The Importance of Optimism: How do Housing Experiences impact Housing Choices?

How do we explain the recent boom and bust in house prices? One explanation that has received increasing attention is that households form their expectations based on recently experienced returns, leading to waves of optimism and pessimism in housing that impact housing demand and prices. To investigate this theory, we study whether experienced housing returns impact homeownership decisions, using administrative tax data from Norway. We show that households’ decision to buy rather than rent is strongly impacted by the housing returns that they have experienced during their lifetime. In addition, we find that households who have experienced strong positive returns are more likely to purchase a second home as an investment property, even when controlling for income, wealth, and other demographics. Our findings are broadly consistent with recent empirical work that uses survey data to show that individuals extrapolate from recent experiences when forming expectations about future outcomes in the housing market. In future work, we plan to simulate and estimate a life cycle model of homeownership using this empirical evidence to discipline the model.

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