Ever accidentally become what you thought you hated? I'm talking about moral hazard in econ.

[Dominus]

If you don't know what moral hazard is, read this.

https://en.wikipedia.org/wiki/Moral_hazard

In economics, moral hazard occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place.

Many people, including me, blame moral hazard as playing a big part in causing the financial meltdown of 2008.

I recently accidentally stumbled into this without knowing it.

A couple months back, I rented a house to a young lesbian couple. The rent rate was based on fair market value. I have an agent that does the research for me. I then compare her results with mine and base my rental rates from that.

Earlier this month, about a week after they paid July's rent, they approached me and asked for early termination. That's only 2 months into the lease. Why? They broke up. I wasn't happy but said ok I'll try to find new tenants ASAP so as not to have to charge them for August.

I listed the place a week ago at 25% more and also increased the security deposit by a couple hundred dollars. I thought I'd try out to see if I could rent it out for that much more than what was considered the rental market. If I got no bite in a week, I would just lower it back down since we still got a lot of time left in July.

I've gotten almost a dozen showings and 5 applications. I just deactivated the listing after just 1 week. I have also chosen new tenants. A nice family (yes, they're married) with kids. Both parents are federal workers, aka job security. Signing the lease tomorrow. They got both the security deposit and first month's rent ready.

A couple things came to mind. So, the prospective tenants I was showing the place to all said that there is nothing out there right now. There was a housing shortage in the rental market around here before. It looks like the shutdown and shelter-in-place orders have made the housing shortage even worse. Also, everybody seems to be thinking that the housing market will crash within the next 6-8 months. This will make things even worse.

Was talking to someone this morning about this experience. And he pointed out that without knowing it, I participated in what is known as a moral hazard. See, since the risk of another month's rent wasn't on my shoulder, I was emboldened to try to see if I could increase the rent by that much. Even though in the end it worked out for everybody, the fact remains that given the opportunity, anyone would take the risk if they weren't responsible for paying for the risk if things went south.

We often blame wall street speculators for the financial meltdown because those guys took way too many unnecessary risks at the expense of the investors and the overall economy. My recent experience has actually changed my perspective on this. Can we really blame people for this phenomenon (moral hazard). Given the opportunity, anyone would take that risk because the consequences of the risk wasn't on their shoulders.

Do you agree with this perspective?

 

[DepravedMuscleFTL]

yes - I (or we) have been guilty of this - after the 2008 meltdown our property got turned upside down - we were left holding a mortgage on a property that was now only worth about half of what the mortgage was - we were going to see it through and hope for the best in the long term BUT then my partner of 15 years got a terminal diagnosis of pancreatic cancer - so we shifted the mortgage solely to his name and stopped paying - he died a few months later - and then I lived there alone after he passed for a few more months before relocating... I left the property abandoned - I was told by friends that I could have lived there a long time - even years - free of rent and bills - but I only stayed long enough to sort out all the loose ends of our affairs and secure a new residence... we paid a very large down payment on that property when we bought it and paid on that mortgage a lot of years and lost every penny we had put into it - I feel zero shame

 

[rareboy]

You are a landlord.

And now you are behaving like one. Looking to maximize income.

And you found a [STRIKE]sucker[/STRIKE] tenant who needs to rent and thought your terms must have been reasonable.

There's no moral hazard here.

 

[Dominus]

^ Well, it is all part of supply and demand. One would argue that the market rate is whatever the tenants or potential tenants are willing to pay.

The moral hazard part comes in when I took the risk of overshooting what people are willing to pay for the place because someone else was bearing the burden of that property sitting there not rented out for another month.

The new tenants as well as others who applied said that if they want to live in an actual single family house there is nothing available right now. Plenty of apartments and multifamily units. Just happens that single family homes are in hot demand.

 

[NotHardUp1]

I'd be interested in knowing how you reconcile the "fair" rent before you assess the market?

