Urban Housing Markets

Prof. Clark

Week #12

Urban Housing Markets

Brief summarySpatial patterns in the housing market

Recall insights of SUM regarding K-Land ratio as you move away from place of employment

Look at some of the characteristics associated with the housing good

Characteristics of the Housing Good

UniquenessFeatures, locational fixity.

There are neighborhood effectsPositive and negative externalities

Long-livedStock of housing generates a flow of services.Housing deteriorates over time without maintenance.

Consumption and investment goodHas been seen as a hedge against inflation

• More later

Characteristics - continued

Housing is typically the largest component of the household budgets

Requires financing.There are tax advantages to owning

housing.Low income typically rent, whereas middle

and upper class typically own.

Market Structure

Monopoly power on supply side of housing market? Monopolistic Competition

Why?

Housing market is segmented. What does this mean?

Housing Market Analysis

Use simple supply and demand analysis of market.

The stock of housing generates a flow of services to the consumer. The stock of housing sells at the asset price,

V. The flow of services sells at the flow price, R. The two prices are related by the user cost of

housing, R=*V

User Cost of Capital Defined

User cost represents costs associated with the holding of housing capital. Think of this as the costs to the owner

of housing. Costs include the sum of mortgage

expenses, maintenance, and property taxes, less any capital gains.

User Cost of Housing Capital

Components of nominal mortgage rate (i=r+ e) which is

deductible at the federal income tax rate (t), property tax rate (p) which is also deductible, maintenance expense rate (m) which increases with age of property, capital gains (g=gr+ e)

[(r+ e)(1-t)+p*(1-t) + m - (gr+e)] Simplifying:

[(r+p)(1-t)+ m - gr -e*t)

Factors that influence

[(r+p)(1-t)+ m - gr -e*t)Thus,

higher is r, p, or m, the higher is . higher is gr, and e, the lower is .

Housing is often seen as a hedge against inflation (i.e., the user cost of housing falls with increases in e).

For rental housing, the maintenance expenses are also tax deductible:

renter[(r+p)(1-t)+ m(1-t) - gr -e*t]

User Cost for Owners & Rentersowner[(r+p)(1-t)+ m - gr -e*t]

renter[(r+p)(1-t)+ m(1-t) - gr -e*t]

There are several reasons why we would not expect the same user cost of capital for rental vs. owner occupied housing

m higher for rental units ( renterrental property riskier, thus higher r ( renterm is tax deductible for owners of rental

property ( rente

Another issue:There is tax advantage to ownership in that

the imputed rent from home ownership is not taxed.

Which is higher? owner or renter?

• Use estimates of parameters.• If t=0.28, mo=0.02, mr=0.03, ro=0.05, rr=0.06,

e=0.03, p=0.02 and gr=0.01

owner[(ro+p)(1-t)+ mo - gr -e*t]owner

owner

renter[(rr+p)(1-t)+ mr (1-t) - gr -e*t]

renter

renter

If V=$100,000, we can derive Rowner and Rrenter

Rowner=0.052*100000 =$5200 per year

Rrenter=0.0608*100000 =$6080 per year

Thus, on same valued property, renters pay about 17% more per year.

Distinguishing Features of Renters and Owners

Low income typically rent. Why? Down payment constraints. Value of t typically lower for low income

householdsHigh mobility households rent due to

the high transactions costs associated with buying. College students are highly mobile and

have low income. Almost universally rent.

Housing Demand

Which price (V or R) is correct?QD=f(R, Ipermanent, demographic char’s)Problem with Q?

Given multidimensional nature of Q, what is a “unit” of housing?

Must somehow standardize. Techniques:Isolate a class of housingUse hedonic housing price technique to create

constant quality unit of housing (more later).

Empirical Findings on Demand

There are numerous housing demand studies. General findings indicate: Demand is slightly price inelastic to slightly

elastic (usually 0.7 - 1.2)Primary determinant of price elasticity?What does SUM suggest income effect would be?

Housing is income inelastic (approx. 0.75)Income elasticity is lower for renters than owner

occupants.Income elasticity increases with income.

• 0.1-0.6 for low income, 0.7-1.1 for high income

The Hedonic Approach

Hedonic approach views housing as a bundle of attributes. As noted earlier, technique can be used to derive

measures of constant quality housing. Derive hedonic price function.

P=f(Structural Chars, Neighborhood Chars, Fiscal)

Derive implicit prices for characteristics as =P/Attribute. Derive value of constant quality housing as the

sum of vector (*attribute).

Demand for Attributes

Can actually derive demand functions for attributes using hedonic approach.

