How Much Should Rent Cost?
The original (Spanish) version of this article can be found here.
These days, we have been going around in circles about the so-called “housing problem,” and how it is not really a housing problem, but rather a problem of wealth distribution.
However, it is true that even if we managed to resolve the wealth problem through other means, we would still need to address the fact that cities must have a rental market. There are people who do not settle permanently in one city, or whose lives change so quickly that buying does not make sense for them, or people who simply prefer not to buy for whatever reason. It makes perfect sense to have a rental supply that meets those needs.
That raises the question of how much rent should cost, especially if it is the public administration providing it. In other words, what is the real cost of having housing available and maintaining it in good condition?
If the answer is not obvious, it is because housing has absorbed such a large speculative component that it is no longer clear what derives from a real cost and what comes from a speculative phenomenon.
But the answer is also unclear for another reason: housing is one of the very few assets whose lifespan is longer than our economic models. The economy is inseparable from time, and you cannot measure the cost of a good that lasts only a few years — or is even consumed immediately — in the same way you measure one that is, for all practical purposes, infinite.
This article is an exercise in trying to determine housing costs from that point of view. Let’s start with the basics: how much does it cost to build?
As of today, construction costs are around €1400/m². With that amount, you can build an apartment block. That means a 100 m² home costs about €140,000.
And how long does that building last?
With the necessary maintenance, a building constructed today could last indefinitely, until someone decides to tear it down. There are buildings standing that are 2,000 years old, and in major European cities it is very common for most of the buildings in historic centers to be more than 150 years old.
The problem arises because our economic models are not designed to value anything over that kind of time horizon. For example, in company accounting, buildings are amortized over 50 years. Obviously, nobody demolishes a building after 50 years, but that is how it is recorded.
But if we annualize construction costs across the entire lifespan of a building, we would have €1400/m² divided by infinity = 0. The annualized construction cost over the life of a building is zero.
Of course, for the building to last forever, it requires maintenance, but that is an ongoing expense carried out year by year. Let’s say that expense is €15/m² (that is, €1,500 per year for a 100 m² apartment).
Unlike the initial investment, which annualized tends toward zero, maintenance costs grow with the life of the building. That investment in maintenance, which seems very small, is actually the primary cost of real estate assets. In fact, if we accept that the building is infinite, then its cost is also infinite.
This is the housing cost that should be attributed to the tenant, who is the one using the property during their occupancy.
Then there is a financial cost because, although the building is infinite, we need the money to build it today. So someone must advance that money, and that has a cost. But, once again, if we annualize the cost of money (the lender’s return) across the lifespan of a building, that cost also approaches zero.
One of the main dysfunctions of the housing market happens because the loans granted by banks have a maximum term that does not match the real life of the asset. So you have to pay for a good that lasts infinite years within a 30-year mortgage, while afterward that asset remains debt-free for eternity.
The problem arises, among other reasons, because the person signing the loan will not live forever. That is why it would make perfect sense for the loan (and ownership) of a building that will last hundreds of years not to be signed by an individual, but by a collective ownership entity, such as the housing associations that exist in Europe. And it would make complete sense to have very long-term loans (the same number of years the building will last) with very low interest rates, making it possible both to reward savers who lend the money, and to align financing with the life of the asset.
And what is undoubtedly nonsensical is that public administrations, when they build, tie their own hands to those same 30-year credit timelines and drown themselves financially, when they could finance construction almost perpetually, and it would make perfect economic sense for them to do so.
What would remain to be studied is the question of land value formation. Should land be compensated? Or is it a public concession that should be granted as a right of use and exploitation, rather than ownership? Is there any inherent value to land, or is its value tied to the building permit (and therefore a public good)?
But that will have to wait for the next article.