In the urban markets I have seen, and I shopped them as I moved from Arkansas to New Mexico to Alaska to New Mexico to Connecticut to Alabama. I also shopped markets in Wyoming and Colorado as I applied for jobs in those markets.

What I discovered was what I already knew: the working class is being sacrificed by American capitalists because they are adrift and at their mercy.

An upper middle class family can often afford to buy a house on one income and allow the wife to stay home to be a mom. Working class people struggle to even afford a house with two people working, and if they live in a city and are descended from the poor and working class, they are left at the mercy of landlords.

Albuquerque and Denver were typical, with disproportionately high percentages of rental properties and higher rents as well. Basically, whereyagonnago?

So, my moral question is how much are your renters paying per square foot to live there each month, before utilities, compared to how much you pay to live in your home per square foot each month, before utilities.

 

[opinterph]

Do you agree with this perspective?

From what you’ve shared, it appears that you decided to excuse your tenants from the early termination provisions of their lease - provided you could find someone else to rent the property. You did not promise the tenants that the condition of your search for a new tenant would include offering the property under the same terms as their lease, nor that your price for the unit would remain the same.

I don’t see the moral hazard. You are not required to base your rental rates on fair market value. Whether you were at risk to suffer a period without rental income, the price adjustment is a reasonable business decision.

 

[NotHardUp1]

Again, I ask how we arrived at a society in which the question is whether one is charging a competitive market rent instead of asking if the rent is reasonable compared with the economic opportunity afforded the average family in the rental market or even the cost of property acquisition and earning a fair rate of return on it?

Of COURSE, anyone can claim the desire to make a property pay for itself much quicker than the average mortgage is paid, hence the ever-escalating rents.

 

[rareboy]

^ Well, it is all part of supply and demand. One would argue that the market rate is whatever the tenants or potential tenants are willing to pay.

The moral hazard part comes in when I took the risk of overshooting what people are willing to pay for the place because someone else was bearing the burden of that property sitting there not rented out for another month.

The new tenants as well as others who applied said that if they want to live in an actual single family house there is nothing available right now. Plenty of apartments and multifamily units. Just happens that single family homes are in hot demand.

I still don't see a moral hazard.

For the longer term, it may have been worth even losing a month of rent to be able to move the rent to a level more appropriate for the market and tenants you are seeking.

 

[sixthson]

Are you just being a good businessman or are you guilty of price gouging?

 

[Dominus]

Are you just being a good businessman or are you guilty of price gouging?

Is it really price gouging, though, if it follows basic supply and demand?

 

[NotHardUp1]

What is ever price gouging? If there is an ice storm and people are willing to pay 10x the fair price for an electric generator, who's to accuse the seller of opportunism and unethical behavior?

Society. That's who.

Why should you feel good about helping to raise the price of rent above the reach of hardworking people? Just because other landlords do it, that makes it ok?

Isn't that the same as a slaveowner might argue? All his neighbors used slaves to farm their plantations. Why would he be expected to do differently?

No one else hires out gay employees. Why should Mr. X?

All the other people at the lynching thought it was the right thing to do. Why should I feel badly about it?

No women had ever been allowed to be a chief executive. Why should our company have to pioneer that and risk lost business?

See how that works?

 

[peeonme]

I was always somewhat fearful of becoming wealthy and exploiting others. Greed is a trap and it's easy to fall into. I have seen employers, land owners and professionals shear the sheep and fleece the flock. Truth be told you don't have to be rich to do this, I have some customers that pay double what others pay just because they decided to pay me more. On the other hand I had a vet. talk me down so I extended that price to other vets. When it comes to rent it's a matter of what the market will bear, I am looking at homes that a mortgage payment on them would cost $450. per month including taxes and insurance. The rent value of these homes is near double that amount. People with out down payments, a good employment history and decent credit pay more for living in a house than those who can buy a house.

 

[Dominus]

I'd be interested in knowing how you reconcile the "fair" rent before you assess the market?

