House Prices, Development Costs, and the Value of Waiting
36 Pages Posted: 2 Mar 2009 Last revised: 18 Feb 2010
Date Written: February 17, 2010
This paper demonstrates that new house prices can exceed direct development costs by considerable margins in competitive housing markets with finite price-elasticities of demand and no restrictive land-use regulation. The premium reflects the value of the option to delay developing the marginal piece of undeveloped land. Competition amongst landowners reduces the option value relative to the standard open-city framework, but - as long as undeveloped land is heterogeneous - does not reduce it to zero. Calibrating a special case of the model to U.S. data suggests that the premium is economically significant. In addition to proving that prices can exceed costs without regulation, this paper shows that the relationship between volatility and the rate of investment is more complicated than previously thought.
Keywords: urban development, house prices, competition, real options
JEL Classification: R21, R31, G12, G13, G31, D51
Suggested Citation: Suggested Citation