Journal of Real Estate Finance and Economics, 19:1, 69±83 (1999)
# 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Housing, Illiquidity, and Wealth
Department of Finance and Real Estate, American University, Washington, DC
This article develops a model of asset allocation relevant for the representative consumer. Consumption is
composed of two items: housing, and other goods and services. The representative household's balance sheet
consists largely of a house and a mortgage. Its income statement is dominated by labor earnings, constraining cash
expenditures. Housing-market behavior thus underlies intertemporal wealth and consumption allocation. With a
housing-dominated portfolio and a maximizing plan, a plausible bound on the intertemporal marginal rate of
substitution in consumption can be estimated for a typical household. The model takes account of idiosyncratic
characteristics of housing returns and ®nance. Underwriting standards oblige borrowers to secure mortgage debt
with a housing asset and with cash ¯ow, usually from labor income. Access to the mortgage market depends on
the loan-to-value ratio, or leverage and debt size, and the debt-coverage ratio, or cash solvency. If there are
seasonals or predictable patterns in house returns, their magnitude is ampli®ed for the typical liquidity-
constrained household. Empirical results for the aggregate U.S. market con®rm predictability and serial
correlation in house capital gains. There are seasonals in housing returns. While there is no January effect, above-
average returns are obtained during the summer months.
Key Words: ®nancial illiguidity, predictability in returns
You see that homeless man on the street. He is really $900 million richer than I am,
because my net wealth is really À $900 million
The representative household holds almost none of the ®nancial assets that underlie
portfolio theories. Instead, the typical household is liquidity-constrained, with its assets
tied up in the housing market. Financial securities ownership, including mutual funds and
assets inside pension and life insurance accounts, is limited to one-third of households,
while the bottom one-third of households has no or negative wealth.
wealth exclusive of pensions and life insurance is less than $1,000, and the representative
household is suf®ciently liquidity-constrained that consumption is adjusted to be equal to
cash income (Deaton, 1991). The value of house equity exceeds $4 trillion, or $36,000 per
household including tenants, more than half of all household wealth.
portfolios being concentrated in housing, homeowners own 95% of ®nancial assets, with
tenants having virtually no wealth, physical, or ®nancial.
Consequently, theories of
intertemporal consumption and allocation must take account of two empirical