Endogenous Gentrification and Housing Price Dynamics

In this paper, we explore dierential changes in house prices across neighborhoods within a city to better understand the nature of house price dynamics across cities. First, we document in detail that there is substantial and systematic heterogeneity in house price dynamics within a city during city wide housing price booms and busts. Second, we propose a new model of within city house price dynamics that is consistent with the empirical facts. We assume that there is a positive neighborhood externality: people like to live close to richer neighbors. We show that there is an equilibrium where households fully segregate based on their income. In response to housing demand shocks, the model predicts that the poor neighborhoods on the boundary with the rich ones are the most price elastic. For example, when richer households enter a city, the rich neighborhoods will expand outward turning previous poor neighborhoods into richer neighborhoods. As the amenities in such neighborhoods increase, land prices in the neighborhood will increase accordingly. We refer to this process as gentrication. We then empirically test this new mechanism against other mechanisms that could explain within city house price dierences. We nd strong support for the existence of endogenous gentrication in explaining housing price dynamics within a city. Finally, we show that even after controlling for other important determinants of land prices, the endogenous gentrication mechanism is still important in explaining cross city dierences in house price dynamics.