar sign next to that. The price of the home should represent all those factors together. Because so many of them are soft and many of them are changing a lot over time, you move into a neighbourhood, and maybe the crime level is elevated, but it's being fixed over time, or vice versa, going worse. Those are the things that it should represent, and because they change a lot of the time, prices are very different and change differently in different locations.
Ben Felix: It's like a stock price. You've got housing services, flows that are maybe worth different things to different people, and then you've got a discount rate that reflects whatever other factors.
Eli Beracha: Exactly.
Ben Felix: The American dream, the psychological desire to own a home, how does that interact with the theoretical price of homes?
Eli Beracha: It's not just about Americans. I'm based in Miami, so arguably, part of the United States of America. Because so many people consider owning a home to be the American dream, there's a bias toward home ownership that makes the demand for home ownership higher. Therefore, even though in equilibrium, it should be equal to the cost of renting, it actually pushes the cost of ownership above the cost of renting. Because it is part of the American dream, it actually makes owning a home more expensive than renting.
Ben Felix: That's so interesting. In a perfect equilibrium, renting and owning should cost the same, because if they didn’t, people would shift between the two until their prices found an equilibrium. But because there's this non-financial desired own homes, you could theoretically see a case where a home ownership is actually more expensive, because you're getting this whatever psychological benefit.
Eli Beracha: Yes. To be honest with you, I mean, there is value to home ownership beside just the service that the home give you. If it gives you a different feel, because you own it, because you believe and feel like you're part of the neighbourhood, or whatever other benefit it gives you, comfort, sense of home, some people tell you, “I rent and I just never feel like home.” You can't argue with that. They just don't feel it. Once they buy something, it can be the condo next door that they don't rent, they own. Now they feel like home. It has value. When we do research, we can't analyze that value. We analyze things that have door signs. When we compare one to the other, we can say, okay, so renting is less expensive and more attractive from a financial perspective, maybe. But you cannot include the other thing, the non-monetary considerations that are important.
Ben Felix: Dan, you once told me a story on this podcast about how you were renting a condo and then bought the same condo. Then as soon as you bought it, you started doing upgrades and renovations. Did you feel like it was more home once you bought it?
Dan Bortolotti: Yeah, I think so. Just to fill in the details, we rented a condo when we moved into downtown Toronto and fully expected to remain renting indefinitely. Then our landlord informed us that they were going to sell the property. They said, “You have to leave when your lease is expired.” We made the decision to just buy it from the landlord. We made the unusual decision to stay and we both rented and owned the same condo. Absolutely, your perspective changes. Once you own it, all of the things, the imperfections that we used to turn a blind eye to, like, well, we don't love the bathroom, we don't love the kitchen, but hey, we don't own the place. Then when it becomes yours, all of those things that you were not content with, you end up spending money on, because now it feels much more like home. That can be both good and bad. I would say, it does add to those additional costs of homeownership that are not often allied up, because we spent a lot more on the exact same property once we owned it, versus when we rented it.
Eli Beracha: That is the dollar amount that you spent, that along the time that you spend thinking about it, dealing with whatever headache, even with renovations, people underestimate how much that is.
Ben Felix: That's very, very true. Eli, what is this behavioural psychological perspective to the equilibrium concept? What does it say about whether we should expect renting or owning to come out ahead in the long run financially?
Eli Beracha: I was teaching buy versus rent for a long time, since I was getting my PhD. I got my PhD in 2007, but I was teaching before. I think I was covering the topic of buy versus rent since maybe 2004-5. I was always doing the simple analysis, consider all those factors and we put them in Excel spreadsheet and we reach some numerical conclusion. Then one of the students asked me, so we're doing something about what we expect up in the future. What happened in the past? Is renting better, or worse than owning from a financial perspective?
Then something that I don't often do, they tell you, hey, I'll go and then check on that. I said, actually, I don't know the answer. I'll go check on that. I went to check on that and nobody knew the answer. There's nothing on that in the literature. I said, well, guess what? I'm going to find out. That's where the first widely cited paper that I wrote on the topic was born. In the beginning, we didn't really know what to expect. The results basically show that renting for the majority of the period, we looked at that time, it was from the early 80s until 2010, I believe, or 2012, the things was 30 some years of study. Then we continue that later, too. It shows that renting, if you're really doing only the monetary consideration, comparison between the two, renting actually comes ahead of owning. We can go over in a second what the analysis includes.
Then later on, what people asked me, so why? Really, the research itself didn't ask why this happened, just ask what happened. Then we came up with this theory and start looking at other things. The idea is that, yes, in equilibrium, it should be 50-50. But because there's this desire to own a home, it pushes ownership the cost above equilibrium, and therefore, renting is the better option if you are doing all the things right and you’re looking only from a monetary perspective.
Ben Felix: Makes a lot of sense. We had Sebastien Betermier on this podcast a while ago. He also talked about the hedging benefits of owning homes, which could also drive down their expected returns.
Eli Beracha: There's a different paper that I wrote. I think you may touch on that later, as putting homes in a portfolio.
Ben Felix: That's a great paper. It really puts a really nice bow on this whole topic. We will come back to that one. For this paper that we're talking about now, the 2012 paper, can you talk about how the model was set up?
Eli Beracha: We try to have something that is relatively simple. We are modelling the buy versus rent decision as we call it a horse race comparison. You can either buy a home or rent. If you buy a home and you put a particular down payment, you own it for the average time that an American owned a home, which right now it's somewhere around eight years or so. You are buying the home with a traditional down payment with the current interest rate in the market. You have the ability to refinance, etc. We tracked how much homes appreciate over that time period, assuming you made payments on time, etc. Then you see, okay, in the end of this holding period, how much money would you have selling your home?
