Homeownership might be the American Dream, but a new report is raising a warning that new homebuyers might be putting themselves at exposure to financial risk by expecting too much return on equity from their residences.
According to the newly released Unison Home Volatility Index, the long run average annualized volatility of home price appreciation has been approximately 15 percent per year since 2000, which is only one percentage point higher than equity stock indices. The report noted that home volatility spiked to more than 35 percent per year during the midst of the 2008 economic meltdown, which would affirm that the financial risk of residential real estate, not unlike equities and fixed-income securities, is amplified during a financial crisis.
“Diversification is the core principle of modern portfolio theory,” said Brodie Gay, vice president of research at San Francisco-based Unison. “We spend a lot of time and diligence on portfolio allocations spanning equities, fixed income securities, and alternative investments, but for a typical household, home equity is typically 60 percent of the total financial portfolio. We believe homes have been left out of financial planning–even though for American homeowners the house is the bulk of their net worth–because we didn't have a good way to measure risk for this asset.”
The Unison report added that new homebuyers are particularly vulnerable because they often cash out their entire liquid portfolios to make a down payment. As a result, a new homebuyer who borrows five to 20 times their net worth runs the risk of losing their entire net worth and becoming insolvent if the economy tanks.
Unison CEO Thomas Sponholtz warned that the “proliferation of very low downpayment, high-leverage mortgages has led to home price risk exposures that are far beyond levels that a homebuyer should be comfortable with. The home is more than a financial asset; it's where you live with your family, and should not be where you take this level of excessive risk.”