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Findings from a Cross-Sectional Housing Risk-Factor Model

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Abstract

Housing data from the last 25 years show that returns to residential real estate in the U.S. can be volatile and vary significantly among locations. The variations in returns are driven by economically as well as geographically and psychologically motivated factors, but so far, no asset pricing model that adequately explains systematic risks in cross-sectional housing returns is widely accepted. This paper proposes an asset pricing model for housing returns that includes a market-wide return factor, an economically motivated factor derived from income growth, a geographically based factor derived from land supply elasticity and a momentum factor, which is psychological in nature. The model explains well the systematic risks in housing returns and is robust to different portfolio segmentations. Moreover, the model illustrates that local risk factors indirectly capture the risk previously attributed to market-wide price changes. While housing is not actively traded when compared to other financial assets, understanding the risk-factors that explain housing return in cross-section provides important insight for real estate investors, builders, real estate future traders, homeowners, banks and other mortgage lenders.

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Notes

  1. Gyourko et al. (2006) argue that housing appreciation in a few “superstar” cities may exceed the national income growth for extended time periods mainly due to growth in high-income population in these cities.

  2. Beracha and Skiba (2011) show that portfolios based on performance from the previous four quarters experience the highest level of return momentum.

  3. The index data are available at http://www.fhfa.gov.

  4. FHFA defines a repeated sale when the same physical address originates at least two mortgages and those mortgages are purchased by either Freddie Mac or Fannie Mae. The use of repeated sales of the same physical address controls for properties’ characteristics, and reduces the effect of changes in construction quality over time on changes in housing prices. For more detail about the index construction see Calhoun (1996) and OFHEO’s website at http://www.fhfa.gov.

  5. For the complete list of MSA land supply elasticities, see Saiz (2008).

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Authors and Affiliations

  1. Department of Economics and Finance, University of Wyoming College of Business, 3985 1000 E University Avenue, Laramie, WY, 82071, USA

    Eli Beracha & Hilla Skiba

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  1. Eli Beracha
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  2. Hilla Skiba
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Correspondence to Eli Beracha.

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Beracha, E., Skiba, H. Findings from a Cross-Sectional Housing Risk-Factor Model. J Real Estate Finan Econ 47, 289–309 (2013). https://doi.org/10.1007/s11146-011-9360-x

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