Overview: Estimate implicit prices (=P/Attribute)

Fresno data can be used to derive these

In second stage, run the following regression model: Attribute=f(,Income,Demographic)

Note, there is an interesting identification problem.

Overview of findings:

Demand for Attributes: Findings(Follain and Jimenez, 1985)

Demand for living space is income inelastic (elasticity is about 0.5).

Demand for structural quality is income elastic (ie., over 1.6)

Demand for neighborhood amenities is income elastic.

Also, Muth finds demand for standard (as opposed to substandard) housing is income elastic.

Supply side of housing market

Little evidence of monopoly power.Sources of supply include new and

used housing.Housing deteriorates w/o maintenance,

and thus quality adjustments may lead to a housing unit passing from one income class to another. Older housing deteriorates faster.

Housing Supply Function

Qs=f(V, Pinput,technology,expectations,govt)Determinents:

Price is the asset price of housing. Higher input prices reduce supply. Technological advancements increase supply. Expectations concerning future prices influence

supply. (e.g., rent control can dampen supply)

Government regulation influences supply e.g., zoning, min. square footage requirements, etc.

Empirical Supply Functions(Price elasticity<1.0)

Reasons: New housing is a small fraction of the

overall stock of housing.Thus, it cannot lead to large quantity

adjustments (for overall market) when price changes.

Deterioration of used buildings into the next lower quality classification.Deterioration is slow.

Remodeling to upgrade quality.Expensive.

Housing Market Equilibrium

R-Q space: (Map Supply curve)

V-Q space:(Map Demand Curve)

S

D

R

Q

S

D

V

Q

Re

Qe

Ve

Qe

What happens when increases?(suppose real interest rates increase)

Rent-Quantity Space

S

D

R

Re

Qe

S’

R’e

Q’eQ

# As user cost increases, the supply curve is mapped to higher values of R for the same value of Q.

# This is because the suppliers command higher rents when their costs increase.

What happens when increases?(suppose real interest rates increase)

As user cost goes up, the demand curve is mapped to lower values of V for each Q.

This is because as rents increase, housing of a given value is less desirable to consumers, and hence demand falls at each Q.

Value-Quantity Space

Q

S

D

V

Ve

D’

V’e

Q’eQe

Role of Demographic Characteristics on Housing Prices

Mankiw and Weil published a paper in late 1980’s suggesting strong impact from baby-boom.

Mankiw and Weil Briefly

Cross-sectional relationship (1970 Census) between quantity of housing demanded (ie., dollar value) and demographic characteristics of household. Specifically looked at age distribution of

population. Findings: Demand rises sharply between age

of 20-30, and then declines after age 40 (by about 1% per year).

What is impact of Baby Boom?

Large cohort moving through population distribution. Findings suggest predictable influence of baby

boom on future values

They simulate impact, assuming housing demand of those in 1970 is stable. Findings suggest housing markets are not

efficient. What might be the problem with their

methodology?

Housing Durability and Filtering

We now know something about the demand & supply sides of housing market.

Furthermore, we know housing is durable. This has several implications

First, as housing deteriorates, costs increase (due to maintenance) and revenues decrease (due to quality).

Second, housing may pass to different income class over time (i.e., filter down)

Examine both phenomena.

Revenue and Cost Adjustments

Suppose an apartment building gets older.

Demand falls as quality declines. Thus TR falls.

Costs go up as maintenance increases. Thus, TC rises.

Quantity falls

TR,TC TRTR’

TC

QQ’

TC’

Eventually, property falls out of this particular submarket.

If this is not the lowest quality housing market, housing will filter to other users.

Filtering

Filtering: A change over time in the position of a

given dwelling unit within the distribution of housing rents and prices in the community as a whole.

As a dwelling ages, it provides less housing services per year, cet. par. Materials deteriorate, and technology

becomes dated.

Look at Filtering Process

Assume all housing rented.Assume constant population.Consider 3 housing quality categories,

and 3 income groups. Housing Quality: High, Medium, Low Income Levels: High, Middle, Low

Assume an initial equilibrium. Maximizing rents requires matching as

follows:

Equilibrium Sorting of Households and Housing

Housing Quality

Income Group

Low

Middle

High

Low Medium High

X

X

X

Assume Income Growth of Highest Income Group

Adjustment in Sorting

Housing Quality

Income Group

Low

Middle

High

Low Medium High Higher

X X

X X

X X

Low quality fallsout of housing stock

Does this lead to permanently higher housing quality for poor?

There is an equilibrium level of maintenance for all income groups.

This will not increase as housing filters down.

Thus, improvement is temporary.Depends on rate of depreciation.If depreciation is slow, it can help.If depreciation is rapid, it cannot.

This is an empirical issue. Next time, we will look at the article by

Weicher.