Ownership Premium

This is a slightly edited re-post of a piece I wrote on housing-analysis about two years ago. It is a culmination of much of the comments and logic advanced by regular wiley veterans of the local blogosphere — VHB, freako, patriotz, mohican, to name a few. True to form, it is still as true today, two years subsequent to the original post date.

No analysis blog would be complete without a paradox and I believe there is none more relevant now than the so-called “ownership premium” that owner-occupiers place on property values. I would like to offer an alternate view of the so-called “ownership premium” that has been discussed on this blog and others in the past years.

The “ownership premium,” sometimes called the “control premium” or “consumer surplus,” is a premium that a potential buyer will pay for the right of owning (and “controlling”) a property compared to renting. Here is an example thought process of how the ownership premium concept works, from a buyer’s perspective:

jesse is renting a condominium for $1200 per month but is on a month-to-month lease. With a wife and young child, jesse does not want the uncertainty of renting month-to-month and his wife wants to customize the suite, something not always possible when renting. jesse looks at the condo for sale next door. If he were to buy it at market rate, the total costs of doing so far exceed that of continuing to rent. After factoring in all expected costs and trade-offs of his specific situation, jesse decides he is willing and able to pay a monetary premium to buy. But — and here’s the thing — he doesn’t have to.

(The “ownership premium”, as described here, is in its essence describing one’s personal preference to own or rent a property — the “intangibles” of ownership. It is not to do with more tangible and fungible premiums related to speculation of future price gains or expected increased utility by densification.)

The alternate view of the ownership premium looks not at individual circumstances but at the overall market comprised of owner-occupiers and investors competing over the same product. Here, for simplicity, we can look at condominiums that have a healthy mix of both owner-occupiers and investors and have relatively meager prospects of increasing land utility. If owner-occupiers are willing and able pay a market premium to own, the investor must compete by also paying the same premium. This has the effect of reducing the investor’s yield and instead must rely on capital gains to compensate for the poor yield.

In speculative bubbles, low rental yields go virtually unnoticed because everybody is “making money” on capital appreciation. Investors can compete head-to-head with owner-occupiers because rental yield is dwarfed by capital appreciation. The “ownership premium” train of thought becomes justified, even amongst many investors who justify it as a premium for scarcity and control of how the property is used. During bubbles, the premium continually increases.

However, when a bubble deflates, total return is not about capital appreciation but net income from rents. At this point the investor will require higher rents or lower prices to make the investment worthwhile. Housing markets around the world are starting to revert to where cash flows make sense again and this means lower prices. Rising rents are muted when there is an oversupply of dwellings and wages are flat to falling with rising unemployment. The ownership premium, for investors, is once again meaningless.

This does not mean that the ownership premium for owner-occupiers is a fallacy. It exists and is real. In addition, for many others, the mobility and lower responsibility offered by renting means their personal premiums are negative. The point is that it doesn’t matter. When a significant portion of a market is focused on monetary returns ex intangible benefits -– i.e. investors –- they will eventually and invariably set the price. It also doesn’t mean anyone is necessarily wrong for paying a premium but ones doing so should not use it to justify high prices and instead realize they made an investment with a lower monetary return.

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Aleks
Aleks
9 years ago

"Renter spends approximately $450,000…

Owner spends $732,000… but has a $350,000 condo = $382,000"

You have to include strata fees, taxes and maintenance in your total costs for the owner, because those things are included in the rent. Not to mention if there are problems with the building (and a lot of buildings will have problems over 25 years). How many owners were completely ruined by special assessments over the last 25 years, compared to zero renters?

Wealthy Vancouver ho
Wealthy Vancouver ho
9 years ago

I ain't racist but are saddened by honky life style which corrupts our good old Canadian way which is the basic foundation of our country.

logic
logic
9 years ago

WVH: stop being such a racist fucktard.

