Financial Security or Money Trap? An ex post financial evaluation of repeat sale residential transactions in the USA

The user cost of capital model evaluates the total return on home equity required from home ownership that makes a household financially indifferent to owning or renting its dwelling. As the non-investment costs of owning or renting property – rent, loan interest, capital maintenance, insurance, taxes, and other operating costs – are relatively non-varying, it is home equity return expectations that are central to this decision. Existing studies concentrate on the role that home equity returns play in consumer spending, personal opinions of financial condition, perpetuating discrimination, and mobility. Scholars have also used the user cost model to project a forward-looking buy vs. rent index to aid current decision making. But few studies have evaluated whether ex post financial returns of home equity validated the original decision to own. This question is important, both as a test of conventional wisdom (renting is perceived as impoverishing) and public policy, which greatly subsidizes the ownership tenure. Using a database of repeat sale transactions in the United States along with a model of alternative investment portfolios, this study evaluates the net present value of every transaction for the two alternative tenures (renting or buying). Results suggest that home owners overestimate home equity returns, possibly influenced by public subsidies. However the combination of high leverage in homeownership and the correlation of home equity returns to upside-biased systemic risks (i.e. inflation) “bails out” homeowners such that the leveraged NPV of home equity often does beat alternative investment portfolio returns. These results suggest that access to leverage is what leads to wealth through home ownership, leaving behind those without steady income or qualifying credit. It also suggests that policy aimed at reducing housing costs, increasing affordability, or decreasing housing inequality will be most effective if it distributes housing leverage more equitably.