Returns on Real Estate Investment in the Case-Shiller Composite Cities

Abstract

In this paper we estimate the housing services dividend in eight major U.S. cities using data from the U.S. Census. We then construct quarterly time series of housing investment total returns using the Case-Shiller house price index and Bureau of Labor Statistics rent index data. Using the resulting total return data we estimate the optimal allocation of household wealth to the housing asset. We find that in each city two equilibrium portfolios obtain, one for renters and one for homeowners. Moreover, we find that the allocation results are critically dependent upon the inclusion of dividends in the analysis. If we optimize using only capital gains on housing investment, optimal investment in the housing asset goes to zero in all but two cities.