Homeownership and Investment in Real Estate Stocks

By Goodman, Jack | Journal of Real Estate Portfolio Management, May-August 2003 | Go to article overview

Homeownership and Investment in Real Estate Stocks


Goodman, Jack, Journal of Real Estate Portfolio Management


Executive Summary. One viewpoint is that because homeowners already own real estate, they should diversify their investment portfolios by not making additional real estate investments. This paper provides an interpretation of owner-occupied housing as an investment and presents empirical results on the financial performances of houses and financial assets, including REITs, as individual investments and within a portfolio. The analysis shows that portfolios with 10% to 20% allocations to REITs historically have generally been able to achieve higher average annual returns, with no increase in volatility, compared to portfolios without REITs. This holds not only for renters, but also for homeowners with one-third or two-thirds of their wealth invested in their house. These findings are attributable to the low correlation between changes in house prices and the returns to real estate stocks, together with the historically competitive returns on real estate stocks relative to other financial assets.

Introduction

Owner-occupied housing is both a source of shelter and, like other physical and financial assets, an investment. Equity in a house is a substantial part of the overall wealth of two-thirds of all households in the United States who are homeowners.1 For most homeowners, their house is easily their largest single investment.

An important consideration for homeowners is how their homeownership should influence the composition of their investment portfolio. One opinion sometimes heard is that, because they already own real estate, homeowners do not need, and should perhaps even avoid, other investments in real estate. This perception is likely one reason why only 6% of all "defined contribution" retirement plans even offer participants the option to invest in real estate funds (PSCA, 2001).

There is little empirical evidence, however, of how homeownership should influence individual investors' positions regarding real estate stocks. The purpose of this analysis is to provide some pertinent statistical results on this issue, as well as an interpretation of owner-occupied housing as both a consumer good and an investment vehicle.

The analysis shows that, for a range of homeownership situations, inclusion of real estate stocks in the past would have improved the overall return and reduced the volatility of the investment portfolios, including home equity, for households with mid-range risk preferences. This outcome results from the low correlation between changes in house prices and the returns to real estate stocks, together with the historically competitive returns on real estate stocks relative to other financial assets. Although the past is no guarantee of the future, the results suggest that many homeowners, as well as renters, could benefit from inclusion of real estate stocks in their investment portfolios.

Owner-Occupied Housing as an Investment

Owner-occupied housing is first and foremost a consumer good. It provides housing services to its occupants, just as does renter-occupied housing. Measuring the cost of owner-occupied housing for its residents is, however, much more difficult than for renters, for whom the monthly rent check and utilities payments are the cost of shelter.

For homeowners, monthly cash outlays are a poor measure of the economic costs of housing. Some costs do not involve cash expenditures, and some cash outlays are not true economic costs. "User cost" measures of the expense of owner-occupied housing are recognized by economists as the most comprehensive and analytically justifiable measure of housing costs of homeowners. User cost considers both cash and non-cash costs and tax considerations.2

Although a consumer good, owner-occupied housing is also widely viewed as an investment. This is understandable, because owner-occupied housing shares several elements with financial assets. Capital gains potential, leverage and tax aspects all give it a feel of an investment.

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