You started with, let's say, down payment of $100,000. The home appreciated, you make payments, you paid off your debt. Let's say, you end up with $200,000 at the end after you sell it, selling commission, etc. During this holding period, of course, there is expenses, which we ignore for the time being. We don't ignore them as we don't look at it, but this is part of the cost of owning a home, but you end up with X amount of money. Then the renter is doing something similar. The renter is getting into a property that is of similar size, quality, etc. Again, we have all this information about how much rent prices went up. We assume that that renter is, of course, not building or putting a home, because you don't buy a home, they invest in a combination of stocks and bonds. That is the investor, the amount that they would have put in a down payment, they would invest the amount that it would have paid toward closing costs, etc. They would invest any differential amount between what it costs them to on a yearly basis to own a home, that mortgage payment, insurance, property taxes, repairs, etc., minus the rent.
For example, if their rent again is $3,000 a month, so that's $36,000 a year. But if they were to buy that home, between the mortgage, insurance, property taxes, etc., let's say the cost, let's make it a simple number, $40,000. That means that as a renter, they should find an extra $4,000 in their account at the end of the year. In reality, we know that it's not how it works, but in theory, they would find an extra $4,000 in account at the end of the year, compared to if they were own a home. That $4,000 would go back into the investment account, reinvested, and go. That is basically how it's set up.
Then we see, okay, how much is that investment account worth at the end of that eight-year holding period? We do it for each beginning from, let's say, 1982, I believe the sample begins, the first quarter of 1982, going eight years. Then the second quarter of 1982, going eight years. Because in hindsight, we know exactly what happened. We know what interest rates were, when the price appreciation was, when the rent was, there's no assumptions. You just know those numbers, and you can really make a comparison of who was better off financially.
Dan Bortolotti: Just to clarify, you mentioned the renter who was investing in a portfolio. What was the mix of stocks and bonds that you tested? I'm wondering if it made a difference if you had a very conservative portfolio versus a very aggressive portfolio. Also, obviously, the time period makes a big difference, because during the 80s and 90s, for example, you had very high returns across the board, fixed income inequities. It would have been different during periods of lower investment returns. How sensitive was the analysis to that asset allocation?
Eli Beracha: We did really two tests. We did one test that to me doesn't make much sense. But if you're aware of how the academic process of publishing a paper works, sometimes you do things that the reviewer, or the referee ask you to do, whether you agree or not, because it is needed to get published. That was basically assuming that you invest in risk-free investment. Whatever down payment, all those other amounts, you put into a risk-free. Then, even under that scenario, renting was still better off. Not quite as much, but it was still better off.
Basically, we did eight-year treasuries to mimic that eight-year holding period, even though it's really unfair, because housing is a risky asset. We know that they’re volatile, they go up, they go down, but this is one test that we did. The other one was what we call the risk-equal portfolio. Risk-equal portfolios are portfolio that we are adjusting the standard deviation of that portfolio, playing the combination between stocks and bonds, until it equals the standard deviation of an average single property, one and one.
We can argue about what is the exact methodology and how you measure that. There's some issues around it. But we're pretty careful about it. It's past the smell test of other people that know something about those calibrations, and that's how it is. We call it risk-equal.
Dan Bortolotti: Is that a roughly balanced portfolio, 50%, 60% stocks? I'm just curious.
Eli Beracha: It was a little bit more heavy towards the stocks than it was the bond. Again, I'm going to go back to the classroom, but just to let you see how students think, or people that maybe are not familiar with the topic as much. Every semester when I teach the intro course of real estate, I give them a buy versus rent project. Pick a property, and tell me whether you should buy it or rent it, and why? They make some assumptions, and they need to justify those assumptions. One of the assumptions is that we invest in a equal, let's say, or 60/40 stocks bonds portfolio. I always have the same comment.
Let's say, that they're considering a condo in Miami, Florida. You really believe that 20% down payment, it is a levered single condo in Miami, Florida, has an equal risk to a diversified portfolio of all the best corporations in the world. You name it, I mean, the Procter and Gamble and the Caterpillar and the IBM and the Google and the Nvidia, and etc., etc., etc. Then, you even de-risk it by putting it with bonds, again, diversified portfolio of those. You really think the two are of similar risk. To me, the answer is clearly that so many things can happen with your own condo, anywhere between mold issue, constructions issue, cost of insurance, rising sea levels, you name it, or even things that I don't think about.
Somebody built a building across from you and just blocked your ocean view. That's a risk, which will affect the property value. It may not harm you physically, but those are the things. To me, it's clear that a condo is a much more risky proposition than a diversified portfolio. To them, it's like, well, a condo, I can touch it, I can feel it, I know where it is. In a stock, it's a bunch of prices running on my screen that today, there's something, and tomorrow, I don't know where they're going to be. That is the perspective of many people.
Dan Bortolotti: We've talked about this before in this context, this idea that if your house was marked to market every day, it would look a lot more volatile. Because it isn't, people feel they're very comfortable in saying, “I don't care what my house is worth, except on the day I sell it.” The same should be true of a stock if you're a long-term investor. People approach those two questions very, very differently.
Eli Beracha: Of course. The problem also, when you sell your house at a day, you decide, okay, we're going to sell it, you don't know what you could have sold it three months before. With stocks, you know. You’re like, “Oh, my gosh. I could have sold my stock portfolio for 8% more. I'm not selling right now.” Or you have this negative bias against selling it. Again, it's really psychological. It's really stemmed from the fact that you do not know the value of your home on a daily basis.
That's actually one of the reasons that make housing, actually, for most people a great investment without being a great investment. It forces them to be long-term holders. It forces them to not look at the price every day. Yes, they can check on Zillow daily. Valuation from Zillow are smooth, and there's other issues there. They hold it for a long period of time. Over time, even if the appreciation is not very high, it is large in dollar amounts, because you're talking about large amount of dollars going to do that, versus compared to most people net worth. That's why most people will tell you, this is the best investment ever made, even if it's not.
