Way back over 18 months ago, I started following my nose down a path about the housing market. Back then, I hadn't thought seriously about the supply problem that has become the central element in my story. At first, I was just wondering how much of an effect tax benefits had on relative home values. My inclination was that housing tax benefits, in addition to being regressive, were destabilizing. This is because, when credit contraction cuts off demand in the owner-occupier market, there is a gap between the equilibrium price of that market, which enjoys tax benefits, and the landlord market, which enjoys fewer tax benefits.
Housing is such a large expense, that income effects dominate. On a national level, total housing & utilities spending has been about 18% of total personal consumption expenditures for decades. There should be a balance between the cost of building a new home and the after tax value of future imputed rents. If tax benefits push the value of future rents up, households will increase their housing consumption until the cost of building a new home moves up to 18%. Obviously, I'm taking a lot of shortcuts here, but that's a very simplified version of what I think happens over the long term.
So, with tax benefits, demand increases, in terms of imputed rents. And prices rise until they reach the present value of the after tax future rents. Again, simplified, but I think this is the best way to think about it.
So, I think partly what we are seeing at the low end of the market is a drop in demand for housing because demand has shifted from owning to renting. Much of the tax advantages are not captured by households with lower incomes, so at that end of the market, the difference between the owner-occupier price and the landlord price is lower than it would be at the high end of the market. But, I think one way to think about the shape of the housing market is that most of the market used to be dominated by owner-occupiers, so that the prices of single family residences basically reflected the tax benefits.
In 2008, when the owner-occupier market was dead, there was probably some distance prices had to fall in order to induce non-owner occupier support.
But, I am thinking about the zip code level data for the 8 years since then. The support for mortgage credit at the bottom half of the market has basically dried up, while the top end of the market has recovered. This is about as pure of a natural experiment as one could hope to get regarding the effect of tax benefits on home prices. What we have are two markets - the low end where an owner-occupier market has become, on the margin, a landlord market. And the top end, which remains an owner-occupier market.
The Open Access cities and other cities that weren't effected by the housing supply problem and the sharp Closed Access city out-migration provide a pretty clear picture of how that transformation has affected prices. My first stabs at this effect, back in parts 1 and 2, were about 23%, which I backed off on to about 15%.
The difference between the highest quintile of zip codes and the lowest quintile in the Open Access cities (here, Atlanta, Dallas, and Houston) has settled in at about 25%, compared to where they were in 2008. I think landlords are making high returns right now, so maybe this is elevated. On the other hand, it does seem like the bottom quintile zip codes have been moving along with top quintile incomes for several years, in all city types, suggesting that those markets are moving along some equilibrium level.
This seems like a topic that would be fruitful for further research.