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Importance of Housing
Housing, as shelter, is one of the basic needs of human kind. Houses are financial investments.Housing is a significant component of the local, regional and national economy.Housing is a social priority as declared by the U.S. Congress in 1949.Housing is a merit good.
K.O.R.E Enterprises, LLC
The Definition of Housing
9/4/08
Functions of Housing
Protection from elements, wild beasts and human predators.Storehouse for personal possessions.Workplace.Assembling workforce.Privacy.Forced savings/store of wealth.Social status.
Housing: What We Care About
Quality: size, amenities, habitability and livability.Quantity: size of GDP, countercyclical measures, and stabilizing the economy.Cost: efficiency , affordability and appropriate incentives.Transactions and outcomes: fairness, equality and equity.
Nature of Housing
Durability: lasts a long-time, difficult and costly to modify, today’s choices set future conditions.Fixed in place and produces neighborhood effects.Limited knowledge by the consumer produces severe information failures.
U.S. Fixed Tangible Wealth
Equipment17%
Durables12%
Residential56%
Ware/Man4%
Office6%Retail RE
5%
Source: Dasso, Shilling and Ring; Hartzell et al.
LandFinance
InfrastructureLabor
Materials
DevelopersBuilders
LandlordsHomeowners
RentersHomeowners(Income and Population)
Inputs Production Demand
PRICES
PRICES
How Housing Markets Work
U.S. Population By Age
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
1950 1960 1970 1980 1990 2000 2010 2020
65 +45-6435-4425-3418-24Under 17
U.S. Households By Type
0
20,000
40,000
60,000
80,000
100,000
120,000
1940 1950 1960 1970 1980 1990 2000 2010
Non-FamilyFemale HeadMale HeadMarried
40%
45%
50%
55%
60%
65%
70%
Pe
rce
nt
ow
ne
rs
1890 1900
1910 1920
1930 1940
1950 1960
1970 1980
1990
U.S. Homeownership, 1890-1996
Homeownership Rates, By Income and Race/Ethnicity
0%
20%
40%
60%
80%
100%
1 2 3 4 5 6 7 8 9 10
Household Income Decile
Hom
eow
ners
hip
Rat
e
WhiteBlackAmerican IndianAsianHispanic
Source: 1993 AHS
Goals of Housing Discussion
Why is Housing Different? What are the Implications? Understand Basic Equations in a Housing
Market Model
Features that Make Housing Different
Housing is heterogeneous Housing is immobile Housing is durable Housing is expensive Moving costs are relatively high
Heterogeneity and Immobility
Housing is – a bundle of housing services– a set of features or – a list of attributes
The bundle of services is produced from– a combination of two set of characteristics– Dwelling characteristics– Site characteristics
Heterogeneity and Immobility
Dwelling Characteristics:– Size: square footage of living space – Layout: the arrangement of rooms within the dwelling– Kitchen: the quality and efficiency of kitchen
equipments– Utilities and utilities systems: heating, air conditioning,
plumbing and electrical– Interior design: type of flooring, windows, cabinets– Structural integrity: durability of foundation and the
roof
Heterogeneity and Immobility
Site Characteristics– Accessibility: sites differ in access to jobs, shopping,
and entertainment
– Provision of local public services: schools, fire protection and police services
– Environmental quality: sites differ in air quality and noise levels (from cars, trucks, airplanes and factories
– Appearance of the neighborhood: exterior features of neighboring houses and lots, curb appeal
Heterogeneity and Immobility
Implications for the Housing Markets
Housing is priced as a composite good. – The market price of a dwelling is the sum of the prices of the
individual components. The quality of housing or the quantity of housing services
depends– not only on dwelling characteristics, but also on the
characteristics of its neighborhood. Benefits of amenities and costs of disamenities are
capitalized into house prices
Heterogeneity and Immobility
Implications for the Housing Markets
Implicit and Explicit markets:– Households shop for characteristics in the implicit housing
markets where they determine their tradeoffs among the different characteristics, but make their home purchases in explicit markets for housing as a bundle.
Segmented but related markets: – The heterogeneity of the housing stock means that a city’s
housing market is composed of a number of submarkets. The housing market is segmented with respect to size, location and quality.
Durability of Housing
Housing is more durable than most goods– If a dwelling is maintained properly, it can last
100 years or more – The durability of housing has three
implications for the housing market» the landlord can control the rate of physical
deterioration» there is large supply of used housing» the supply of housing is relatively inelastic
Durability of Housing: Implications
Deterioration and Maintenance The landlord can control the rate of physical deterioration
– by spending time and money on repair and maintenance. The question for the landlord is
– how much should be spent on maintenance over time. Whatever amount of maintenance expenditure
– that maximizes the landlord profit should be spent. However, the optimum quality of housing services
changes overtime– as a result of
» changes in variable costs due to the aging of dwelling » and also a decrease in demand for housing in the area.
Durability of Housing: Implications
Durability and Supply Elasticity– There is large supply of used housing on the market
every year– The supply of housing is relatively inelastic.
» The market is dominated by the stock of used housing, so changes in price cause relatively small changes in the quality supplied.
– There are three types of supply responses to an increase in price:
» building new dwellings, slow deterioration of used buildings, and remodeling used dwellings
Durability of Housing: Implications
The Filtering Model of the Housing Market The filtering model captures some of the essential features
of the market for used housing. It describes the interactions between different housing
submarkets and the process through which dwelling passes from one use to another.
The filtering process has two basic features:– Decrease in housing services. The quality of housing services
produced by particular dwelling decreases overtime. » The decrease in quality results from physical deterioration,
technological obsolescence, and changes in housing fashion.– Decreases in occupant income: the dwelling is occupied by
households with progressively lower incomes.
