The Risk and Return of Home Ownership
September 9, 2010
Ortec Finance Research Center Applied Paper No. 2010-02
In several countries the economic crisis has again confronted homeowners with the risks of their ownership. Price-increases are not self-evident. The uncertainty of the costs of home ownership has increased. We will present a stochastic model by which the costs and risks of home ownership will be determined simultaneously. The costs of home ownership consist of two components: the difference between the buying price plus transaction costs at the start of the occupation period and the selling price at the end of the occupation period; and the home ownership related cash flows during the occupation. An important risk factor is the difference between the expected price-increase of the house and the uncertain actual price development during the occupation period. Other risks are for instance the uncertainty of the inflation influencing maintenance and the uncertainty of the future costs of refinancing the debt. We will determine those risks with a stochastic analysis, also taking into account the correlation between house price increases, inflation and the interest rate. The levels of the costs are amongst others dependent on the amount of own funds invested in the house and the length of the occupation period in the house. We show that just looking at the volatility of house prices underestimates the true risk of owner occupation, especially for longer occupation periods and with high initial loan-to-value ratios.
Number of Pages in PDF File: 28
Keywords: Home Ownership, User Costs, Risk Analysis
JEL Classification: C15, C32, D14, D31, R29working papers series
Date posted: November 5, 2010
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