Dear young renter

Why are you not buying a home?

Let’s say that a house is priced at $800,000. What does it really cost you?

The biggest cost factor is interest cost. Multiplying an interest rate of 3.5 percent times the $800,000 price gives $28,000. (I am implicitly using the mortgage interest rate to measure the foregone interest on a down payment. This is a decent approximation.)

Property taxes and maintenance are another factor. If we assume that they come to 2 percent, then this adds $16,000 to the cost of owning the home. So we are at $44,000.

How much do you save in rent? Suppose that the rent on a comparable dwelling is $2500 a month. In that case, you save $30,000 a year in rent. Think of this as “earning” $30,000 on your home purchase.

How much will the house appreciate in price each year? If it appreciates at 2 percent per year, then you gain $16,000 a year, and that plus the rental earnings gives you $46,000 a year. Since that is higher than the $44,000 annual cost, you are better off buying the home.

(I am not including the transaction costs, notably real estate commissions, that you incur when buying or selling a home. These are detrimental to buying a home, particularly if you will be relocating in less than five years or so.)

The key unknown is future price appreciation. If the price were to appreciate at a 4 percent rate, or $32,000 per year, adding in your rental earnings would give you $62,000 per year, much more than the cost of $44,000. But if the price stays at $800,000 and never goes up at all, you only earn the rental savings of $30,000, and that is less than the cost of $44,000.

How much will house prices appreciate? That will depend on overall inflation and on whether houses are overpriced or underpriced today. If houses are underpriced today, then they will appreciate faster than overall inflation. If they are overpriced, then they will appreciate more slowly than overall inflation.

Overall inflation is expected by most economists and investors to be about 2 percent over the next ten years. But my readers know that I expect it to be much higher than that. And I do not believe that houses are overpriced today. This leads me to believe that the prospects for home price appreciation are good. If you share these views, then you should be inclined to buy.

But my sense is that many renters who live in expensive coastal cities believe that they are shut out from buying a house. Noah Smith recently wrote an essay about young urban renters, who he calls

the haut precariat, without real estate or stock portfolios or high-paying jobs of their own

the haut precariat, almost by definition, don’t have enough cash or credit to buy a home in the expensive places they want to live in. So they’re shut out of the wealth escalator, and unless they know how to invest in stocks, they may end up wasting much of their savings by holding it in cash or just consuming it because they don’t know what else to do with it.

Note the phrase “without high-paying jobs.” If this describes you, then in hindsight going to college probably was not the right financial decision. If you paid full tuition, the cost might have been, say, $200,000 for four years. And had you worked instead, you probably could have earned another $120,000 or so over four years. So going to college subtracted $320,000 from the assets you could have today.

Everyone told you that you should go to college, and you probably never even considered doing anything else when you left high school. But I would advise your younger brothers or sisters to try something else first, and then to approach choices about college when they are a year or two more mature.

The two housing markets

Kevin Erdmann argues persuasively that America has two types of housing markets. In wealthy coastal cities, most notably New York, Boston, San Francisco, and Los Angeles, there are supply restrictions, so higher demand translates into price increases. Erdmann calls these the closed-access cities. In the rest of the country, supply is more elastic, so that higher demand translates into more homebuilding. These are open-access cities

Living in a closed-access city and renting is an expensive proposition. As with going to college, you may find that a lot of your peers are doing it, and you may feel encouraged to do it. But you should consider alternatives.

If you are making a long-term commitment to live in a closed-access city, then you probably will be better off buying than renting. If you are uncommitted about where you want to end up living, then it might be a good idea to start out in an open-access city.

I wish I could tell you that living as a renter in Boston or San Francisco will work out fine for you. But I worry about a scenario in which inflation remains high and you end up falling behind.