Ben Felix: Even if it's not. But they might be right for the wrong reasons, I think, is how you describe it in one of your papers. Anyway, we're going to come back later and ask you what you think most people should do, because I think after we had the whole discussion, your answer to that question will be very interesting.
In this 2012 paper, you basically find that renting comes out ahead most of the time throughout your sample. Have you followed the results from that paper out of sample since it was published?
Eli Beracha: We have. We've been publishing a different version of those results with an index of buy versus rent since then. Overall, the results are similar. I mean, they change from one period to the next, but overall, they're similar. Yes.
Dan Bortolotti: If there is a well-established, at least based on the findings of your studies, that renting comes out ahead most of the time, what are the reasons why people still prefer owning a home, if financially, there's some evidence that it's not the best decision long term?
Eli Beracha: I think, first of all, the number of people that read my academic paper, that is 45 pages long, and have some mathematical equations and graphs, and it's printed in black and white, and it's not on Instagram available readily, it's not very many. I don't think this fact is very well known. Also, there's no much reason for, let's say, the National Association of Realtors to advertise that. I think most people are not aware of that. That's number one.
The number two is, again, this is part of the American dream. They want to have ownership, and that is the main reason why people still buy. They still believe that renting is throwing money away, paying your landlord's mortgage, etc. Now, don't get wrong, there's a lot of benefits of owning, because we talk about, again, the monetary versus the non-monetary, but I think people are just not aware of these type of noises. When I do it in my classroom, and again, remember, those are students that are coming to study about real estate at the master's level. Those are people that already have interest in the real estate. They're in the real estate, and, etc., they do not know anything about that. When I tell them that renting with the majority of parts coming ahead, they're scratching their heads. How can that be?
Ben Felix: I want to come back real quick to something that you emphasized a couple of times earlier, but I just want to make sure listeners caught it, is the difference between a single property. When you're talking about volatility matching a portfolio of stocks and bonds to the volatility of a real estate asset, I think a lot of people are familiar with the volatility of real estate indexes, which are smooth, because evaluation lags and because they're diversified. When you own a home, or a condo, or whatever, you live in one thing, because it's a large, indivisible asset. The volatility of that one thing is going to be very different from a portfolio, even if the stocks are more volatile on an individual basis. The single real estate asset is likely closer to the volatility of a diversified portfolio of stocks. You emphasized that a couple of times earlier, but I just want to make sure listeners caught that difference.
Eli Beracha: Yes. It is very different. For example, we know that if you take 100 years of data in the stock market and the index, the standard deviation is somewhere around 20%, depends what period you’re looking at. The standard deviation of an average stock is about 50% over that time period. That ratio of between 20 and 50, which is 2.5 times, we find pretty similar ratio when you're looking at indices versus single homes in terms of volatility. Yes, there's greater volatility. Yes, you do own only one home, which is another somewhat disadvantage of owning a home, because when you own a portfolio of stocks, it's easy to own a portfolio. You can just buy SPY, whatever it is, index. When you buy a home, you can't really buy a portfolio of homes. At least, most people can't.
Ben Felix: Yeah, most people can’t. In the 2012 paper, you look at both the ex ante and ex-post performance of renting relative to buying. How does the ex anti probability that renting is preferred change throughout the sample? Are there periods where renting looks relatively good or bad?
Eli Beracha: For example, if you're looking at the ex ante, it changes. When the housing price appreciates significantly and the rent does not follow. Think about a period of, let's say, 2000 until 2006, and during that time, prices went up significantly and rent didn't change much, because everybody want to own. There wasn't much demand for rental. Again, it threw the model into – it was screaming, do not buy right now. What do people do? Let's buy. Then they’re surprised, there's a bubble.
Now, it doesn't mean that I know exactly when the collapse is coming, but there's some periods where it's pretty obvious that one outcome will come ahead of the other. The other periods where it's not obvious, the odds are tilted a little bit one way versus another, but there's some periods that extreme, that the ex ante was basically telling you the probability of you coming ahead, only at that time is very small over, again, extended period of time of eight years.
Ben Felix: Very interesting. Ex ante, just for any listeners that aren't familiar means before the fact, like evaluating before the fact.
Eli Beracha: When we do ex ante, we pretend we don't know what happened after. We're feeding the model only data that was available at that time. That's in 2006. Of course, at that time, for the paper, we knew what happened after, but we pretend we don't by feeding the model only data before that. The ex-post is with all the information, whatever we know, that maybe we didn't know at that time when we made the decision.
Ben Felix: You mentioned your rent versus buy index. Can you talk about how that index works?
Eli Beracha: The index is basically modelled after the same horse race comparison that I described before, except we wanted something that is easier to interpret and understand by the average reader, somebody who want to make a buy versus rent decision for themselves. We standardize it between negative one and one within three standard deviation above and three standard deviation below, basically the probability of should we be buying, should we be renting.
On average, that index, we forced it to be zero on average. That means every time you're above that, the probability of buying and being ahead is higher. Every time you’re below that, the probability of renting and being ahead is higher. That's how we calibrate it. It's the same model, just calibrated. People can look at between negative one and one, it's easy to interpret.
Ben Felix: How has the advice implied by that index changed? What did it say when you published the paper and then how did it change afterwards?
Eli Beracha: Well, 2012, basically coming out of the great recession. At that time, if you're looking at the model in 2009, then it tells you you should be buying. Guess what? At that time, really, nobody was buying, because are you crazy? Real estate is the worst thing in the world right now. But it came out of equilibrium. 2012, it was still in advice to buy rather than rent, but not quite as much. The real estate market surprised me, the model. I was bullish and realistic in general, but I think it was better than we expected.
