Interest Rates and Fundamental Fluctuations in Home Values Albert - PowerPoint PPT Presentation

Saiz – Interest Rates and Fundam entals Interest Rates and Fundamental Fluctuations in Home Values Albert Saiz 1

Saiz – Interest Rates and Fundam entals Focus Changes in the user cost of capital driven by lower interest/mortgage rates and financial innovations (risk premium on real estate investments) Without a doubt, these have been the main factor used to explain evolution of housing prices during the boom Saiz: Interest Rates & Fundamentals in Housing 2 2

Saiz – Interest Rates and Fundam entals Real Estate Valuation r Gordon valuation model = − V (Poterba, 1984) i g Cap rate method (income = r comparables) V c Comparables Saiz: Interest Rates & Fundamentals in Housing 3 3

Saiz – Interest Rates and Fundam entals Agenda Combine the urban economics model (Alonso-Muth-Mills) with the asset pricing (Poterba, 1984) approaches Study impact of changes in user cost of capital Examine the roles of: • Replacement costs • Housing/land Supply elasticity • Demand for space • Rent endogeneity • Heterogeneity in rents Parsimony Saiz: Interest Rates & Fundamentals in Housing 4 4

Saiz – Interest Rates and Fundam entals 150 6.00 140 5.00 130 4.00 Price Index REAL Mortgage rate 120 3.00 110 2.00 100 1.00 90 0.00 199901 199903 200001 200003 200101 200103 200201 200203 200301 200303 200401 200403 200501 200503 200601 200603 200701 200703 200801 200803 Saiz: Interest Rates & Fundamentals in Housing 5 5

Saiz – Interest Rates and Fundam entals 150 140 130 Price Index 120 Explainable with CC 110 100 90 199901 199903 200001 200003 200101 200103 200201 200203 200301 200303 200401 200403 200501 200503 200601 200603 200701 200703 200801 200803 Saiz: Interest Rates & Fundamentals in Housing 6 6

Saiz – Interest Rates and Fundam entals 190 170 New England 150 Middle Atlantic Pacific Explainable with CC 130 110 90 199901 199903 200001 200003 200101 200103 200201 200203 200301 200303 200401 200403 200501 200503 200601 200603 200701 200703 200801 200803 Saiz: Interest Rates & Fundamentals in Housing 7 7

Saiz – Interest Rates and Fundam entals Beverly Hills (Zip Code 90210): from Matt Kahn Saiz: Interest Rates & Fundamentals in Housing 8 8

Saiz – Interest Rates and Fundam entals http://mysite.verizon.net/vodkajim/housingbubble Saiz: Interest Rates & Fundamentals in Housing 9 9

Saiz – Interest Rates and Fundam entals http://mysite.verizon.net/vodkajim/housingbubble Saiz: Interest Rates & Fundamentals in Housing 10 10

Saiz – Interest Rates and Fundam entals http://mysite.verizon.net/vodkajim/housingbubble Saiz: Interest Rates & Fundamentals in Housing 11 11

Saiz – Interest Rates and Fundam entals http://mysite.verizon.net/vodkajim/housingbubble Saiz: Interest Rates & Fundamentals in Housing 12 12

Saiz – Interest Rates and Fundam entals Saiz: Interest Rates & Fundamentals in Housing 13 13

Saiz – Interest Rates and Fundam entals 150 140 130 East South Central West South Central 120 West North Central East North Central Explainable with CC 110 100 90 199901 199903 200001 200003 200101 200103 200201 200203 200301 200303 200401 200403 200501 200503 200601 200603 200701 200703 200801 200803 Saiz: Interest Rates & Fundamentals in Housing 14 14

Saiz – Interest Rates and Fundam entals http://mysite.verizon.net/vodkajim/housingbubble Saiz: Interest Rates & Fundamentals in Housing 15 15

Saiz – Interest Rates and Fundam entals http://mysite.verizon.net/vodkajim/housingbubble Saiz: Interest Rates & Fundamentals in Housing 16 16

Saiz – Interest Rates and Fundam entals The Model Most parsimonious AMM that captures main issues 17 Housing Supply and Pricing

Saiz – Interest Rates and Fundam entals Owner-renter assumption In this paper I conceptually and conventionally assume everyone is a renter Arbitrage between buyers: landlords versus owner-occupiers Can think of owners as leasing property to themselves Saiz: Interest Rates & Fundamentals in Housing 18 18

Saiz – Interest Rates and Fundam entals Consumer Utility Saiz: Interest Rates & Fundamentals in Housing 19 19

