Many bears in the housing blog space emphatically declare their intention to short the housing market. Some have posited the viability of shorting some REIT or housing sector related equities. The thing is, as financial journalist Felix Salmon and Carleton University’s Nick Rowe have written, we are born with a short position in housing. Professor Rowe explains:
The rent on a house is like the dividend on a stock. If I do not own a house, and rent one to live in, I pay rent, which is like having a short position. If I own a house and live in it, I neither pay rent nor receive rent, which is like being neither long nor short. If I own two houses, live in one and rent out the other, I receive rent, which is like having a long position.
So we are born with a short position in housing. We need shelter, and must pay rent to live somewhere. When we buy a house to live in, we are covering that short position.
So if you’re renting, you’re already shorting the Vancouver housing market. If you’re a bear, you don’t need to actually do anything. Just keep renting. The same goes for all of you that sold your homes hoping to cash in later IF the market goes down. Being long or short is just a bet.
Anyways I think this kind of thinking sheds some light on the local market. In his article, Professor Rowe goes on to state some of the risks associated with owning:
1. My house may burn down, fall down, or in some other way stop providing me with the shelter I need. Some of those risks I can insure against; others I cannot.
2. The house may stay the same, but the type of shelter I need may change. I may need a bigger house, a smaller house, or one in a different place. I face the risk that my old house may fall in price when I sell it, relative to the price of the new house I buy. True, but if my old and new house prices are positively correlated, I have at least partly hedged my risks, which is better than renting.
3. If I need to borrow money to buy the house, the future interest rate may be uncertain, and the risk that my mortgage payments will rise needs to be compared to the risk that my rents would rise.
4. If my house will last another 100 years, but I will only live another 40 years, I will have covered 60 years more than my short position. The future reverse-mortgage value of my house is uncertain. But if I make a bequest to my children this is not a problem. My children will have a short position in housing too. They will need somewhere to live.
The reason why the above risks are useful is that it can explain additional motivating factors to own a home in Metro Vancouver beyond mere cap rates or other like-minded metrics. If we quantified these additional factors, you could call it an ownership premium, i.e. a justification for paying beyond what “fundamentals” call for.
Risk #4 above is particularly salient for the local market. If you have kids, I’m sure you’ve probably wondered how your children are going to afford a place here. As well, there are other risks (such as potential high rates of inflation, which penalizes cash holdings) that adds more weight to the hedging notion. So logically, the ownership premium is your housing hedge. For individuals in the right circumstances, owning is risk management.
So if housing is an absolute must and you don’t want to gamble, hedge your bets and take the plunge as many homeowners have done in the past. However, if you’re sure of the future direction of the market, then take a short position if you think it’s going down (by renting or selling your principal residence) or going long (by purchasing additional homes beyond your principal residence). At the end of the day, the rational foundation for prices above “fundamentals” is this ownership premium. Ownership depends dually on the importance of housing to you as well as your tolerance of the risk of “being priced out”.