DP3501 The Portfolio Implications of Home Ownership

Author(s): Frans de Roon , Piet Eichholtz , Kees Koedijk

Publication Date: August 2002

Keyword(s): portfolio choice , real estate , home ownership

JEL(s): G11

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP3501.asp

This Paper analyses the effects of residential property holdings on optimal investment portfolios. Using a mean-variance framework, we show that residential real estate offers significant diversification benefits relative to investments in stocks and bonds for US investors. Risk averse investors that hold residential real estate for investment purposes have future wealth that is less volatile. For most geographical areas in the US, investors have the best diversification benefits from residential real estate when about 30% of their investment portfolio is residential real estate. In addition to this diversification effect, we find that stocks and bonds do not provide a good hedge for positions in real estate, implying that the relative demand for either is not significantly affected by home ownership. For less risk averse agents the price return on real estate is too low in order to justify inclusion in the investment portfolio. This implies that if agents invest a significant fraction of their wealth in their house, the non-price increase, i.e., the consumption benefits, should be significant. Our estimates suggest that the order of magnitude of these non-price increases is about 10% per year.