Chapter 13 Why Is Housing Different?

Why is Housing Different?
• Heterogeneous: dwellings differ in size, age, style, features, location
• Durable: Deterioration rate depends on maintenance and repair
decisions
Chapter 13
• Costly Moving: Adjustment when gap between ideal and actual large
Why Is Housing Different?
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Questions to Address
Questions to Address
• Why do we care about heterogeneity, durability, and moving costs?
Features that make it different.
• Base price. The average house, has three bedrooms, is five miles
from the city center.
• Access price. The price drops for every additional mile from the city
center.
• Size. The price increases for every additional bedroom.
• Air Quality. Price decreases for every additional unit of air pollution.
• Schools. The price increases for every one- unit increase in the test
score of students in the local elementary school.
The classic hedonic study (1970). Used data from the St. Louis
housing market in the 1960 to estimate values of different housing
attributes.
• Is it efficient for low-income households to live in used housing?
• Who benefits from subsidies for new housing?
• How do growth controls affect the housing market?
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Hedonic Pricing Approach
• Each dwelling has a different bundle of characteristics
• Dwelling features: quality, age, size
• Neighborhood effects: quality of other dwellings
• For each component of the housing bundle, there's a price
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Results of Other Hedonic Studies
Housing Quality Ladder
• Positive influence: proximity to jobs, schools, transit stations,
churches
• Normal deterioration moves dwelling down the ladder
• Moderate expense: keep dwelling at same level
• Negative effects: crime, toxic waste, noisy highways
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• Large expense for remodel & renovate to raise level
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Durability, Deterioration and Maintenance
• The total- cost curve is convex, reflecting diminishing returns to
maintenance: As quality increases, it becomes progressively more costly
to maintain the dwelling at the given quality level.
• The total- revenue curve is linear, reflecting the assumption that
consumers, willingness to pay for a dwelling increases linearly with
quality.
• Owner's objective is to maximize profit, equal to the gap between total
revenue and total cost.
• The gap is maximized at a quality level q*.
• The profit-maximizing quality is where the marginal benefit of
quality equals the marginal cost
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Changes in Quality and Retirement
• As a dwelling ages, the cost of maintaining increases shifting the
marginal- cost curve upward.
• If the price hasn't changed, the profit- maximizing quality decreases.
• Eventually, the marginal- cost curve will lie entirely above the
marginal- revenue curve. At that point, the property is retied from
the market.
• Increase in price shifts the marginal- revenue curve upward,
increasing the profit- maximizing quality. In the case, the extra
revenue from a higher quality dwelling exceeds the extra cost of
upgrading
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Retirement Scenarios
Abandonment and Public Policy
Possible scenarios when a dwelling is retired from the market
• Declining income from property and constant property tax
• Boarding up: short-lived reduction in price; low opportunity cost of
funds
• Abandon when Income < Property tax
• Conversion: Profit from alternative > Conversion cost
• New York: Elasticity(abandonment, property tax) = 1.65
• Abandonment: Profit from alternative < Conversion cost
• Externalities from abandoned buildings: Eyesores and crime havens
• A flexible property tax declines with income, prolonging use
• During the 1980s the property tax was the most important factor in
abandonment in New York City.
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Durability and Supply Elasticity
Supply is Relatively Inelastic for Long Periods
•
• Most of the stock (97% - 98%) is used
Increase in price of housing increases quantity supplied
•
Increase the quantity of new dwellings (2-3 percent per year)
• Rate of deterioration relatively slow
•
Increase maintenance on used dwellings
• Upgrading (Remodel & renovate) costly, so large price hike required
•
Remodel and renovate used dwellings
• Estimates of Supply Elasticity
• Ozanne & Struyk: 10-year elasticity for used housing = 0.20 to 0.30
• DeLeeuw & Ekanem: Long-run elasticity for rental housing = 0.30 to
0.70
The supply of used housing is relatively inelastic for two reasons.
1. Rate of deterioration is relatively low,
2. Renovation are relatively expensive.
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Moving Costs and Consumer Disequilibrium
• Large moving cost: move possessions and detach from neighborhood
• Households tolerate mismatch until large enough to justify a move
• Figure 13-4-A: Increase in income causes mismatch
• Figure 13-4-B: Decrease in housing quality causes mismatch
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Filtering and the Housing Stepladder
• Over time, Quality of dwelling decreases
• Response to decrease in quality
• Costly upgrade of old dwelling
• New house with new materials, technology, fashion
• Used house filtered down from higher level
• Filtering: Income level of occupant decreases over time
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Filtering and the Housing Stepladder
Filtering process has two basic features.
• Decrease in quality- because of physical deterioration, technological
obsolescence, and changes in housing fashion.
• Decrease in occupant income- occupied by households with
progressively lower incomes.
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What About the Highest Quality Housing?
• Filtering doesn't always work: Some features don’t filter downward
• Wealthiest households remain in highest quality houses
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Filtering with Rising Income
Effects of Growth Controls [Building Ban]
• Increase in income increases demand for housing quality
• Direct effect on high-income: tolerate mismatch or incur high
upgrade costs
• Larger advantage of filtering process
• No filtering to middle-income household: tolerate mismatch or costly
upgrade
• Remain in old dwelling: costly upgrade (renovate/remodel) to higher
level
• No filtering to low-income household: tolerate mismatch or costly
upgrade
• Move to vacated dwelling: move up quality ladder
• Result: cost of building ban borne by everyone in market
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Step 1: High-Quality Submarket
Price Effects of Growth Controls
• How does ban on new housing (high quality) affect housing prices?
• Market interactions generate higher prices for all types of housing
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Step 2: Supply Effects on Medium-Quality Submarket
Step 3: Demand Effects on Medium-Quality Submarket
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