Tag Archives | Owning vs Renting

Can Owning a Home Hedge the Risk of Moving?

Conventional wisdom holds that one of the riskiest aspects of owning a house is the uncertainty surrounding its sale price, especially if one moves to another housing market. However, households who sell a house typically buy another house, whose purchase price is also uncertain. We show that for such households, home owning often hedges their net exposure to housing market risk, because their sale price covaries positively with house prices in their likely new market. That expected covariance is much higher than previously recognized because there is considerable heterogeneity across city pairs in how much house prices covary and households tend to move between the highly correlated housing markets. Taking these two considerations into account increases the estimated median expected correlation in real house price growth across MSAs from 0.35 to 0.60. Moreover, we show that households’ decisions whether to own or rent are sensitive to this “moving-hedge” value. We find that the likelihood of home owning for a mobile household is more than one percentage point higher when the expected house price covariance rises by 38 percent (one standard deviation). This effect attenuates as a household’s probability of moving diminishes and thus the moving-hedge value declines.

Can Owning a Home Hedge the Risk of Moving? with Nicholas Souleles, American Economic Journal-Economic Policy vol 5, number 2 (May 2013), pp. 282-312 (PDF)

Timing the Housing Market

We create reliable measures of the cost of owning and the cost of renting that enable us to compare the level of rents and ownership costs across MSAs. We show that households can predict whether renting or owning will end up being less expensive ex post. This exercise is more robust than trying to predict house price changes or housing returns because much of that uncertainty is inframarginal in the optimal own/rent decision, which depends only on the which tenure mode is cheaper. We show that households can profitably time the home ownership decision. Using several simple trading rules, we estimate that households can save as much as 50 percent of annual rental costs over a five-year period by timing the decision of when to buy a home. The potential savings varies across cities.

Timing the Housing Market with Cindy Soo, Mimeo, March 30, 2013

Safety in Renting

A recent decline in the home ownership rate raises the possibility that people now realize that home owning is too risky for some. However, we should not forget that renting also is risky for others. This article outlines two sources of risk that owning avoids and renting does not – by owning, low-mobility households can lock in their housing costs and all households can hedge themselves against changes in the cost of housing from moving – and a source of risk that renting avoids: Uncertainty over the sale price of a house. The article shows which kinds of households would best avoid risk by choosing renting, or owning. The recent decline in the home ownership rate does not appear to be driven solely by natural renters returning to renting, and the article issues a challenge to landlords to find ways to make renting less risky for natural owners.

Safety in Renting , Wharton Real Estate Review(2012) (PDF)

Does Home Owning Smooth the Variability of Future Housing Consumption?

We show that the hedging benefit of owning a home reduces the variability of housing consumption after a move. When a current home owner’s house price covaries positively with housing costs in a future city, changes in the future cost of housing are offset by commensurate changes in wealth before the move. Using Census micro-data, we find that the cross-sectional variation in house values subsequent to a move is lower for home owners who moved between more highly covarying cities. Our preferred estimates imply that an increase in covariance of one standard deviation reduces the variance of subsequent housing consumption by about 11 percent. Households at the top end of the covariance distribution who are likely to have owned large homes before moving get the largest reductions, of up to 40 percent relative to households at the median.

Does Home Owning Smooth the Variability of Future Housing Consumption? with Andrew Paciorek, Journal of Urban Economics vol. 71(2012), 244-257 (PDF)

Understanding and Mitigating Rental Risk

The decision of whether to rent or own a home should involve an evaluation of the relative risks and the relative costs of the two options. It is often assumed that renting is less risky than homeownership, but that is not always the case. Which option is riskier depends on the risk source and household characteristics.
This article provides a framework for understanding the sources of risk for renters. It outlines the most important determinants of risk: volatility in the total cost of obtaining housing, changes in housing costs after a move, and the correlation of rents with incomes. The article characterizes the magnitudes of those risks and discusses how the effects of risk vary across renter types and U.S. metropolitan areas. In addition, the article shows that renters spend less of their cash flow on housing than do otherwise equivalent owners and, thus, are better able to absorb housing cost risk
This article provides a framework for understanding the sources of risk for renters. It outlines the most important determinants of risk: volatility in the total cost of obtaining housing, changes in housing costs after a move, and the correlation of rents with incomes. The article characterizes the magnitudes of those risks and discusses how the effects of risk vary across renter types and U.S. metropolitan areas. In addition, the article shows that renters spend less of their cash flow on housing than do otherwise equivalent owners and, thus, are better able to absorb housing cost risk

Understanding and Mitigating Rental Risk , Cityscape vol.13, number 2 (July 2011) 105-125 (PDF)

Spatial Variation in the Risk of Home Owning

Spatial Variation in the Risk of Home Owning in Edward Glaeser and John Quigley(eds.),, Housing Markets and the Economy, Risk Regulation, and Policy Lincoln Institute of Land Policy(2009), pp 83-112 (PDF)

Urban Housing Demand

Urban Housing Demand , The New Palgrave Dictionary of Economics, Second Edition, Steven Durlauf and Lawrence Blume, eds. (2008, Palgrave MacMillan) (PDF)

Owner-Occupied Housing as a Hedge Against Rent Risk

Many people assume that the most significant risk in the housing market is that homeowners are exposed to fluctuations in house values. However, homeownership also provides a hedge against fluctuations in future rent payments. This paper finds that, even though house price risk endogenously increases with rent risk, the latter empirically dominates for most households so housing market risk actually increases homeownership rates and house prices. Further, the net effect of rent risk on the demand for homeownership increases with a household’s expected length of stay in its home, as the cumulative rent volatility rises and the discounted house price risk falls. Using CPS data, the difference in the probability of homeownership between households with long and short expected lengths of stay is 2.9 to 5.4 percentage points greater in high rent variance places than low rent variance places. The sensitivity to rent risk is greatest for households that devote a larger share of their budgets to housing, and thus face a bigger gamble. Similarly, the elderly who live in high rent variance places are more likely to own their own homes, and their probability of homeownership falls faster with age (as their horizon shortens). This aversion to rent risk might help explain why older households do not consume much of their housing wealth. Finally, we find that house prices capitalize not only expected future rents, but also the associated rent risk premia. At the MSA level, a one standard deviation increase in rent variance increases the house price-to-rent ratio by 2 to 4 percent.

Owner-Occupied Housing as a Hedge Against Rent Risk with Nicholas Souleles, Quarterly Journal of Economics vol. 120, number 2 (May 2005), pp. 763-789 (PDF)