Consumption and investment values in housing price: a real options approach
Abstract
Homeowners can be viewed as the put option holders who can sell housing to lenders when the housing price is lower than its mortgage value and sell houses when the housing price rises above a certain threshold. On the basis of the theory of investment under uncertainty, we model the housing value from the perspective of houseowners who can choose to either live in their houses or switch houses for comfort improvement and price appreciation. We can decompose the housing value into consumption and investment values by exploring parameters affecting housing value and decision making of houseowners. We find that the proportion of investment value to housing value increases with the volatility of the housing market, indicating the possible formation of housing bubbles. In addition, the comfort and utility provided by housing are critical for homeowners to decide whether to sell their houses. The analysis provides policymakers and market participants in the real estate market with insights into the price formation of real estate.
Keyword : consumption value, housing value, investment value, real options, utility rental benefit
How to Cite
Hung, C.-H., & Tzang, S.-W. (2021). Consumption and investment values in housing price: a real options approach. International Journal of Strategic Property Management, 25(4), 278–290. https://doi.org/10.3846/ijspm.2021.14914
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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https://doi.org/10.1016/j.red.2009.09.005
Merton, R. C. (1973a). On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 29(2), 449–470. https://doi.org/10.2307/2978814
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Piazzesi, M., Schneider, M., & Tuzel, S. (2007). Housing, consumption and asset pricing. Journal of Financial Economics, 83(3), 531–569. https://doi.org/10.1016/j.jfineco.2006.01.006
Qian, W. (2013). Why do sellers hold out in the housing market? An option-based explanation. Real Estate Economics, 41(2), 384–417. https://doi.org/10.1111/j.1540-6229.2012.00345.x
Rosen, H. (1979). Housing decisions and the U.S. income tax: an econometric analysis. Journal of Public Economics, 11(1), 1–23. https://doi.org/10.1016/0047-2727(79)90042-2
Sarkar, S., & Zapatero, F. (2003). The trade-off theory with mean reverting earnings. The Economic Journal, 113(490), 834–860. https://doi.org/10.1111/1468-0297.t01-1-00156
Teng, H.-J., Chang, C.-O., & Chen, M.-C. (2017). Housing bubble contagion from city centre to suburbs. Urban Studies, 54(6), 1463–1481. https://doi.org/10.1177%2F0042098016631297
Titman, S. (1985). Urban land prices under uncertainty. The American Economic Review, 75(3), 505–514.
https://www.jstor.org/stable/1814815
Wang, H., Yu, F., & Zhou, Y. (2020). Property investment and rental rates under housing price uncertainty: a real options approach. Real Estate Economics, 48(2), 633–665.
https://doi.org/10.1111/1540-6229.12235
Yao, R., & Zhang, H. H. (2005). Optimal consumption and portfolio choices with risky housing and borrowing constraints. The Review of Financial Studies, 18(1), 197–239.
https://doi.org/10.1093/rfs/hhh007
https://doi.org/10.1007/s11146-007-9092-0
Arrondel, L., & Lefebvre, B. (2001). Consumption and investment motives in housing wealth accumulation: a French study. Journal of Urban Economics, 50(1), 112–137.
https://doi.org/10.1006/juec.2000.2209
Black, F., & Cox, J. (1976). Valuing corporate securities: some effects of bond indenture provisions. Journal of Finance, 31(2), 351–367. https://doi.org/10.2307/2326607
Bloom, N. (2009). The impact of uncertainty shocks. Econometrica, 77(3), 623–685. https://doi.org/10.3982/ECTA6248
Brueckner, J. (1997). Consumption and investment motives and the portfolio choices of homeowners. The Journal of Real Estate Finance and Economics, 15(2), 159–180.
https://doi.org/10.1023/A:1007777532293
Campbell, J. Y., & Cocco, J. F. (2015). A model of mortgage default. Journal of Finance, 70(4), 1495–1554.
https://doi.org/10.1111/jofi.12252
Chen, M. C., Chang, C. O., Yang, C. Y., & Hsieh, B. M. (2012). Investment demand and housing prices in an emerging economy. Journal of Real Estate Research, 34(3), 345–373. https://doi.org/10.1080/10835547.2012.12091339
Chen, Y., Connolly, M., Tang, W., & Su, T. (2009). The value of mortgage prepayment and default options. Journal of Futures Markets, 29(9), 840–861. https://doi.org/10.1002/fut.20388
Childs, P. D., Ott, S. H., & Triantis, A. J. (1998). Capital budgeting for interrelated projects: a real options approach. Journal of Financial and Quantitative Analysis, 33(3), 305–334. https://doi.org/10.2307/2331098
Dixit, A. K., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton University Press. https://doi.org/10.1515/9781400830176
Gallin, J. (2006). The long-run relationship between house prices and income: evidence from local housing markets. Real Estate Economics, 34 (3), 417–438.
https://doi.org/10.1111/j.1540-6229.2006.00172.x
Gallin, J. (2008). The long-run relationship between house prices and rents. Real Estate Economics, 36(4), 635–658. https://doi.org/10.1111/j.1540-6229.2008.00225.x
Geltner, D., Miller, N., Clayton, J., & Eichholtz, P. (2014). Commercial real estate analysis and investments (3rd ed.). Mbition.
