Homeowner Equity: Part One

NAR Research has looked at the equity a homeowner might have in a home owned for 5, 10, 15, and 20 years if it were purchased at the median price. This analysis allows us to learn about the effect of price patterns in many metro areas on homeowner equity over longer periods of time. Examining longer periods of time is important because a typical buyer expects to own a home for 7 to 15 years, depending on the buyer’s age¹  and because over time some market fluctuations even out. Among all buyers, the typical expected time of ownership is 10 years.

For the second year, the effect of falling house prices in many metros has shown up in our look at equity in a wide-spread manner at the 5 year time frame. In 2005, prices in 25 of 154 (16 percent of) metro areas studied were at their peak² . Since that time, while some metro areas have experienced double-digit price growth many of those areas that peaked in 2005 have experienced double-digit decline. The average experience has been for a 5 to 7 percent decline, a frustrating experience, but a setback that does not erase all of the owner’s equity.
Over a 10 year period, the typical expected time of ownership, the equity situation for our experimental buyers is much more sanguine. In a part two of this commentary, we’ll look at more results of the metro area experiment. In this introduction, we will examine what home equity does for homeowners and why it is important to the overall economy.

Equity and Wealth

Homeowner equity is a substantial component of homeowner wealth. The Federal Reserve's Survey of Consumer Finances³  provides a snapshot of family income and net worth along with basic demographic details and more detailed information on where families keep the wealth they have accumulated. The most recent

survey, offers a picture of the situation before home price declines and the tumbling equities market hit household balance sheets. At that time, median homeowners had well over $200,000 in net worth compared to median renters who had just over $5,000. Furthermore, $200,000 was the median value of owners’ homes. In the research paper accompanying the survey results⁴ , Fed researchers conducted a thought experiment to determine how market declines might have impacted the mean and median households through October 2008. Looking at aggregate data, the National Association of Realtors® estimated the impact for renter and homeowner households through calendar year 2010. The result, shown in Figure 1, suggests that despite declines in equity and housing markets, homeowners ended 2010 with a net worth orders of magnitude greater than renters⁵.

Drivers of the Difference

There are several potential explanations for the difference in the net worth of renters and owners. Renters tend to be younger and have lower income on average than typical homeowners. One other possible explanation comes from behavioral economics. Traditionally, economists have assumed that individuals are rational, self-interested actors capable of making the choices that maximize their benefit. In the last several decades, researchers in behavioral economics have challenged this conventional view pointing out instances where the framing of alternative choices affects decisions or where people express a desire to make a choice, such as saving more for retirement, but seem unable to carry that choice out. Behavioral researchers have speculated that the mortgage could serve as a useful commitment device or low-will power savings vehicle like defined benefit pensions and social security. In a paper on retirement saving, two behavioral economists note, “[O]nce a home is purchased, the monthly mortgage bill provides a useful discipline in building up equity.”⁶

1. National Association of Realtors® Research, Profile of Home Buyers and Sellers 2010
2. Price peak is based on prices from 2001 to 2010.
3. The Survey of Consumer Finances is conducted once every three years.  The most recently available data is from the 2007 survey.
4. http://www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf
5. The recovery of the stock market and sluggish housing market likely affected owners and renters differently. For the first time ever, the Federal Reserve resurveyed the 2007 participants in 2009 to directly measure how the crisis and recession affected their finances.  These results have not yet been made public.
6. Benartzi, Shlomo and Thaler, Richard H., “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.” Journal of Political Economy, Vol. 112, No. 1, pp. S164-S187, February 2004. Available at SSRN: http://ssrn.com/abstract=489693.