Even at times that the probability of owning were lower, we know that we stayed ahead. Because if you bought a house in 2012, 13, 14, 15, almost any of those times, hold it for eight years, in the US, on average, you benefited from unusual price appreciation, which you're ahead of renting a home.
Dan Bortolotti: Just to clarify, so it's a national index, right? It uses house prices from all over the US? Because there will be obviously a lot of local variation.
Eli Beracha: Yes. We did one that was national. In the paper, we do one for every of the four regions. The index, we did for national, plus 23 other cities. Now, we're running different indices that are not necessary buy versus rent, but an evolution of that price premium indices. We do it for the 100 largest metrics in the country.
Dan Bortolotti: What is it saying now in terms of favourability of buying versus renting?
Eli Beracha: Right now, there is a slight moderate variability, depending on the area for renting, but it doesn't scream that. There's one thing that the model does not consider, and maybe it's due for some, I guess, correction, or tweaking there, because it does consider, again, the price of the home, the price of the rent, the expected price appreciation, interest rates, cost of ownership, like insurance, probability tax, etc., and some reversion to the mean, what it doesn't consider is the overall supply-demand equilibrium in the market in terms of the number of homes that we have in the market versus what we actually have.
We know that in the United States right now, there is a severe shortage of housing. If you really think about it, looking at numbers, around 2006-7, we had a surplus, so we have too many homes. About 3 million homes altogether. Then we know what happened. Too many homes, whatever happened with the economy and basically, severe housing price collapse. At that time, basically, all construction virtually stopped, and we're building significantly less homes than we needed every year since 2008, 9, 10, 11, 12. I'm talking about 300, 400, 500,000 homes less than we need. When I say we need, we need an amount of familiarity to support natural population growth, that is immigration and natural birth include, exceed mortality.
At the same time, about 1% to 1.5% replacement of the existing stock, because housing gets obsolete. Some houses are becoming unusable at some point, those need to be replaced. In those years, talking about between 2007 and 2012, we built about 400,000 to 500,000 homes less than we need, and we'll reach equilibrium at that time. Guess what? Since 2012, until 2023 or so, we continue to build too few homes. That's a long time. That's another 12 years after you reach equilibrium, that you continue to build too few homes. That is because a lot of the builders went bankrupt. Those that did not go bankrupt just become a lot more cautious and did less. We created ourselves around 2023, 2024, a shortage of 4 million homes.
Since then, we build about the same, or maybe slightly more than we need, but it's a drop in the market that were still somewhere between 3.7 and 3.9 million homes shortage. That's a big number. Add to the fact that not only it's a shortage, there is one thing about having a shortage, let's say, you have a shortage of iPads in one location. You ship from one place, you have too many to a place where you don't have enough. In housing, we know it doesn't happen. You can have a surplus in one location and a shortage somewhere else. Maybe overall, you have the right amount of housing, but you don't have it in the right places, and you still have shortage in places where people want to be.
We know that COVID changed where people want to be. COVID changed type of property that people want to live in, a lot of those things. That number that is 4 million of shortage is without considering that location needed. To put this supply-demand in balance, that should fit also in the model, it doesn't. That is probably why we got higher price appreciation than the model would expect without considering that.
Ben Felix: The model can't be perfect. Otherwise, it would just be reality.
Eli Beracha: Well, we can always improve it, but I'm always working on something.
Ben Felix: That's good to hear. I look forward to the updated version. You gave that example where the model did not work. More generally, when you've studied it, how well does the index predict house price movements?
Eli Beracha: We had a paper that tested that against what actually happened, and the predictability is extremely high. Not so much in a sense that the model say it will increase by 4.5%, increase at 4.5%. I'm not talking about that type of predictability. I'm talking about the predictability that if you are predicting, let's say, the 23 markets, or 100 markets, and you say these markets will perform better than the other one, they generally do. Those markets were before worst than other ones, they generally do. That predictability is extremely high. Actually, I use that model. I don't know if you're familiar with the post-nomic survey that they have. Basically, they're asking leading real estate economists and real estate experts, they're asking them about price appreciation over the next few years. I'm one of those people filling that survey. It's about 150 of us. They publish our opinion.
Then, they go back and say, okay, here's what you thought. A few years later, here's what happened. I'm on a 150 or so economist-resident professionals that guess, or model, or whatever it is, how they made a prediction, I end up as number one in that prediction. I actually just received the award.
Ben Felix: That's pretty cool.
Dan Bortolotti: A master forecaster. Yeah.
Ben Felix: Master forecaster, or a good model.
Eli Beracha: Yeah. I would guess, I was showing the show. They give me a crystal ball for the crystal ball. But to answer your questions of how well it predicts, the idea is, of course, the future is unknown. But if you use good data and you have models that are based on real factors and fundamentals, you're going to be wrong in the short run. You're going to be a little bit off an upside, downside each period. But on average, you're going to be correct. That's really what we try to do.
Ben Felix: It sounds a lot like, discount rates and stocks. You can look at the Shiller earnings yield and say, expected returns are low. That's usually not good enough to predict market returns in a way that you can time the market to profit. But it is useful where it explains some portion of future returns. It sounds similar.
Eli Beracha: I like the Buffett answer even more, or the approach. The weighing machine versus holding machine thing. In the short run, it's voting and the long term is a weighing machine. Even Buffett by himself will tell you that he can never predict what's going to happen over the next year, and somebody that tell you that they do, they’re either a fool, or they're lying to you. Over a long period of time, it is quite easy to say, okay, over the next 10 years, stocks will do better than they did over the last 10 years, or worse. This is really what he's doing.
Ben Felix: You have this great model in the horse race. Now, as you talked about, we can show that, hey, the wealth of renters should come out ahead of owners most of the time. I think that makes a lot of sense for all the reasons we've talked about. The reality, though, is that homeowners tend to be way wealthier. In Canada, it's many multiples wealthier. Why? If we can show analytically that renting can come out ahead, why do owners tend to be so much wealthier?