Goodman, A. C. (1988). An econometric model of housing price, permanent income, tenure choice and housing demand. Journal of Urban Economics, 23(3), 327–353.
https://doi.org/10.1016/0094-1190(88)90022-8
Henderson, J. V., & Ioannides, Y. M. (1983). A model of housing tenure choice. The American Economic Review, 73(1), 98–113. https://www.jstor.org/stable/1803929
Hung, C. H. (2012). Applying the concept of real options to the pricing of houses and rent in Taipei. Journal of Housing Studies, 21, 47–70. https://www.hyread.com.tw/hyreadnew/search_detail_new.jsp?sysid=00242037
Ioannides, Y. M., & Rosenthal, S. S. (1994). Estimating the consumption and investment demands for housing and their effect on housing tenure status. The Review of Economics and Statistics, 76(1), 127–141. https://doi.org/10.2307/2109831
King, M. A. (1980). An econometric model of tenure choice and demand for housing as a joint decision. Journal of Public Economics, 14(2), 137–159. https://doi.org/10.1016/0047-2727(80)90038-9
Kishor, N. K., & Morley, J. (2015). What factors drive the pricerent ratio for the housing market? A modified present-value analysis. Journal of Economic Dynamics & Control, 58, 235–249. https://doi.org/10.1016/j.jedc.2015.06.006
Lambrecht, B. M., & Myers, S. C. (2008). Debt and managerial rents in a real-options model of the firm. Journal of Financial Economics, 89(2), 209–231. https://doi.org/10.1016/j.jfineco.2007.07.007
Leland, H. (1994). Corporate debt value, bond covenants, and optimal capital structure. Journal of Finance, 49(4), 1213–1252. https://doi.org/10.2307/2329184
Lin, C. C., & Lin, S. J. (1994). An estimation of price elasticity and income elasticity of housing demand in Taiwan. Journal of Housing Studies, 2, 25–48. https://www.hyread.com.tw/hyreadnew/search_detail_new.jsp?sysid=00036292
Lustig, H. N., & Van Nieuwerburgh, S. G. (2005). Housing collateral, consumption insurance and risk premia: an empirical perspective. Journal of Finance, 60(3), 1167–1219. https://doi.org/10.1111/j.1540-6261.2005.00759.x
Lustig, H. N., & Van Nieuwerburgh, S. G. (2006). Can housing collateral explain long-run swings in asset returns? (Working paper). National Bureau of Economic Research.
http://www.nber.org/papers/w12766
Lustig, H. N., & Van Nieuwerburgh, S. G. (2010). How much does household collateral constrain regional risk sharing? Review of Economic Dynamics, 13(2), 265–294.
https://doi.org/10.1016/j.red.2009.09.005
Merton, R. C. (1973a). On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 29(2), 449–470. https://doi.org/10.2307/2978814
Merton, R. C. (1973b). Theory of rational option pricing. The Bell Journal of Economics and Management Science, 4(1),
141–183. https://doi.org/10.2307/3003143
Piazzesi, M., Schneider, M., & Tuzel, S. (2007). Housing, consumption and asset pricing. Journal of Financial Economics, 83(3), 531–569. https://doi.org/10.1016/j.jfineco.2006.01.006
Qian, W. (2013). Why do sellers hold out in the housing market? An option-based explanation. Real Estate Economics, 41(2), 384–417. https://doi.org/10.1111/j.1540-6229.2012.00345.x
Rosen, H. (1979). Housing decisions and the U.S. income tax: an econometric analysis. Journal of Public Economics, 11(1), 1–23. https://doi.org/10.1016/0047-2727(79)90042-2
Sarkar, S., & Zapatero, F. (2003). The trade-off theory with mean reverting earnings. The Economic Journal, 113(490), 834–860. https://doi.org/10.1111/1468-0297.t01-1-00156
Teng, H.-J., Chang, C.-O., & Chen, M.-C. (2017). Housing bubble contagion from city centre to suburbs. Urban Studies, 54(6), 1463–1481. https://doi.org/10.1177%2F0042098016631297
Titman, S. (1985). Urban land prices under uncertainty. The American Economic Review, 75(3), 505–514.
https://www.jstor.org/stable/1814815
Wang, H., Yu, F., & Zhou, Y. (2020). Property investment and rental rates under housing price uncertainty: a real options approach. Real Estate Economics, 48(2), 633–665.
https://doi.org/10.1111/1540-6229.12235
Yao, R., & Zhang, H. H. (2005). Optimal consumption and portfolio choices with risky housing and borrowing constraints. The Review of Financial Studies, 18(1), 197–239.
https://doi.org/10.1093/rfs/hhh007