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Housing Return and Construction Cycles

  • Spiegel, Matthew
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    This paper presents a model that derives both housing returns and housing construction patterns from events in the real economy. The value of a home, unlike the value of many other financial assets, depends upon the care its owner exerts on upkeep. Within the model banks respond to this moral hazard problem by restricting the size of the loans they are willing to issue. As a result housing prices no longer follow a random walk, but rather are tied to changes in the endowment process which are both predictable and time varying. That is, in some states of nature homeowners expect to earn an above market return on their housing purchase while in others they expect to earn a below market return. Developers in the model are fully cognizant of the housing price process and react accordingly. The result is a construction cycle that seems at odds with conventional wisdom. When endowments are growing quickly (a city with a rapidly growing economy) housing prices exhibit above market expected returns. However, since housing prices are expected to increase faster than the rate of interest, developers delay construction. Thus, during periods of rapid expected economic growth housing construction ceases until one reaches the crest whereupon development booms. In response housing supplies dwindle during economic booms (as homes deteriorate) and then increase when the boom ends.

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    Paper provided by Research Program in Finance, Institute for Business and Economic Research, UC Berkeley in its series Research Program in Finance, Working Paper Series with number qt8647j8gq.

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    Date of creation: 01 Jan 1999
    Date of revision:
    Handle: RePEc:cdl:rpfina:qt8647j8gq
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    1. Capozza, Dennis R & Sick, Gordon A, 1991. "Valuing Long-Term Leases: The Option to Redevelop," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 209-23, June.
    2. Somerville, C Tsuriel, 1999. "Residential Construction Costs and the Supply of New Housing: Endogeneity and Bias in Construction Cost Indexes," The Journal of Real Estate Finance and Economics, Springer, vol. 18(1), pages 43-62, January.
    3. Bar-Ilan, Avner & Strange, William C., 1998. "A model of sequential investment," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 437-463, March.
    4. Capozza Dennis R. & Sick Gordon A., 1994. "The Risk Structure of Land Markets," Journal of Urban Economics, Elsevier, vol. 35(3), pages 297-319, May.
    5. Bar-Ilan, Avner & Strange, William C., 1996. "Urban Development with Lags," Journal of Urban Economics, Elsevier, vol. 39(1), pages 87-113, January.
    6. Case, Karl E & Shiller, Robert J, 1989. "The Efficiency of the Market for Single-Family Homes," American Economic Review, American Economic Association, vol. 79(1), pages 125-37, March.
    7. Jeremy C. Stein, 1993. "Prices and Trading Volume in the Housing Market: A Model with Downpayment Effects," NBER Working Papers 4373, National Bureau of Economic Research, Inc.
    8. Spiegel, M. & Strange, W., 1989. "A Theory Of Predictable Excess Returns In Real Estate," Papers fb-_89-09, Columbia - Graduate School of Business.
    9. Meese Richard & Wallace Nancy, 1994. "Testing the Present Value Relation for Housing Prices: Should I Leave My House in San Francisco?," Journal of Urban Economics, Elsevier, vol. 35(3), pages 245-266, May.
    10. Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December.
    11. Joseph T. Williams, 1997. "Redevelopment of Real Assets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 25(3), pages 387-407.
    12. Titman, Sheridan, 1985. "Urban Land Prices under Uncertainty," American Economic Review, American Economic Association, vol. 75(3), pages 505-14, June.
    13. Ambrose, Brent W. & Pennington-Cross, Anthony & Yezer, Anthony M., 2002. "Credit Rationing in the U.S. Mortgage Market: Evidence from Variation in FHA Market Shares," Journal of Urban Economics, Elsevier, vol. 51(2), pages 272-294, March.
    14. Williams, Joseph T, 1991. "Real Estate Development as an Option," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 191-208, June.
    15. Grenadier, Steven R, 1995. "The Persistence of Real Estate Cycles," The Journal of Real Estate Finance and Economics, Springer, vol. 10(2), pages 95-119, March.
    16. Capozza, Dennis & Li, Yuming, 1994. "The Intensity and Timing of Investment: The Case of Land," American Economic Review, American Economic Association, vol. 84(4), pages 889-904, September.
    17. Williams, Joseph T, 1993. "Agency and Ownership of Housing," The Journal of Real Estate Finance and Economics, Springer, vol. 7(2), pages 83-97, September.
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