The High Cost of Housing
When a household buys a home, it typically spends between two and four times its annual income on the house.
The large cost of housing has four implications for the housing market.– First, given the large investment required for homeownership, a
large fraction of households rent instead of owning. In the United States, about one-third of households are renters.
– Second, most middle-income households use homeownership to accumulate wealth. In other words, a large fraction of the savings of middle-income households is tied up in dwellings.
The High Cost of Housing
When a household buys a home, it typically spends between two and four times its annual income on the house
The large cost of housing has four implications for the housing market– Third, most households need a loan to be able to
purchase their homes, hence the existence of the elaborate mortgage finance infrastructure supporting the housing market
– Fourth, the government assists the housing markets with a substantial and wide range of subsidies especially through the tax code
The High Cost of Housing
Taxes and Housing The federal government provides a number of tax
breaks for both rental and owner-occupied property. – The tax breaks for rental property decrease the
landlord’s costs, and these savings are passed on to consumers in the form of lower rent.
– The tax break for homeowners are more explicit: Homeowners deduct interest costs from their gross income, so they pay lower taxes
Large Moving Cost
Housing consumption changes sometimes require a move to a different dwelling
Moving cost is substantial: – in addition to the large cost of moving furniture,
clothes, and kitchen equipment, – there is also a large personal cost associated with
leaving behind the old neighborhood» with its people, schools, and stores.
In other words, a move to a new neighborhood disrupts social and consumption patterns
Large Moving Cost: Implications
Housing costs:– a household changes its housing consumption only if benefits of
moving exceeds the cost of moving. Small changes in income or price are unlikely to change
housing consumption. – Most households tolerate some dissatisfaction with their housing
circumstances because moving is costly. A household moves to a different dwelling only if the
change in income and price is large relative to moving cost.
When a household changes houses, it is likely to make a large change in its housing consumption.
Large Moving Cost: Implications
Economic Elasticities– Because of large cost of moving, households
base their consumption choices on permanent, or long run, income.
– Given the cost of moving, the household makes a long-term commitment to living in a particular dwelling.
Large Moving Cost: Implications
Income Elasticity of Demand for Housing There is a consensus on three points regarding income
elasticity of demand for housing (1) the overall income elasticity is about .75:
– a 10 percent increase in income increases housing consumption by about 7.5 percent.
(2)the income elasticity of renters is less than the income elasticity for owner-occupants.
(3) the income elasticity increases with income, – the elasticity for low-income households is between 0.14 and 0.62
and for high-income households is between .72 and 1.10.
Large Moving Cost: Implications
Price Elasticity of Demand for Housing What is the price elasticity of demand for housing?
– Most estimates of the price elasticity fall between -0.75 and -1.2. The consensus is that demand is slightly price-inelastic
– (elasticity slightly less than 1.0 in absolute value). This means that an increase in price decreases the quality
demanded by slightly smaller percentage amount, so total expenditures (price times quality) increase by a small amount.
Basic Equation in Housing
Concept of the Price of Housing Housing Demand Housing Supply Home ownership Choice
What is the price of rental housing?
Rental price (pr): cost per period for a constant quality of housing
Rent = pr h h is the quantity of rental housing services
per period
What is the price of owner-occupied housing?
User cost: analog to rental price Value = P H H is the quantity of the housing owned at
one point in time
User Cost: Definition
The cost of using one unit of capital for one period.
Equals the sum of the opportunity cost of capital invested in housing, mortgage payments, depreciation in the housing unit less tax benefits and appreciation
Components of User Cost
cost of equity = ie E cost of mortgage debt = im M property taxes = pt P depreciation = d P expected appreciation = pi P tax benefits = tax P
Equation for User Cost
uc = (ie E + im M + pt + d - pi - tax) P
User Cost: Example
Let i = .1 k = .75 (ratio of mortgage to price of house) =
M/(M+E) d = .02 pi = .04 P = 100,000 tax = 0 UCo = (.75*.1 + .25*.1 + .02 - .03)100000 = $9,000
Housing Demand for Renters
Standard Utility Maximization Problem Max U(x,h) subject to: pr h +p x x = Y
Result: h = f(pr, Y, px , preferences)
Housing Demand for Owners
Same except we now have h = f(uc, Y, px , preferences)
Empirical Specification
h = a0 + a1 pr + a2 px + a3 Y + a4 Z
pr = rental price for renters and UCo for owners
usually in natural logarithms ln q = ln alpha + ln y - ln ph
Measuring Ph
Problem: how do we measure the price of a standard housing unit
Method #1: Repeat Sales Measure change in same housing unit over
time to determine change in P Method #2: Hedonic Index Estimate causes of variation in Value among
housing units in one market
Measuring Income (Y)
Problem: Housing is a decision that lasts for many years; therefore, current income is not the sole or even primary determinant
Permanent or average income is key Method #1: Proxy: average consumption Method #2: Predicted Income ln y = b0 + b1 Education + b2 Age + b3
occupation, etc
Housing Supply
Standard Specification Profit Maximization Max PQ subject to: C(Q) where C = C(Q, production function, w, i,
pm)
Empirical Specification
Q = c0 + c1P + c2 w + c3 i + c4 pm Q is the value of the entire stock
– number of units– average value per unit
To Own or Rent?
What is the cost of owning (UCo) What is the cost of renting (rental payments
= pq)
Why would they differ?
– Externalities– Income Tax Preferences for Home ownership
To Own or Lease a Car?
Same logic but different parameters