In the urban markets I have seen, and I shopped them as I moved from Arkansas to New Mexico to Alaska to New Mexico to Connecticut to Alabama. I also shopped markets in Wyoming and Colorado as I applied for jobs in those markets.

What I discovered was what I already knew: the working class is being sacrificed by American capitalists because they are adrift and at their mercy.

An upper middle class family can often afford to buy a house on one income and allow the wife to stay home to be a mom. Working class people struggle to even afford a house with two people working, and if they live in a city and are descended from the poor and working class, they are left at the mercy of landlords.

Albuquerque and Denver were typical, with disproportionately high percentages of rental properties and higher rents as well. Basically, whereyagonnago?

Well, that's one way of looking at it. Another way of looking at it is because the working class are moving around going after where the jobs are, rental properties spring up to meet the demands.

The house I mentioned in the OP has 5 bedrooms. It was a duplex. After I bought it, I turned it back into a single family home. Even though I listed it 25% more than what was considered market price, I still had plenty of people enquiring and applying. I had so many showings in just one week. The family I ended up giving the place to have 6 members: Mom, dad, 3 daughters, and a son. Part of the reason why I gave them the place was the mom and dad are federal workers. But more importantly, the mom kept texting me asking if I had made my decision yet? When I finally told her over the phone that I'm giving the place to them, she was very happy. Here is a text I received after we hung up.



I just don't see any sign of them feeling they're being exploited. In fact, it was them that insisted on a 2 year lease. I tend to see this as me and other investors fulfilling a demand in the market.

So, my moral question is how much are your renters paying per square foot to live there each month, before utilities, compared to how much you pay to live in your home per square foot each month, before utilities.

Are you comparing rental versus home ownership? Of course, it is cheaper per month to live in your own house versus renting. It's always been this way because the market has always been like this.

 

[Dominus]

I was always somewhat fearful of becoming wealthy and exploiting others. Greed is a trap and it's easy to fall into. I have seen employers, land owners and professionals shear the sheep and fleece the flock. Truth be told you don't have to be rich to do this, I have some customers that pay double what others pay just because they decided to pay me more. On the other hand I had a vet. talk me down so I extended that price to other vets. When it comes to rent it's a matter of what the market will bear, I am looking at homes that a mortgage payment on them would cost $450. per month including taxes and insurance. The rent value of these homes is near double that amount. People with out down payments, a good employment history and decent credit pay more for living in a house than those who can buy a house.

Even though I agree with you that building wealth often involves exploiting others, I am convinced that one can build wealth without exploiting others.

For example.

https://en.wikipedia.org/wiki/J._K._Rowling

She literally went from being on benefits to becoming the world's first billionaire author. Would anyone ever say she exploited others?

I threw her out there as an extreme example. I believe that some have gained their fortunes by providing a service or created something that a lot of people wanted.

I'll tell you a little of my strategy in the REI field. Right now, if you visit any of the various REI websites, you will see repeatedly that people urge people to get multi-family units. Go to any REI seminar and the gurus will tell you to get multi-family units. Why? They say it is the most profitable way to make money in real estate investment. And because of this latest craze, landlords everywhere are converting single family houses into duplexes and triplexes. They try to cram as many people into a single structure as they can. Say a house goes for $900-1000/month. If you divide it up into upper and lower units, you can charge $600/month each. That's a total of $1200/month.

But what about families that have more than 1 kid and want to have a single family house? I own properties in 3 different cities, 1 big 2 small, and I see the exact same pattern: too many multi-family units and only a hand full of single family homes. So, most of my properties are single family homes. And every time I list one, I get dozens of inquiries and applications. In other words, I'm filling a market demand.

How is that exploiting others? They want to rent a house and I am providing a house to rent.

 

[Latimer]

Lean periods follow fat periods as surely as night follows day. Remember the story of Pharaoh's dream in Genesis? Seven fat cows devoured by seven thin cows: correctly interpreted by Joseph to mean that seven years of famine would follow seven years of plenty.