Eli Beracha: I would say, it's not because of owning a home. It's in spite of owning a home. I hear that a lot. If renting is so great, how all the renters, not as wealthy? The idea is that it's a selection bias. People that are wealthy can afford to buy a home. People that are not wealthy, not have enough down payment, cannot make or qualify for mortgage, then they don't. The idea is that you're not wealthy because you own a home, almost in many cases, in spite of.
Also, really, if you think about it, again, I mentioned before, it is a force mechanism for sale. It makes you disciplined. You buy a home and you're not going to sell it a month from now, because your neighbour just sold it for 5% more, then you bought it, and you think you can also get 5% more. People would do it with a stock, or they would panic if it's go the other way around. But with home, you basically have this force mechanism that is not only it appreciates at least in nominal terms over time, you also decrease your debt over time, simply by paying off your mortgage. We're talking about large amount of money. Most people invest in the stock market, for example, again, talking about the average person. They wouldn't just, “Oh, you know, so I'm going to just put the initial investment at $350,000.” They don't.
Most people, okay, I'll invest $5,000. Here's another $500. Here's another $1,500. Even if the performance there is high, we're talking about relatively small amount of dollars. If you think about it, there's so many people that have homes that are worth $400,000, $500, $600, $800,000, but the stock portfolio is maybe $50,000. I mean, there are a lot less people that have $800,000 portfolio. All but the very rich, their home is worth significantly more than their stock-bond portfolio. It's really a selection bias for the most part.
Dan Bortolotti: When people compare, or look at how their wealth grows as a homeowner, I think the number one factor that they believe to be the generator of that wealth is price appreciation in the homes. I think a lot of people believe that in general, houses go up in value, at least as fast as stocks tend to go up in value, maybe more. Can you talk about how important property appreciation truly is? If it's not the most important factor here, then what is?
Eli Beracha: Property appreciation is the most important factor in creating wealth when you own. It is. Property appreciation is by far not as fast as return on stocks. It shouldn't be, because really, you're getting out of benefit from living a home. It is a place where you live, where you raise your family. That benefit, you can think about it as a cash flow, because if you would not live in your own home, you'd pay somebody else whatever that home is worth every month. Together, the two should be maybe somewhat comparable to a commercial real estate return between price appreciation and what you would have paid yourself in rent. But price appreciation by itself is not nearly as high as stock appreciation. It can't be.
Let me emphasize it, because it's important. We're talking about price appreciation versus inflation. Basically, price appreciation inflation are very, very, very similar. Which means that home prices on average do not appreciate in real terms. Let me say in real term that we adjusted for inflation. That means that if you have no real price appreciation, but at the same time, you have to pay insurance, property taxes, maintenance, you basically, from a financial perspective, in real term, you losing money every year. It's like, well, how does it make sense? Well, yes. It's not that you lose money. It's the cost of living in the home. You're living it out, but this is the benefit that you're getting.
Ben Felix: If you look at real estate index returns, especially in recent history, they look pretty high. I was talking to some of the people from Statistics Canada recently, and I figured out how to isolate the amount of renovation spending that Canadians do every year from their data. It's huge, because the proportion of the net housing stock in Canada is massive. You look at index returns. A meaningful portion of that has come from people's spending, not just on maintenance and depreciation, but on renovations, like on property improvements.
Eli Beracha: Yeah, and there are indices that consider that. Okay, but commercial rates, they consider that. People will be surprised that, for example, the CapEx, or the expenditure on repair of offices is very high with less low for retail, even less so on, well, the family very low for industrial storage, etc. Regardless, all over our universe is a big number. Again, when people thinking about, okay, I bought this house for $200,000 and sold it later for $400,000, and let's say, it was over a 10-year period, so I doubled my money. It's like, well, you really have to think about it.
First of all, are you talking nominal or real? Well, most people don't really understand the difference, but it is a very important distinction. The other thing is that what happened in those 10 years? Did you pay insurance? Yes. Did you pay property taxes? Yes. Did you fix this, that? Did you renovate the kitchen? Did you renovate it? The answer to those, almost all of those is yes. Yet, they don't tell you that. They just said, “I bought for $200,000. I sold for $400,000, so I made $200,000.” They ignore everything that happened in the middle. It's almost like, if I invested $10,000 in the stock market, I added $500 every month. Then I would be surprised that I have a lot more, significantly more, 10 years later, of course, not only because stocks appreciate, because you continue to add money in. But those are things that homeowners tend to ignore. They know it happened, but nobody would say, “I bought for $200,000. $400,000 minus the $150 that I spent in, discounted and adjust for risk.” People don't calculate this way, which is okay. They're not academics. Finance is not what they do. But it makes their statement of, I doubled my money, or this is the best investment I've ever made. It makes it often wrong, or at the very least, inaccurate.
Ben Felix: Yeah, I think you had a piece in there is compounding. They'll see what they bought for and what they sold for, but they won't consider the time that has passed. Over a very long period of time, you can get a really big dollar amount, but the compound return is actually really small, especially relative to some other investment like stocks. Can you talk about how important the renter's savings rate is for them to have a comparable wealth outcome to an owner?
Eli Beracha: Again, the model is pointing to renters doing better than owners, if they do other right things. Meaning, that investing in a right combination of stocks and bonds, if they are taking the down payment and investing it in a portfolio, also the additional costs of clothing and any differential amounts. In reality, people don't.
You asked before, for example, why renters are less wealthy than homeowners? One thing is a selection bias. Those that can buy buy. But even more than that, if you know that you need, let's say, to save $60,000 for down payment, you would make a real effort to get there, that by itself move you ahead. You're going to give up a lot of other things. You save this $60,000, now you buy a home. It also means that you are a person of different character that were able to put together and save enough $60,000, so you're not tempted by things along the way. That's another one of those factors that make homeowners better off.