Wealthy Vancouver ho
Wealthy Vancouver ho
9 years ago

@Anonymous:

But you forgot that most of those renters are whites, not thrifty Chinese , who are not keen in managing their finance sensibly and prudently so whatever they have saved in renting are drained down in a flash to soft drug,liquor and cocaine.When you stupid Van bears have come up a predestined and bias conclusion,you gotta consider corrupt honky life style will put a big dent in such a self defeating theory.

Anonymous
Anonymous
9 years ago

@SquareNinja: Too simplistic. You also assume that interest rates will stay flat for the entire 25 year amortization. You've also failed to take into account the opportunity cost of the down payment plus the investment of the difference in rent versus the mortgage.

At the end of 25 years, the renter would have about $300k in cash using an annual interest rate of just 2% and about $530k in cash using 6%.

SuperSmartSomething
SuperSmartSomething
9 years ago

@patriotz: Those dirty Indonesians live in a state founded around nothing… that's why they wholesale adopted a foreign religion. It's why they wear headscarves, even though the country is tropical. It's also why the Tsunami targeted them for annihilation.

patriotz
9 years ago

@oneangryslav2:

"Islamist" does not simply mean a country where most people are Muslims. It means a state founded around Islamic ideals, which Egypt, Turkey, and Indonesia are not.

However this one which Canadians are defending is:

Islamic Republic of Afghanistan

patriotz
9 years ago

@SquareNinja:

Renter spends approximately $450,000…

Owner spends $732,000… but has a $350,000 condo = $382,000

As I have noted previously, this is the fallacy of ignoring present value. At the end of the 25 years the present value of the money that the owner has spent far exceeds $350K + the PV of the renter's expenditure. The renter is ahead.

I think this topic needs a thread of its own and I'll try to come up with one.

oneangryslav2
oneangryslav2
9 years ago

@Anon: @realpaul: “the entire GDP of every Islamic country combined is less than Mexico. We could build a wall around Islam and never notice it was gone…..these shit for brains sand fleas should wake up” i thought i would check to see if that was true or you were full of shit. Full of shit I am afraid. The GDP of Mexico is the same as Indonesia and Saudi Arabia. That leaves Malaysia, Egypt, and 40 more countries. One of which is Turkey which has a GDP almost as much as Mexico. Having fact-checked a few of realpaul's statements in the past, I've set out what I've called Realpaul's Theorem, which has a corollary. If realpaul makes a factual assertion, it is more likely than not that the assertion is false; that is, it is refutable by readily available public… Read more »

Renting
Renting
9 years ago

@SquareNinja:

So basically, if you stay put for 25 years…you win!

Assuming interest rates stay low (not likely) and to get your money out you need to pay a realtor 20K. During the 25 years who pays for new appliances, carpets, roofs and other consumables? All the risk is in owning. That is why is should come at a discount.

Devore
Devore
9 years ago

@Renting: But… but! /lipquiver

SquareNinja
SquareNinja
9 years ago

@Renting: I did a little analysis the other day… but just to make a long analysis short, I compared a $350,000 condo that would rent for $1,500/month; owning vs. renting. If there was absolutely no capital appreciation (flat price)… after 25 years…

Renter spends approximately $450,000…

Owner spends $732,000… but has a $350,000 condo = $382,000

(10% down… interest on that $35,000 cancels out CMHC insurance… 5% interest rate… includes taxes/maintenance fees…)

So basically, if you stay put for 25 years… you win! The difference of course gets greater and greater over time. I don't think anyone stays put for that long, however.

Renting
Renting
9 years ago

The term "OWNERSHIP PREMIUM" is a joke thought up by those trying to justify the bubble. It will be laughed at years from now. It should be ownership discount. Monthly ownership costs should be lower than rental costs and not depend on capital appreciation. The intangibles are just a bunch of excuses for overpaying. Any of the intangibles can be negotiated in a lease. A shorter lease (flexibility) is for the benefit of the renter not the landlord. Most landlords would not have a problem with a 5 year lease if stability is what you are after. Most landlords would not have a problem with alterations or improvements if you are in a longer term lease. Look at commercial leases. You can negotiate what you want at almost any term you want. Very few retailers buy their properties. If they… Read more »

Anonymous
Anonymous
9 years ago

@Anon:

"i thought i would check to see if that was true or you were full of shit. Full of shit I am afraid. The GDP of Mexico is the same as Indonesia and Saudi Arabia. That leaves Malaysia, Egypt, and 40 more countries. One of which is Turkey which has a GDP almost as much as Mexico."

