Housing in Big Cities: The Capitalization Premium

This paper establishes a novel city size premium which may be termed the capitalization premium. Real estate investors derive benefits from investing in larger cities, most notably lower housing risk and/or higher expected rent growth. Standard asset valuation implies that, given the level of rents, investors are willing to pay increasingly higher housing prices as city size increases, a capitalization premium. Enabled by fine-grained microgeographic property prices and rents and an estimation strategy combining fixed-effects and instrumental variables, the key contribution of this paper is to identify the relationship between city size and the capitalization rate and to provide an estimate of the magnitude of this capitalization premium. We also spell out key implications of this finding for urban economics and macroeconomics.