The effectiveness of homeownership in building household wealth

Jordan Rappaport

Economic Review, 2010, vol. 95, issue Q IV, 35-65

Abstract: The recent economic and financial crisis and the current slow recovery highlight that homeownership plays a critical role in the U.S. economy. The estimated ?equivalent rent? implicitly paid by homeowners accounts for more than 8 percent of gross domestic product. Investment in single-family housing also represents a significant share of GDP and is closely tied to the business cycle. During the past decade, such investment has ranged from as little as 1.3 percent of GDP during recessions to as much as 3.4 percent during expansions. The associated large fluctuations in demand for owner-occupied housing play an important role in driving the business cycle. In addition, demand for owner-occupied housing is especially sensitive to intermediate-term real interest rates and hence to inflation and monetary policy expectations. ; Homeownership also plays an important role in determining household saving, which has implications for national saving and investment. Some aspects of homeownership increase household and national saving. For example, renters intending to purchase a home have an incentive to save to make a down payment on their first home. In addition, new homeowners must promise to save far into the future by making monthly mortgage principal payments. On the other hand, homeownership typically requires large house-related payments and so can reduce household cash flows available to invest in financial assets such as stocks and bonds. ; For decades, conventional wisdom has viewed homeownership as an effective way to build household wealth. However, the recent fall in house prices has caused some observers to question this belief. Rappaport examines whether homeownership effectively builds household wealth. He develops an analytical framework to compare the wealth that homeowners have historically accumulated by building equity in their houses with the wealth they could have accumulated by renting an identical house and investing the resulting saved cash flow in stocks and bonds.

Date: 2010
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