Risk in the Housing Industry: Why You Shouldn't Put All Your Eggs in Your Home Basket

Guest Post by Brodie Gay, VP of Research at Unison

Homeownership gives us a permanent place to call home, a roof under which we raise our families, and the potential for financial gain over time. But Americans are woefully over-indexing on their homes, and it's more than just "house rich and cash poor". Homes aren't nearly as stable a financial asset as many assume.

Housing market volatility

American homes are in fact as volatile in value as the stock market, as shown in the benchmark Unison Home Volatility Index. The index, which explored data pertaining to single-family, owner-occupied homes, found that homeowners entering very low down payment, high-leverage mortgages has led to increased risk when it comes to home price volatility. So, for the many Americans whose homes are the key anchor of their financial portfolios and retirement plans, there needs to be a new understanding of the reality of housing risk.

The index shows that the average annualized volatility of home price appreciation has been around 15 percent per year since 2000 — only a single percentage point higher than U.S. equities index (14 percent), followed by U.S. high yield index (8 percent), and U.S. treasuries index (4 percent).

Home volatility spiked to more than 35 percent per year in the midst of the 2008 financial crisis, suggesting that, similarly to equities and fixed-income securities, the financial risk of residential real estate is amplified during financial crises.

The impact of housing volatility is important to understand, especially when it comes to matters of liquidity.;

For example, a typical homeowner (net worth: $156,400) with most of their wealth ($95,800) tied up in home equity can’t access that capital for household expenses. A downturn in the housing market could cause a $200,000 home to drop in value to $100,000, meaning not only does the homeowner not see the increase in value generally assumed for homes, but they could be left upside down on a home they can no longer afford with only $60,600 in liquid assets — assuming those assets aren’t tied up in stocks, bonds or annuities.

Perception vs. reality

What’s especially troubling is the contrast between homeowners’ perceptions of home volatility and the reality of risk.

Typical homeowners believe their household portfolio volatility to be around 9 percent, but due to a large amount of leverage that’s typically taken, in reality, it’s more than double (21 percent). Homeowners are betting big on their homes, but they don’t realize the actual risk.

New homeowners are particularly vulnerable to housing market risk, the index found. This cohort traditionally has to take out a larger mortgage to purchase, and they haven’t had as much time to build equity in their home, and they’re also contending with mountains of student loans. They also often cash out their entire liquid portfolios for a downpayment, leaving little wiggle room for unexpected expenses like booking a last-minute flight or having an emergency medical procedure.

To address this misalignment, it’s important for homeowners to understand how to fit their homes into overall financial planning. While diversifying your financial portfolio (between commodities, bonds, stocks, 401k, etc) is tried and true advice, homeowners need to factor their homes into their financial plans keeping the actual levels of volatility in mind.

It is also important to note that a homeowner should never extend themselves too much when it comes to leveraging their home. While a homeowner might be able to afford a $400,000 house, a much safer bet would be to purchase a $350,000 using a larger down payment. Larger down payments mean more equity into the house. More equity into the house means less volatility risk.

With new models like home co-investing, homeowners have the opportunity to re-allocate some of their investment into large, diversified institutional portfolios.

With the average household holding 60 percent of their total financial portfolio in their home equity, the index shows that diversifying equity in this way can eliminate trillions of dollars in risk.

The bottom line

As our CEO Thomas Sponholtz has said: The home should be the place where you are most financially secure and conservative, so if you’re challenged with a life event or income shock, you can weather the storm and still have a place to call home. Today, your home is more of a roof over your head than an investment strategy.

Yes, there are certainly significant financial benefits to owning a home. But these benefits are only available over the long term and to those who invest wisely in the home to begin with. If you’re the risk-seeking type, you are better off taking risk in your non-home investments.

Brodie Gay is the Vice President of Research at Unison, a San Francisco-based company that is pioneering a smarter, better way to buy and own your home. We are a team of financial and real estate professionals who are committed to helping home buyers get the home they want, and homeowners finance their life needs without adding debt. For additional information, visit www.unison.com or follow us on Facebook, Instagram, LinkedIn, Twitter, and YouTube.