Importance of Housing

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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.

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K.O.R.E Enterprises, LLC

• The Definition of Housing
• 9/4/08

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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.

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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.

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Nature of Housing

• Durability lasts a long-time, difficult and
  costly to modify, todays choices set future
  conditions.
• Fixed in place and produces neighborhood effects.
• Limited knowledge by the consumer produces severe
  information failures.

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U.S. Fixed Tangible Wealth
Source Dasso, Shilling and Ring Hartzell et al.
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How Housing Markets Work
Inputs
Production
Demand
Land
P
P
Renters
Developers
Finance
R
R
Homeowners
Builders
I
I
Infrastructure
(Income and
Landlords
C
C
Labor
E
E
Population)
Homeowners
Materials
S
S
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U.S. Population By Age
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U.S. Households By Type
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(No Transcript)
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Homeownership Rates, By Income and Race/Ethnicity
Source 1993 AHS
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Goals of Housing Discussion

• Why is Housing Different?
• What are the Implications?
• Understand Basic Equations in a Housing Market
  Model

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Features that Make Housing Different

• Housing is heterogeneous
• Housing is immobile
• Housing is durable
• Housing is expensive
• Moving costs are relatively high

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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

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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

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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

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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

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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 citys housing market is composed of a number
  of submarkets. The housing market is segmented
  with respect to size, location and quality.

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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

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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.

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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

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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.

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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.

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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

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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
  landlords 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

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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

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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.

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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.

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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.

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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.

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Basic Equation in Housing

• Concept of the Price of Housing
• Housing Demand
• Housing Supply
• Home ownership Choice

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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

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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

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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

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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

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Equation for User Cost

• uc (ie E im M pt d - pi - tax) P

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User Cost Example

• Let i .1
• k .75 (ratio of mortgage to price of house)
  M/(ME)
• d .02
• pi .04
• P 100,000
• tax 0
• UCo (.75.1 .25.1 .02 - .03)100000 9,000

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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)

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Housing Demand for Owners

• Same except we now have
• h f(uc, Y, px , preferences)

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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

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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

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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

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Housing Supply

• Standard Specification
• Profit Maximization
• Max PQ
• subject to C(Q)
• where C C(Q, production function, w, i, pm)

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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

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To Own or Rent?

• What is the cost of owning (UCo)
• What is the cost of renting (rental payments pq)

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Why would they differ?

• Externalities
• Income Tax Preferences for Home ownership

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To Own or Lease a Car?

• Same logic but different parameters