The Impact of Social Psychology on Real Estate Bubbles: An Exploratory Analysis

Pop goes the weasel or does the weasel go pop? In our culture, so often it is headlines, water cooler gossip and cocktail party embellishments that cause economic markets to fluxuate. Take, for example, the housing market. If you read the Chronicle, you will think we are in a real estate slump. If you are out there looking for a home, you will think something very different. Key, is the NYTimes Real Estate Magazine. This past week, there is an interesting read on why real estate (at least residential housing) will never be like the stock market. I’ll provide a link to the entire article but in one word: LEVERAGE.

Leverage and the tax savings (income and capital gains) is the main reason why owning is better than renting even if you pay more in rent.
The dirty little secret of home ownership is that it lets you play with other people’s money. Say you want to purchase the median home (in California the cost would be about $565,000, but let’s take the United States median, which would run you $220,000).
Typically, you would take perhaps $50,000 from savings as a down payment, borrow the balance and pay the monthly mortgage from your income. But wait! Just before you close, a friendly real estate bear points out that you could rent the same house, or a similar one.
Your monthly payment would go to the landlord, not the bank. And you could invest the $50,000 in stocks, which, with dividends, might appreciate at close to 10 percent a year, rather than the 5 percent or so you could expect from your house. That would be a very dumb move. Suppose the stock market did rise 10 percent; after a year you would be up $5,000. Whereas the gain on your home would be 5 percent over the entire purchase price or $11,000. Over 10 years the gap becomes huge — not to mention over 20 or 30 years. This is the little guy’s (and also Donald Trump’s) trick for accumulating equity: leverage.
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