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The Risks And Rewards Of Owning A Home

Knowledge@Wharton, 04.06.10, 12:25 PM EDT

One-fifth of mortgage holders are underwater. That doesn't mean you shouldn't be looking for bargains.


Nearly 11 million homeowners who bought at the peak of the real estate market before the economic downturn, or who took cash out of their homes through readily available refinancing, are now feeling the pain of owing more than their properties are worth.

That population--roughly one-fifth of those who pay mortgages--is big enough to make even the most cavalier consumer think twice before buying a home, especially when key pricing indexes are showing continuing weakness in markets across the country. According to the Case-Shiller 10-city composite house price index, real home prices dropped by more than 31% between the end of 2005 and the end of 2008.

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But potential home buyers' fears may not be entirely justified. While the change in housing values might discourage home ownership, new Wharton research suggests owning a home is less risky than might be expected and can effectively hedge against volatile prices for shelter, including rental rates, as long as a buyer does not take on excessive debt to make the purchase.

In a paper titled, "Can Owning a Home Hedge the Risk of Moving?" Wharton real estate professor Todd Sinai and co-author Nicholas S. Souleles, a Wharton finance professor, explore the risk of home ownership among consumers who move from one market to another. The authors use Census data that tracks individual moves to study the volatility of housing prices between the markets where people live and the markets where they tend to migrate. When the correlation between housing prices in these corresponding housing markets is taken into account, price increases and declines track more closely than they do in the market as a whole, reducing the amount of volatility, or risk, involved in buying a house.

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In other words, by buying now consumers can protect themselves from increases that could price them out of a housing market they might move into later, the authors find. Sinai notes that while homeowners often focus on the market value of their home, what really matters is the relative price--how that figure compares to the price of finding shelter when they decide to move to a new market.

Houses are different from other assets, such as stocks, he says, because the seller must replace the asset with someplace else to live. "If a house goes up by $10,000, it's still the same house with the same kitchen. Just because it is worth more on paper doesn't really change anything," Sinai says. "And if a new house in a new city has also gone up in price by $10,000, a homeowner can cover that higher price with the capital gain. A renter would be out of luck."

The research extends a notion that Sinai says local real estate agents seem to have always known: If a buyer thinks he or she would like to live in a certain community in the future, buying a small home in the area will help make a move up more possible later on, even if prices shoot up rapidly. If prices go down, the "upgrade" home will also have dropped in price. Sinai and Souleles found that the same idea often holds even if the buyer would like to live in a different community in the future. That's because many homeowners move to a city similar to the one they left behind, according to the study.

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To better understand the true impact of housing price changes, Sinai and Souleles reviewed household data from the U.S. Census in 1980, 1990 and 2000. In all, they took into account 12 million data points, including housing prices, occupation statistics and rental prices in high-end apartment buildings in 44 major markets. Controlling for numerous variables, including education and marital status, the researchers found that the correlation in real house-price growth across those complementary metropolitan areas was higher than the median across all markets.

The paper shows that the median correlation in house-price growth across U.S. metropolitan statistical areas is 0.35. However, after accounting for where homeowners are actually likely to move, the median correlation rises substantially to 0.60. The top 75th percentile of correlated moves has an even higher rate of 0.89.

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