House Prices, Development Costs, and the Value of Waiting

36 Pages Posted: 2 Mar 2009 Last revised: 18 Feb 2010

See all articles by Graeme Guthrie

Graeme Guthrie

Victoria University of Wellington - School of Economics & Finance

Date Written: February 17, 2010

Abstract

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

Guthrie, Graeme, House Prices, Development Costs, and the Value of Waiting (February 17, 2010). Available at SSRN: https://ssrn.com/abstract=1351143 or http://dx.doi.org/10.2139/ssrn.1351143

Graeme Guthrie (Contact Author)

Victoria University of Wellington - School of Economics & Finance ( email )

P.O. Box 600
Wellington 6140
New Zealand
64 4 463 5763 (Phone)

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