As a landlord, luck or prudence or a combination of both during the good times can help one weather the bad times.

My partner and I own some residential rental units. Older, architecturally-interesting but derelict when we bought them, beautiful now. They require constant, often expensive maintenance. Fortunately for our tenants, my partner is an exemplary manager, and attends to their problems and needs immediately. Some of the units are at market rents, some moderately or slightly below, and one is easily 50% below market, as the unit is under under rent control, and the tenants (who pull in 600K + a year) have been there a long time.

Due to laws enacted by both the state legislature and local authorities to help tenants through the coronavirus crisis, none of our tenants is required to pay rent, nor are they required to show evidence of hardship. This has been so for 3 months, and has now been extended for another 3, for a total of 6 months. Tenants are then allowed to repay deferred rent over a 12 month period. Some of our tenants are paying full rent, others are paying 75% and 50%, one is paying nothing. The city and the state expect us and other landlords to carry our tenants during this period. We are effectively asked to provide welfare for them. It is entirely possible that after the end of the crisis, a tenant would choose to simply leave, and we would have to bring a suit in small claims court in the hopes of recovering rent.

Two days after the local BLM marches, looting and riots, someone set a fire outside the alley entrance to one of the properties, and the tenants in the 2 apartments above, two young women, were awakened at 3:30 AM to flames lapping at their windows. The fire was set adjacent to and damaged the gas lines entering the complex. Fortunately no one was hurt, but all 4 of our tenants were unable to use their apartments for the next five days while old gas lines were removed and new ones installed, portions of the building repainted and the apartments cleaned. Most, but not all of these expenses, including pro-rated rent adjustments, were covered by insurance, but my partner and I are still out of pocket 4K, plus the time my partner need to spend organizing repair work, dealing with the gas company, the building department and the insurance adjustor.

Fortunately, both my partner and I have other substantial sources of income. We are not suffering financially or in any other way, other than our fear that there will be another fire at one of the properties, and our continuing concern for the safety of our tenants there. However, had the profits from these investments been our only source of income--as it often is for retired couples--life would be very difficult.

 

[NotHardUp1]

Are you comparing rental versus home ownership? Of course, it is cheaper per month to live in your own house versus renting. It's always been this way because the market has always been like this.

Absolutely untrue.

It has become like this because of speculators in housing.

And if rents are exorbitant, finding one less exorbitant would indeed cause a lot of interest.

So, if there is too little available on the market, and yours is not the highest or is not in a bad neighborhood, of course there is clamor to rent it.

That doesn't change it from being potentially and exploitation of the working class. What percentage of median income is it for your area? How much profit is it turning per year vs. the cost of the mortgage and upkeep? I'm not asking you to post such information, but I'm stating that those are the questions that an ethical man should be asking, not merely is he the worst of the rental barons.

The Sanskrit proverbs reads true: it is not goodness to be better than the worst.

Working class men once could afford to own their homes without three people in the household having to work to make the mortgage and other bills. Now that realty speculation has become a norm, that is no longer true for people who didn't inherit something.

It's very obvious that when the wealthy class buys up housing and then rents it out to the poorer class, it is constricting supply and driving up price. I even see it in the used car market here. If a good car comes on the 2nd hand market, it is quickly snapped up by myriad small used car resellers, who often don't even have a license and are operating under the radar. But, they are smart and know they have to get the bargains off the market, else their cars will sit and the price will fall to the reasonable price.

Even in my hometown, there was a piano dealer, and he bought up bargain pianos 2nd hand for decades to keep them from slowing the sale of his new pianos. There was literally a 3-story barn behind my home that was a decades old warehouse to keep all the old pianos off the market.

