This paper was submitted as my undergraduate thesis.
Abstract
Most rental housing is supplied by amateur households, rather than professionally run businesses, yet little is known about what motivates individuals to invest in this sector. I examine the hypothesis that households invest in this asset class because mortgages allow for high leverage that is not subject to margin calls. To do this, I model portfolio allocation between rental properties and stocks for investors with future expected labor income, and allow for both mortgage and stock-margin leverage. My analysis demonstrates that rental properties partially crowd out stock ownership for young investors, who are attracted to the high leverage available with mortgages. The model results show that initial wealth has a non-monotonic effect on the amount of rental housing purchased, because rental-property ownership is most attractive at medium values of wealth, which are high enough to afford the smallest possible property without taking on too much risk and low enough that future income makes leverage highly desirable. In addition, I analyze how the results change depending on the availability of leveraged stock investment, the rental yield of the property, and the riskiness of labor income.