Imperfect Substitutability in Real Estate Markets and the Effect of Housing Demand on the Macroeconomy

43 Pages Posted: 5 Oct 2020

See all articles by Scott Davis

Scott Davis

Federal Reserve Banks - Federal Reserve Bank of Dallas

Kevin X. D. Huang

Federal Reserve Bank of Philadelphia; Vanderbilt University - College of Arts and Science - Department of Economics

Ayse Sapci

Utah State University

Date Written: September 1, 2020

Abstract

Changes in housing demand can have a macroeconomic effect through the collateral channel, where the change in residential real estate prices is associated with a change in commercial real estate prices, affecting firm collateral and thus firm investment. We argue that this channel is weaker when residential and commercial real estate are poor substitutes. Using cross-state heterogeneity in the strength of zoning regulations as a proxy for heterogeneity in the substitutability of residential and commercial real estate, we first show with firm level data that the strength of local zoning regulations has a negative effect on the estimated increase in firm investment following an increase in local residential real estate prices. We then construct a DSGE model where land has both residential and commercial uses and estimate it using Bayesian techniques and U.S. macroeconomic data. We find the average elasticity of substitution between commercial and residential real estate in the U.S. to be around 0.35, but in states with strong zoning restrictions it can be as low as 0.16 and in states with weak zoning restrictions it can be as high as 0.66. Simulations of the model show how these differences in zoning restrictions can affect the transmission of a housing demand shock to the macroeconomy.

Keywords: Commercial real estate, residential real estate, housing demand shock, zoning

JEL Classification: R10, R30, E30

Suggested Citation

Davis, Scott and Huang, Kevin X. D. and Sapci, Ayse, Imperfect Substitutability in Real Estate Markets and the Effect of Housing Demand on the Macroeconomy (September 1, 2020). Globalization and Monetary Policy Institute Working Paper No. 401, Available at SSRN: https://ssrn.com/abstract=3704099 or http://dx.doi.org/10.24149/gwp401

Scott Davis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Kevin X. D. Huang

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States

Ayse Sapci

Utah State University ( email )

Logan, UT 84322
United States

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