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Housing Return And Construction Cycles

  • Matthew Spiegel
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    This paper presents a model of a mature city that depends upon the rehabilitation of old home sites for new housing. Within the model housing returns, housing construction, mortgage loan terms, and household maintenance behavior are all endogenous. The model?s premise is that the value of a home, unlike the value of many other financial assets, depends upon the care its owner exerts on upkeep. Banks respond to this moral hazard problem by restricting the size of the loans they are willing to issue. As a result people bid what the can for housing, rather than what they may wish to. This in turn ties housing prices to changes in the endowment process which are both predictable and time varying. When endowments are growing quickly (a city with a rapidly growing economy) housing prices exhibit above market expected returns. Because banks within the model act rationally, they set mortgage terms based upon their beliefs regarding future housing prices. This leads to the empirically verified prediction that current mortgage loan to value ratios can be used to forecast future housing returns. Developers are also fully cognizant of how housing prices are set and react accordingly. When housing prices are expected to increase faster than the rate of interest developers acquire land for construction. Then once the developers believe housing returns will stop increasing they develop an

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    File URL: http://icfpub.som.yale.edu/publications/2577
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    Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm114.

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    Date of creation: 01 Mar 1999
    Date of revision: 01 Mar 2001
    Handle: RePEc:ysm:somwrk:ysm114
    Contact details of provider: Web page: http://icf.som.yale.edu/

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    1. Deng, Yongheng & Quigley, John M. & Van Order, Robert & Mac, Freddie, 1996. "Mortgage default and low downpayment loans: The costs of public subsidy," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 263-285, June.
    2. 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.
    3. Karl E. Case & Robert J. Shiller, 1988. "The Efficiency of the Market for Single-Family Homes," NBER Working Papers 2506, National Bureau of Economic Research, Inc.
    4. Topel, Robert H & Rosen, Sherwin, 1988. "Housing Investment in the United States," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 718-40, August.
    5. 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.
    6. Francois Ortalo-Magne & Sven Rady, 1998. "Boom In, Bust Out: Young Households and the Housing Price Cycle," Finance 9810004, EconWPA, revised 25 Oct 1998.
    7. 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.
    8. 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.
    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. Owen Lamont & Jeremy C. Stein, 1997. "Leverage and House-Price Dynamics in U.S. Cities," NBER Working Papers 5961, National Bureau of Economic Research, Inc.
    11. 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.
    12. 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.
    13. 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.
    14. Spiegel, M. & Strange, W., 1989. "A Theory Of Predictable Excess Returns In Real Estate," Papers fb-_89-09, Columbia - Graduate School of Business.
    15. 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.
    16. Titman, Sheridan, 1985. "Urban Land Prices under Uncertainty," American Economic Review, American Economic Association, vol. 75(3), pages 505-14, June.
    17. Admati, Anat R & Pfleiderer, Paul, 1994. " Robust Financial Contracting and the Role of Venture Capitalists," Journal of Finance, American Finance Association, vol. 49(2), pages 371-402, June.
    18. Bar-Ilan, Avner & Strange, William C., 1996. "Urban Development with Lags," Journal of Urban Economics, Elsevier, vol. 39(1), pages 87-113, January.
    19. 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.
    20. Coulson, N Edward, 1999. "Housing Inventory and Completion," The Journal of Real Estate Finance and Economics, Springer, vol. 18(1), pages 89-105, January.
    21. 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.
    22. Vassilis Lekkas & John M. Quigley & Robert Order, 1993. "Loan Loss Severity and Optimal Mortgage Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(4), pages 353-371.
    23. 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.
    24. Stuart S. Rosenthal, 1999. "Residential Buildings And The Cost Of Construction: New Evidence On The Efficiency Of The Housing Market," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 288-302, May.
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