Saiz – Interest Rates and Fundam entals Rental Price of a Housing Unit Saiz: Interest Rates & Fundamentals in Housing 20 20

Saiz – Interest Rates and Fundam entals The Fundamental Rental Arbitrage Condition Leasing cost of Ricardian markup structure Saiz: Interest Rates & Fundamentals in Housing 21 21

Saiz – Interest Rates and Fundam entals Graphic: rents and prices per square foot Prices Rents /sq.ft. r(d) v*cc Φ Saiz: Interest Rates & Fundamentals in Housing 22 22

Saiz – Interest Rates and Fundam entals Growth Utility at border Utility at exurbs: And posit: 23

Saiz – Interest Rates and Fundam entals Radius and Population: Inelastic Land Supply Λ Saiz: Interest Rates & Fundamentals in Housing 24 24

Saiz – Interest Rates and Fundam entals Radius and Population: Elastic Land Supply Λ Saiz: Interest Rates & Fundamentals in Housing 25 25

Saiz – Interest Rates and Fundam entals Housing Asset Pricing Equation: Theory At any point in time, asset market arbitrage for home-owner (can At any point in time, asset market arbitrage for home-owner (can think of this as natural tendency) think of this as natural tendency) Main arbitrage formula in housing markets (Poterba, 1984) Main arbitrage formula in housing markets (Poterba, 1984) • τ stands for time (e.g. 2015) • τ stands for time (e.g. 2015) • d stands for distance to employment/amenities • d stands for distance to employment/amenities • With being the user cost of the • With being the user cost of the capital invested (frozen) into housing capital invested (frozen) into housing • The formula simply reads: the annual cost to the owner has to • The formula simply reads: the annual cost to the owner has to be equal to the annual benefit (capital appreciation plus rent) be equal to the annual benefit (capital appreciation plus rent) 26

Saiz – Interest Rates and Fundam entals • The previous differential equation can be solved if we have an expected rental-equivalent growth “temporal path” for every period and distance : r( τ ,d) • In fact, the path of rental (use value) growth is quite predictable in most markets • As discussed in economics part of the class, rental growth quite predictable by economic, demographic, and consumption trends • These trends are quite persistent 27

Saiz – Interest Rates and Fundam entals Graphic: rents and prices per square foot Prices Rents /sq.ft. r(2010) r(90) v*cc Φ 90 Φ 2010 Saiz: Interest Rates & Fundamentals in Housing 28 28

Saiz – Interest Rates and Fundam entals Vancouver, Canada 29

Saiz – Interest Rates and Fundam entals Capitalization of Rents An exponential growth rate can be rationalized for 1 ‘representative’ location: Saiz: Interest Rates & Fundamentals in Housing 30 30

Saiz – Interest Rates and Fundam entals Graphic: rents and prices per square foot Prices Rents p(d) /sq.ft. cc r(d) v*cc Φ Saiz: Interest Rates & Fundamentals in Housing 31 31

Saiz – Interest Rates and Fundam entals Changes in User Cost in the AMM Model • In the short to medium run I will assume that population is not mobile. Note that there are four main effects of changes in v : • Decrease in structural user rents • Increase in demand for space and larger homes: land rents increase everywhere • Structure-intensive locations more attractive: land rents decrease in central locations • Discounting effect in price equation: applicable only to land Saiz: Interest Rates & Fundamentals in Housing 32 32

Saiz – Interest Rates and Fundam entals Other Manufactured Durables 33

Saiz – Interest Rates and Fundam entals Other Manufactured Durables Computer Price Index, consumer, monthly (index, 2001=100) Leasing cost with decreasing interest rates? 34

Saiz – Interest Rates and Fundam entals Other Manufactured Durables 35

Saiz – Interest Rates and Fundam entals Consumer Price Index: New Cars Leasing Costs? 36

Saiz – Interest Rates and Fundam entals Manufactured Homes Saiz: Interest Rates & Fundamentals in Housing 37 37

Saiz – Interest Rates and Fundam entals Evolution of Home Prices: Manufactured Single Real Price of Single Manufactured Home 32000 31000 30000 Real Price of Single Manufactured 29000 Home 28000 27000 26000 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Saiz: Interest Rates & Fundamentals in Housing 38 38

Saiz – Interest Rates and Fundam entals Financing/leasing a mobile home Buy a 30,000 mobile structure: Mortgage rate 8%: Annual payment 2,641 Mortgage Rate 6% Annual Payment 2,158 20% percent cheaper (v*cc) Saiz: Interest Rates & Fundamentals in Housing 39 39