Essay Asset Price Risk and Rent Risk: Homeownership

Essay Asset Price Risk and Rent Risk: Homeownership

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Rent risk may veritably carry more risk than the common presumption of the risks associated with homeownership. University of Pennsylvania Wharton School professors Todd Sinai and Nicholas S. Souleles introduce a model of tenure choice that takes into consideration the rent volatility, a household’s expected length of stay (a household’s expected horizon), the correlation in future housing prices, and evaluates the demand for owning through rent risk and asset price risk.
Renters are subject to annual fluctuations in rent, but do not incur the asset price risk that homeowners carry. On the other hand, households that own their houses enjoy a known, up-front expenditure; the purchase price. The choices households make to own versus rent are mutually exclusive, and all households must make the choice; households require a place to live, and asset price risk alone does not take this into account. Households that choose to own rather than rent enjoy annual dividends in what would have been paid in “spot” rent. Further, owning provides the owner with a hedge against fluctuations in endogenous and speculative housing pricing. House prices realize a premium in exchange for the successful resistance of rent risk with the acquired risk in asset prices. The model shows how house prices, in equilibrium, carry the present value of expected future rents and this premium for avoidance of rent risk.
The empirical data used to assess this model consists of data from 44 metropolitan statistical areas gathered from various sources. Annual house prices are derived from the growth rate from a Freddie Mac index and the 1990 Census. The average annual rents are for higher-quality apartments from surveys from the real estate information company Reis...

... middle of paper ...

...d purchase and the sales prices for both of the houses is the ex post cost of housing, CO:

PA at time 0 is the initial known purchase price of location A. The model will show how future house prices will fluctuate amidst rent shocks. Since housing supply is held fixed, house prices must capitalize on the demand for homeownership. In equilibrium, these prices should adjust to leave households indifferent between the tenure choice to rent or own at the beginning of their lives (time 0).
This equilibrium price is the aggregate sum of the present value of future spot rents and the total risk premium, RP, that households are willing to pay to be a homeowner instead of a renter.

Works Cited

Sinai, Todd, Souleles, Nicholas S. 1/27/14. “Owner-Occupied Housing as a Hedge against Rent
Risk.” The Quarterly Journal of Economics, Vol. 120, No. 2 (May, 2005), pp. 763-789

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