Dan Bortolotti: It's interesting that you mentioned that, because I think a real-world experiment that you can use to see this tendency. I work with a lot of clients who had a year or two left in their mortgage, and they would say to us, “As soon as my mortgage is paid off, I'm going to take that $3,000 a month that I was paying to my mortgage, and I'm going to start saving $3,000 a month.” Almost nobody does it. That is a real testament to this idea of forced savings is a lot easier than optional savings. You don't have a choice between paying your mortgage and not paying the mortgage, but you do have a choice between saving and spending. Just for most of us, the spending just comes so much easier. I have very rarely seen people making that transition from forced savings to optional savings. I think the renter is making that decision every month, because there's no forced savings.
Eli Beracha: For most people, actually the best decision from a monetary perspective is still to own a home, even though if you do the perfect horse race comparison and you do all the right thing, you should be a renter. Owning a home still works for most people, because it changes the way they behave in a way that mortgage to investor, for saving, long-term holder, etc., etc., etc., work in order to get to this down payment, upgrading their home, because once you have a home, it's nice. But after a while, it's like, well, but can we get a bigger one? Then you continue that cycle. That's why most, at least American owners, the majority of the wealth is in an equity to having a home.
Ben Felix: I do want to come back to that question later. I want to ask about who should rent, even if we agree that most people should buy? I did a YouTube video on this that has not been released yet. It'll come out this Sunday at the time that we're recording. I say, that most people should probably own a home, but then I joke that the nerds watching my YouTube channel about finance are not most people. We’re going to come back to the later. We've been talking about rent versus own in fairly general terms, but homes are an asset that can fit into the overall household portfolio. Can you talk about the paper that you did and how you set the model up to compare the risk-adjusted wealth accumulation of renter and owner households?
Eli Beracha: We followed up the study with another study that instead of just looking buy versus rent in a vacuum, because you always take a step further of, okay, a home is one of the things that we have in our portfolio. Then you say, well, is buying home makes sense when it's not the only thing, but it's one additional thing that you have in your portfolio. The results are basically such that it makes home ownership a little bit more attractive than if it looks in the vacuum, because it has some hedging characteristics in addition to the other things you have in your portfolio.
The problem is for most people, people that don't have a lot of wealth, they have very little of other things beside homes, and then home become too big part of their portfolio. Again, the example of a middle-class family that may own almost by default, because house appreciates so much, they own a $500,000 home, but they really have a stock portfolio of $50,000. By the way, their net worth is $500,000 and maybe have a mortgage year of $300,000. The net worth is maybe $250,000, but their home is twice as much as the net worth, because the home is worth $500,000. That brings them this over-leverage, high volatility, etc. For those families owning a home is still less advantageous than renting, again, from a portfolio perspective, where it makes sense to own a home, from a portfolio perspective, is where owning a home in the down payment to owning the home is not too big part of your overall portfolio.
Meaning that, let's say, you have a million-dollar net worth, and you can put $200,000 into a down payment for home, the other $800,000 investment somewhere else, maybe take a $300,000 mortgage. In those cases, homes have hedging characteristics that make it a good buy, in addition to all the things that we cannot measure.
Ben Felix: That's really interesting. Someone who's relatively high net worth buying a home, making the home an asset that's part of their broader portfolio actually looks pretty good on a risk-adjusted basis. If you're overreaching to buy a home, and it's your only asset, you're making yourself worse off.
Eli Beracha: Also, overreaching is a problem that a lot of people have. I tell people, you should decide whether you want to take a 30-year mortgage, or a 15-year mortgage. I'm telling you, if you cannot afford to take a 15-year mortgage, you probably should not be buying a home. Well, but I'm not taking a 15. I'm taking a 30. Well, that's okay. You can still choose to take a 30. If you cannot take a 15, that means you're stretching yourself too tight. That means the first thing that is going to come along, whatever it is, major repair, etc., you're not going to be able to handle that. You may be getting into financial distress, and the outcome is typically not favourable.
Ben Felix: Owning a home kind of sucks. I rented it for a very long time. I bought a house four years ago now, and it's brutal. It's not fun.
Dan Bortolotti: What is it that you don't like about it? Is it the headaches, the maintenance?
Ben Felix: That's what I mean. I like the house that we bought and I like where we live. You hear a noise and it costs $10,000. That part's not that fun. It sounds like, from what you just said, Eli, for Dan and I who tend to work with relatively high net worth investors, in their case, owning a home probably makes sense, because it hedges their housing costs and it fits into their overall portfolio.
Eli Beracha: It probably does. It also makes a lot of sense in places where if you're really looking at a blue city, and I happen to live in Miami, and really, the only way that you can hedge the cost of living effectively is by buying. Miami, and I don't know how many of your viewers are probably aware, the cost of living in Miami increased over time, because we became a more and more attractive place to live in the opinion of, I guess, the consumer. But it really increased significantly during COVID and after COVID. Housing prices doubled and more than double in the cases. Became a very expensive place to live. Some people are leaving the town, because it's too expensive.
Those people that leave town tell me it's too expensive, those are not people that own. People that own a home, they basically locked the biggest item on their, whatever, the budget, which is home ownership, home cost, or mortgage, whatever it is, fixed rates most of the time. They're increasing taxes, or capped by law here. Yes, insurance is volatile, but still not a huge part of the mortgage. They're not being forced to leave. The people that are being forced to leave are those that used to rent a place for $2,500, but now it's $6,000. It really happened over a three or four-year period. If you cannot afford this $6,000 instead of $2,500 and most people can, you have to find a solution.
