Owner-Occupied Housing as a Hedge Against Rent Risk

Conventional wisdom assumes that homeownership is risky because house prices are volatile. But all households start life short housing services, and homeownership could be a less risky way of obtaining those services than the alternative, renting. While a renter faces year-toyear fluctuations in rent, a homeowner receives a guaranteed flow of housing services at a known price, and so is hedged against rent risk. Although the homeowner is in turn exposed to asset price risk when she sells her house, that risk can be relatively small since it arrives at the end of the stay in the house and so is discounted, or it is deferred even later if the homeowner moves to a correlated housing market. We show in a stylized model with endogenous house prices that rent risk can indeed outweigh asset price risk. The net benefit of homeownership increases in the owner's expected horizon in the home, as the number of rent risks avoided rises and the asset price risk occurs later in time. This effect of horizon on the demand for owning should increase multiplicatively with the magnitude of the volatility of rents. Another implication of our analysis is that the aggregate wealth effect from fluctuations in house prices may be small since higher prices are generally offset by equivalent increases in the expected cost of future housing services. We test these implications using MSA-level data on house prices and rent volatility matched with CPS data on homeownership. Consistent with the model, the difference in the probability of homeownership between households with long and short expected horizons in their residences is 2.9 to 5.4 percentage points greater in high rent variance MSAs than in low rent variance MSAs. The sensitivity to rent risk is greatest for households that exogenously must devote a larger share of their budgets to housing. Similarly, the younger elderly who live in high rent variance MSAs are more likely to own their own homes on average, but their probability of homeownership falls faster as they approach the end of life and their horizon shortens. Finally, we find that the house price-to-rent ratio capitalizes not only expected future rents, but also the associated rent risk premia, consistent with asset pricing models. At the MSA level, a one standard deviation increase in rent variance increases the house price-to-rent ratio by 2 to 4 percent