The same damned thing happened in the housing collapse of 2017. Banks and mortgage companies had record defaults. The natural market force should have driven down home values as a result. The effect was very mitigated and short term because banks literally pulled many homes off the market and artificially controlled the pricing. There is always support for free-market capitalism when record profits are being made, but let a market tank and all sorts of contrivances protect the rich.

 

[NotHardUp1]

How is that exploiting others? They want to rent a house and I am providing a house to rent.

Often when we ask for advice, we're seeking an accomplice. Or a vindication.

What of the doctor or pharmacist who claims narcotics addicts are going to get their drug somewhere? Are they creating more dependency just because they are providing the drug? Equivocation is an old game. Pontius Pilate needed a laver to demonstrate his purity.

 

[Dominus]

Often when we ask for advice, we're seeking an accomplice. Or a vindication.

What of the doctor or pharmacist who claims narcotics addicts are going to get their drug somewhere? Are they creating more dependency just because they are providing the drug? Equivocation is an old game. Pontius Pilate needed a laver to demonstrate his purity.

Actually, I'm not asking for advice. My conscience is clear on the business. And here is why.

Saturday night, I got a text from one of the tenants. She said they just noticed the toilet was slightly leaking. I told her ok I will come by in the morning.

It was probably the wax seal. It was an old toilet. You know one of those that you press the flush button and it takes like 5 minutes for the water to twirl down? I stopped by menards and got them a new elongated dual flush toilet. Got there at about 12. They had just woken up. Their friends were sleeping on the couches. They had a drinking party the night before. We sat and chatted for a while. They poured me a drink. It was pretty good. Never had one of these before. I'll have to introduce it to my husband.



And here is their cat.



Then eventually they went out to do some grocery shopping while their friends started dispersing. I started working on the toilet.

After taking out the toilet, I noticed that the metal flange underneath was all corroded and no good. I went down to the basement and saw that the cast iron pipe for the toilet was all corroded. Originally, I intended it to be a quick toilet swap with new wax sealant. But now, I decided to replace the cast iron pipe and the toilet flange... pretty much the entire setup. Might as well do it now. I spent from 1pm to 8pm cutting out the cast iron pipes and switching them to pex and pvc. Everything worked out. No leaks at all. New toilet flushed wonderfully. It was beautiful. (DT impression)

I stayed a little bit longer conversing with their families. By then, about a dozen other people had shown up. Moms and dads came. Friends came. They gathered around and talked.

The thing is I have noticed that their families and friends like to gather at their house. They gather there very often. I have stopped by there at different days of the week in the evening and almost always I saw people gathered there. They sat around either out back or in the garage. Very nice crowd. Not rowdy at all. And they are always very respectful to me and me to them.

My point is the reason their families and friends like to gather there is because it is a single family house with a lawn and stuff. Everyone else is living in a duplex or apartment. I made the house affordable enough for them to rent it comfortably within their budget and I'm not just some slumlord. I form a very good relationship with my tenants on a human to human level. They will go visit family for a week or so in August and I have arranged for roofers to replace the roof. I let the tenants pick the color for the new roof. I always let them pick out colors when I replace roofs and sidings. And that's another strategy that we have. Gives some control to the tenants. You'd be surprised how much it makes the tenants feel at home.

People rent. I provide rentals. Yes, it's a business and I'm trying my best to run a conscientious business. I just refuse to believe that if you're a landlord you must be exploiting the weak members of society.

A couple of my tenants are perfectly capable of buying their own house. They just don't. I've seen their credits. They have professional careers. For whatever reason, they don't want to own. Hence, providing them a rental benefits us both.

I have come to believe that there is a fine line between exploitative capitalism and conscientious capitalism. There simply is not a fair comparison between the two.

 

[Dominus]

It's very obvious that when the wealthy class buys up housing and then rents it out to the poorer class, it is constricting supply and driving up price.

I wasn't going to respond to this post, but I have to respond to this line. Because this is the biggest misunderstanding regarding the REI line of work.