Buying a home makes a lot of sense for those areas where you have limited amount of land, and there's something happening in the city and the area that may make it prohibitively unaffordable. Miami is one of those places. Again, people here that ask me, “Should I buy or rent?” I tell them, again, here's the analysis, what happened in Harvard, etc. Really, if you really want to protect yourself and you want to stay living in Miami for a while, you probably should buy. That is one thing.
Then if you want to hedge all the rest of the cost of living in Miami, or any other place, then you should buy yourself a rental property. That again, you hedge your own cost of living by buying your own home. Then, as a city getting more expensive, you own a rental property where there is a fourplex or town homes, whatever it is, the rent that you receive is now a lot higher, allow you to do the other things that the city is asking more for. Those tend to be highly correlated. It's not like grocery costs are going up and private schooling costs is going up, and then rent does. It typically go hand and hand. I'm not saying one to one, but it's probably the closest hedge you can get. If you own a rental property, any on your own home, in the area you live, it is extremely unlikely you're going to be kicked out of that city, because it becomes unaffordable to you.
Ben Felix: That's my favourite argument for owning. I completely agree. The thing that I'm always careful to say though is that a hedge can cut both ways if living costs are going up in a city. Great. I look at Toronto in March 2022, it was 1.3 million dollars for a composite index to buy a home. As of March 2025, it's just over a million. It's great if living costs are going up, if housing costs are going up, but you have to be really certain you're going to stay there for a long time, because the person that bought in Toronto in 2022 and decided to leave now.
Eli Beracha: That's the thing. If you decide to leave from Toronto to a different place, I understand. Also, if they decide to leave, I'm assuming they're going to be moving to another city in Canada, most likely, where probably the price, it's unlikely, even though it's possible, it also went down. They are selling for 20% less, but also buying something else for 20% less. Those that are not selling, you have to think about it. Again, we have a lot of discussion about that. Your house went up from a million to 800,000. Guess what? Your house is still a three-bedroom, two bathrooms. It's still in the same neighbourhood, the same amenities, and the same school. You didn't really decrease your lifestyle because of that.
It is different if your portfolio is going down, or if your income is coming down, or if any benefit you receive changed. In this case, the amenities you receive from that moment, it's the exact same, same size, same neighbourhood, it's the same benefit you receive every month, it's just less. Even more so on the upside, if you really think about it, people that feel richer because they have a property that they bought for half a million, now it's a million, they have more net worth, but the lifestyle did not change. They still live in the same place, same neighbourhood, same size apartment, etc., etc., etc. The only thing that changed for them is that it becomes more difficult for them to upgrade their home, because now price is double, so their property went from half a million to a million. Let's say, that historically, they can add $100,00, or $200,000 dollars and get a significantly better home that they wanted at some time but couldn't afford then.
Now, it's not $100,000 or $200,000 or more. Now it's $400,000 or $600,000 or more. Okay, it makes more difficult to make the next level. Yes, it's going in both ways, but it's clearly a hedge. You really have to think about your housing wealth and how much wealth you generate by increasing the value of your homes does not really change your value flight. To me, somebody who's wealthier, somebody who can afford a higher quality of life, if you just have more dollars to your net worth, but your lifestyle is the same, then it depends on what definition you use, but I would say, you're not wealthier.
Ben Felix: We've been talking about how realistic prices change. A lot of it sounded like a discount rate story. Anyway, how efficient do you think the real estate market is relative to the stock market?
Eli Beracha: The real estate market is a lot less efficient than the stock market. There is no doubt about it. There's a lot of evidence that I can predict where housing prices will be higher than with pretty high probability. I can predict that CDA is going to appreciate faster than CDB. You cannot predict with any high probability, basically 50-50. If I give you two stocks, which stock are going to do better next year? Stock X or stock Y? You can guess. But you're going to be 50-50 in most cases.
On housing, I can probably do that without 80-20 probability, simply based on momentum and a few other factors. There's a lot of evidence of the housing market. It's a lot less efficient than the stock. It's just more predictable.
Ben Felix: What do you think causes it to be less efficient?
Eli Beracha: One of the main things that make it less efficient is the fact that most transactions are being done by non-professionals. Think about it. Who owns home? It's just the average person that own a home. They're a nurse, they're a doctor, they're an engineer, they're a scientist, teacher, whatever it is, they're not a real estate professional. These are the people that buy and sell homes. They’re the one deciding the prices of home just by buying and selling them. That's very different than the stock market, where the majority on the margin, the price of every stock, is being decided by professionals.
That run, flash for analysis, and they predict what's going to be the earning of this company versus the other company in the future, etc. They're pricing it every single second of the day. Just that pure distinction between price determined by professionals, then this is what they do versus price being determined by just the average homeowner make the stock market a lot more efficient.
In addition to that, I can give you 20 factors, but we don't have time. I think another big one is the emotional factor going into buying. I don't know if you're married, but if you are, you can describe to your wife, for example, and I'm half joking, but that this house is a better deal than this house. It's just a better value. You can maybe put an Excel spreadsheet and you can show her that you get more money per square foot. All this is nice and good, except if your spouse feels better in the house that is maybe not as good of a value, then it doesn't matter. It's an emotional connection. It's an emotional decision, of course, financial too, but the logic isn’t emotional. Sometimes they would pay more or less for a home, just because how they feel about it. Not necessarily because it's a good value, or less value.
I tell my students all of the time, you can relatively easy find deals on what I call the piece of property. That's an investment property. I bought in the past, I bought properties, side-end thing. I know the area. You send a broker, whatever you can buy based on cash flows. But on a home, it's a lot more difficult to get a great deal. Something that is offsetting, really cheap, and you happen to love it, more difficult, a lot more difficult. The emotional part and the fact that is professional versus non-professional determining prices, those are probably the biggest two factors.
Dan Bortolotti: Can you give us some examples of those emotional, or psychological biases, like specific ones? I'm wondering when people are selling their homes, I think there's a tendency to exploit some of those psychological and emotional biases in order to get a higher price. Is that something you can think of examples of?
