The dangerous development of the market-timing mindset

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Of all the unfortunate circumstances to emerge from the housing bubble and bust, one of the most underappreciated is the development of a market-timing mindset when it comes to the decision about when to buy a home. I mention this now because this morning’s New York Times has a story about using price-to-rent ratios to tell whether or not it’s time to buy. By comparing the cost of owning a home to renting one, you can determine if houses are under or overpriced. If houses are underpriced, you want to get in on that. If they are overpriced, you don’t.

This is a market-timing mentality. And the possibility of it sticking around makes me nervous.

Now, trying to time the housing market is not always a bad thing. In fact, before the bubble burst, it was a fantastic idea. In the summer of 2005, I wrote a story arguing that in many markets it was smarter to rent than to buy. Last summer, I wrote another story, revisiting the original one. It was very similar to today’s piece in the NYT.* It showcased Michael Choe, who in 2005 sold his house in Sacramento and started renting. He managed to avoid a 50% drop in property values, and in late 2008 scooped up a new house out of foreclosure at a 35% discount to its sales price two years earlier.

Is it a good idea these days to check out your local price-to-rent ratio before setting off to house hunt? Arguably it is, since some markets probably have further to fall. Another example of smart market-timing: buying a house you were going to buy anyway but just a smidge sooner in order to collect an $8,000 tax credit from the U.S. government.

More broadly, though, the development of a market-timing mindset in housing is worrisome. That’s because it’s not clear to me at what point metrics like price-to-rent ratios go from being tools used by homebuyers to stand-alone reasons people decide to buy. If everyone starts talking about how “cheap” houses are, don’t you want to grab your piece of the action? Doesn’t that quickly become the sort of attitude that got us into this mess in the first place?

This could prove particularly dangerous in the realm of investor-bought houses. There is a solid financial reason to own a house and rent it out: you get to collect the rent. Of course, there’s another reason, too, which is the hope that the house will become worth more over time and eventually you’ll be able to sell at a profit. People who buy houses because they’re “cheap” are almost certainly oriented more towards this second reason—that is, the speculatory one. Again, that outlook was part of what fed the housing bubble.

I’m not arguing that we’re on the cusp of Housing Bubble II. Nor am I arguing that price-to-rent ratios are themselves dangerous. Quite the opposite. All I’m saying is that during the housing run-up we moved far away from the mindset that houses are first and foremost homes. The investment component of owning a house became more and more important. A little bit of that in the popular mindset isn’t a problem. I just hope it continues to stay in its place.

*The fact that Time magazine and the New York Times published these stories nearly a year apart should tell you something about how smart it is to take advice from the media on such matters.