This line of reasoning is assuming that investors are buying properties that are in move-in ready conditions on the open market. Perhaps this is true with investors that have money oozing out of their ears. But this is simply not true at all with overwhelmingly most of the investors out there. You're thinking of multi-million dollar corporations that are buying up million dollar condos or apartment complexes.

Yes, there are small time investors that buy newly built houses and houses that are more or less in move-in ready conditions. These guys don't last very long usually because they barely break even most of the time.

Let me tell you how small time investors succeed and then you will see just how silly your premise there is.

Imagine a house that is boarded up and abandoned. The inside is a mess. There's a leak or two in the roof and it's been left like that for years. Now, really, do you honestly expect a working class family to buy something like that with the hopes of fixing it up to live in? NO! There's a reason why that property just sat there for years before someone like me came along.

You want to know how I managed to own a dozen properties outright with no mortgages on them at all? The property I just described above accounts for how half of my properties looked when I got them.

See, most people have no imagination. They see a broken down house and that's all they could see. My husband and I can see through the rotting and the mess and see the real potential of a property. We refuse to push and shove in a crowd to get to these properties. We always go for the properties that nobody else wanted.

A specific example. Last year we bought a property for $14K with cash. The house was all boarded up. Several holes in the roof. The floors were crumbling. Etc. About $10K of renovation cost, lots and lots and lots and lots of human labor (mainly husband and I), and 2 months later, it was appraised at about $100K. Typical 3 bedroom house with a garage, yard, etc. All the flooring in the house now is either hardwood or porcelain tiles. There is now a family of 4 living there.

But take a step back for a moment and think about this. Can you look me in the eyes and seriously say a working class family was going to buy that and made it their own? That house sat there for years before we got to it. No joke, a few of the neighbors even came by and thanked us for getting rid of an eyesore in the neighborhood.

People like me are not constricting anything. Most working class Americans don't want to buy a house that they have to do work on. The ones that are willing to do some work don't want to do that much work. Certainly not on a house with crumbling floors, holes in the roof, and boarded up windows. Again, if anyone else wanted to take on such a project, they had at least 2 years to get that place before we got to it.

I recently bought a property for $7K. About 5 years ago, the owner boarded it up and just abandoned it. No leaks, so the property been sitting there untouched for this long. Will start working on it soon. A couple of the neighbors came over when they saw me moving equipment and stuff in. Told them I just bought it and will bring it back to life. They thanked me and said it's been an eyesore for years. Told them it will get new sidings, roof, windows, everything. A couple were lookie loos and walked through to see the place. They were curious to see how terrible the inside looked. They also commented that oh my god it was awful! One of them half jokingly said they ought just tear down this place after seeing the inside.

I'm telling you now. By the end of this summer, no one will recognize the house. The outside will get new sidings, roof, and window trims. The inside will get new walls, hardwood flooring, and porcelain tiles. The kitchen will be brand new. My agent has seen my work before and she thinks it will be appraised for around $100K by the time I'm done with it.

If you can show me that regular working class folks are willing to take on this kind of project, I'll stop competing with them. They can have at it.

I'm not constricting anything. People like me are bringing back to life properties that have been abandoned to die a long, slow death.

 

[sixthson]

I've read most of what you have posted in years gone by about being a landlord. I would never think of you as other than as a very responsible, conscientious owner/landlord. I was also not accusing you of price gouging. I was just answering your question with a question since I've often learned more about myself when someone does that to me. In the future, I would err on the side of initially asking more rent and security before ever showing the property. Market rate if often deceiving. You can always lower the amount if it doesn't rent, but to me that smacks of looking desperate and is something I have always tried to avoid. My experience has also been that the people most likely to be able to afford the property are not always the best tenants and it doesn't mean they are any more likely to pay on time. Many people live paycheck to paycheck no matter how much they make. Credit checks also don't always reflect everything about the person. There are many benefits and risks in being owner/landlords.

One question, would you even sell a property to a tenant?