Importance of Housing

					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
Functions of Housing
Protection   from elements, wild beasts and human
Storehouse for personal possessions.
Assembling workforce.
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
Transactions and outcomes: fairness, equality and
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
                                                Ware/Man     Office
                                                  4%          6%
                                                             Retail RE

                         Residential                            17%


Source: Dasso, Shilling and Ring; Hartzell et al.
            How Housing Markets Work

   Inputs            Production         Demand

    Land         P                 P      Renters
                 R    Developers   R
   Finance                             Homeowners
                 I     Builders    I
Infrastructure   C                 C   (Income and
    Labor        E                 E    Population)
                 S   Homeowners    S
U.S. Population By Age
  250,000                                             65 +
  200,000                                             35-44
  150,000                                             25-34
                                                      Under 17
            1950 1960 1970 1980 1990 2000 2010 2020
U.S. Households By Type


   80,000                                             Non-Family
                                                      Female Head
                                                      Male Head
   40,000                                             Married


            1940 1950 1960 1970 1980 1990 2000 2010
                         U.S. Homeownership, 1890-1996

P ercent ow ners





                      1890          1910          1930          1950          1970          1990
                             1900          1920          1940          1960          1980
Homeownership Rates, By
Income and Race/Ethnicity
       Homeownership Rate

                            60%                                               Black
                                                                              American Indian
                            40%                                               Asian

                                   1   2    3   4   5   6   7   8    9   10
                                           Household Income Decile

 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
      – Utilities and utilities systems: heating, air conditioning,
        plumbing and electrical
      – Interior design: type of flooring, windows, cabinets
      – Structural integrity: durability of foundation and the
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
      – 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
        » 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
       – 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
      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
       – 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:
     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
     When a household changes houses, it is likely to make a
      large change in its housing consumption.
Large Moving Cost:
   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:
     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:
     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
Basic Equation in Housing
   Concept of the Price of Housing
   Housing Demand
   Housing Supply
   Home ownership Choice
What is the price of rental
    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
   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
   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,
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