Eli Beracha: I don't think they're trying to exploit those, but it's definitely a bias of my home's the best. Look how beautiful it is. I know that the neighbour sold their house for 50 about hours. Of course, it's a lot nicer. Really, to them, it is nicer, because they have maybe memories there, they have connection, it's their choice of whatever the carpet, the wood, the kitchen. To them, it's the best. Many times, I think the job of a good real estate agent is to bring them down, it's like, “Well, I know you love the home, you have emotional connection and maybe you raise three kids here and you have a lot of memories, etc. But at another day, this kitchen is dated. This carpet, it's your choice. That's fine. Whoever is going to buy it, he's going to probably completely replace it.” Those are actually the things that need to be worked out during the transaction. That's why it's an emotional decision, not just for the buyer, but for the seller. I don't know that was specific enough, but that is definitely a factor that need to be considered.
Ben Felix: Sounds like the endowment bias. People value it more just because they own it already. Maybe familiarity bias, too. I don't know. You've said, and Dan and I have said this on this podcast too, most people should probably buy a home, or own a home, as opposed to renting for all of the behavioural and hedging reasons that we've talked about. We've also established that renting can come out ahead. We can show in a model that renting should come out ahead, more often than not. What are the main decision points that would push you, or lead you to push someone else, one way or the other, between renting and owning?
Eli Beracha: We talked about why you should be buying and there's a lot of reasons for that. On the rent side, I think the people that, again, for them, it's a big stretch to buy a home. Meaning, that it’s too big of a mortgage. The mortgage payment will be too big part of their monthly income. They may not be able to afford repair, or things like that. That's number one. Then, probably almost important is that, especially for young people, those people that are young professionals, they would move around a lot more often than they think they will. As you are becoming more value in the market, it is likely you're going to be moving out from one position to the next.
How many times there is a person that just bought a home? They got a promotion, but they need to move from Canada to Chicago? They wouldn't take this promotion, because they just bought a home, except that if they rent, they can just cancel the lease. Maybe they pay a small penalty, or maybe even their employer will pay that for them, two months of rent, typically. They would protect the promotion, make more money, move them ahead for whatever the next position after that, etc. People underestimate how often you move when you're young. This is especially true for large countries where every move is make it impossible to stay in the old location.
If you think about the United States, if you move from Canada to Chicago, you have to. You can just commute. Even in South Florida, if you got a position from Miami, now you got a position in Boca, with traffic and all that, no, you have to move again. In those cases, if you move a lot, or if you expect to move a lot, even if you don't know it, probably renting make a lot of sense in large countries like the US. I'm originally from Israel. That problem is not there. Israel is a very small place. Typically, again, you buy your home, the home ownership is very high. If you move around, then you drive instead of 30 minutes this direction, you just drive 30 minutes the other direction. It's not like you're going to be moving far as away. There is no far as away almost.
Yes, you're moving, you are moving one company to the next, so you get promotion, etc. But you can still keep living in the same place. This is not how it is in the United States. Transaction costs in terms of moving, leaving, and giving up on the opportunity because you own a home is very costly. Again, something the moderate does not consider, but should be considered.
Dan Bortolotti: Hey, Eli, we always conclude our interviews with the same question. How do you define success in your own life?
Eli Beracha: I think success in my life, or in anybody's life, what I would consider is being able for the majority of the time to do the things that you love doing. There's never 100% of the time. If you can wake up in the morning, you know that for the rest of the day, you're going to be doing for the majority of the time the things that you want to do, whether it is work for people you like, work in a field that you enjoy for the majority of the part, spending time in a place that you like with the people that you like or love, that's what makes it successful.
Dan Bortolotti: Agreed.
Eli Beracha: Part of that, of course, to do what you like is it takes money, because when you don't have money, many times you have to do things that you don't like. But if you're passing this hurdle, and now you can choose your clients, you can choose your co-workers, you can choose what you're working on, again, not all the time, but a large extent, I think you're successful.
Ben Felix: Great answer. All right. That said, Eli, this has been a great conversation. We really appreciate you coming on the podcast.
Eli Beracha: Thank you, Ben. Thank you, Dan. I really appreciate it. I enjoyed it very much myself.
Dan Bortolotti: Thanks.
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Papers From Today’s Episode:
‘Lessons from Over 30 Years of Buy Versus Rent Decisions: Is the American Dream Always Wise?’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1814227
‘Housing Ownership Decision-Making in the Framework of Household Portfolio Choice’ — https://www.tandfonline.com/doi/abs/10.1080/10835547.2017.12091472
‘Findings from a Cross-Sectional Housing Risk-Factor Model’ — https://www.researchgate.net/publication/236023682_Findings_from_a_Cross-Sectional_Housing_Risk-Factor_Model
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Benjamin Felix — https://pwlcapital.com/our-team/
Benjamin on X — https://x.com/benjaminwfelix
Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/
Dan Bortolotti on LinkedIn — https://www.linkedin.com/in/dan-bortolotti-8a482310/
Episode 325: Addressing 200+ Comments on Renting vs. Owning a Home — https://rationalreminder.ca/podcast/325
Episode 196: Sebastien Betermier: Hedging, Sentiment, and the Cross-Section of Equity Premia — https://rationalreminder.ca/podcast/196
Dr. Eli Beracha — https://www.theberachateam.com/
Dr. Eli Beracha on LinkedIn — https://www.linkedin.com/in/eli-beracha-b8082250/
Dr. Eli Beracha on Instagram — https://www.instagram.com/dreliberacha/
Tibor and Sheila Hollo School of Real Estate | FIU — https://business.fiu.edu/academics/departments/real-estate/
KBIS Capital — https://kbiscapital.com/
Journal of Real Estate Literature — https://www.tandfonline.com/journals/rjel20