Of course he's full of shit.

Anonymous
Anonymous
9 years ago

@realpaul:

"#84 A….Ok genius…Dubai is not a race…its a place…Islam is not a race..its a religion…..knee jerk PC much?"

You don't think "shit for brains sand fleas" is a racist remark? That doesn't surprise me, you're obviously not the sharpest tool in the box.

Anon
Anon
9 years ago

@realpaul:

"the entire GDP of every Islamic country combined is less than Mexico. We could build a wall around Islam and never notice it was gone…..these shit for brains sand fleas should wake up"

i thought i would check to see if that was true or you were full of shit.

Full of shit I am afraid. The GDP of Mexico is the same as Indonesia and Saudi Arabia. That leaves Malaysia, Egypt, and 40 more countries. One of which is Turkey which has a GDP almost as much as Mexico.

capital punishment
capital punishment
9 years ago

@patriotz "As for Haiti, why would they be interested in helping out a US client state on the other side of the planet?" For the same reason that US troops were pulling civilians out of the flood waters of pakistan and Canadian troops are dying in afghanistan to protect afghanis from the taliban – because it is the right thing to do. The arab nations have an obligation to pull their weight, the same as the rest of us. It is not open to debate. I would hate to look back on my life and realize I was the guy who argued against humanitarian aid for ideological reasons. It's not racist to say that the men in the muslim countries need to get off their ass and be men. That means trying to save jewish babies instead of building the… Read more »

capital punishment
capital punishment
9 years ago

"In fact the only people who you haven’t attacked were the Rich and Jews.

I guess we can draw our own conclusions as to your back-ground."

I'm going with poor muslim. Possibly a civil servant.

capital punishment
capital punishment
9 years ago

"I don’t remember many Christians – except those from the ethnic groups involved – marching to protest the slaughter of Christians by Christians in the former Yugoslavia less than 20 years ago."

Thats because marching would have been useless to stop the slaughter. But this christian had his bags packed and his papers signed and was on standby to head to Kosovo with his unit if a ground war had been started. We would have primarily been defending muslims though. And proud to do it. I just wish they would stop trying to kill us.

Anonymous
Anonymous
9 years ago

While we are on the topic of Islam… Educate yourselves so you will be more prepared when radical Islam comes to Vancouver. (Hint… its already here)

http://www.thereligionofpeace.com/Pages/AboutSite

http://www.jihadwatch.org/

chilled
chilled
9 years ago

The thug-a-lug shot dead in New Westminster yesterday, in front of his 3 yrs old, was returning his kid to his ex wife after visitation. She is a REALTURD!!!!

The most corrupt place on earth.

Frank
Frank
9 years ago

Realpaul you bring nothing to this site but hatred and your visibly bloated ego. For some reason the site owners tolerate you. I wish there was a way of putting you on ignore.

Anon
Anon
9 years ago

@realpaul:

What's up Realshit – too close for comfort? Anon 92 here.

In fact you defend Jews and the rich in several posts.

No shame in admitting your background. Now we know the bias behind your drivel. Everyone else is crap. Everyone who provides value to the community is over-paid and lazy.

realpaul
realpaul
9 years ago

#84 A….Ok genius…Dubai is not a race…its a place…Islam is not a race..its a religion…..knee jerk PC much?

#92 Anon……apparently I don't go around hating the rich or the jews

No shortage of PC shit for brains on the site today…..whats next…theres no telling what dipshits with no brains will pick up from the union brochures next.