Urban Decline and Housing Reinvestment: The Role of Construction Costs and the Supply Side

Federal Reserve Bank of Philadelphia Working Paper No. 03-9

56 Pages Posted: 29 Jul 2004

See all articles by Joseph Gyourko

Joseph Gyourko

University of Pennsylvania - Real Estate Department; National Bureau of Economic Research (NBER)

Albert Saiz

MIT Department of Urban Studies and Planning; IZA Institute of Labor Economics

Date Written: May 2003

Abstract

Negative demand shocks have afflicted many American cities in the 20th century and are the main explanation for their decaying housing markets. But what is the role of housing supply? Rational entrepreneurs should not invest in new buildings and renovation when home values are below replacement cost. Households with an investment motive should behave similarly. Empirically, the authors find that construction costs are not very sensitive to building activity but do vary with local income, unionization rates in the construction sector, the level of local regulation, and region. They also document that the variance in building costs generates substantial variance in renovation expenditures across cities. Owner-occupied homes with market values below replacement costs spend about 50 percent less on renovation than similar homes with market values above construction costs. The authors also report on the distribution of the ratio of house value-to-construction cost across markets. The distribution is relatively flat in a number of declining cities, especially older manufacturing areas. In these places, a relatively modest 10 percent decline in replacement costs would find between 7-15 percent of the local housing stock moving from being valued below cost to above cost. Even though modest declines in construction costs are unlikely to change basic urban trends, the authors' results suggest they can be an important factor in determining whether various neighborhoods in declining cities will experience any significant reinvestment. In this respect, declining cities truly cannot afford to be expensive cities in terms of replacement costs: urban scholars and policy makers should begin to pay more attention to the cost side of cities.

Keywords: Construction costs, city decline, renovation, unions

JEL Classification: R12, R31

Suggested Citation

Gyourko, Joseph E. and Saiz, Albert, Urban Decline and Housing Reinvestment: The Role of Construction Costs and the Supply Side (May 2003). Federal Reserve Bank of Philadelphia Working Paper No. 03-9. Available at SSRN: https://ssrn.com/abstract=570323 or http://dx.doi.org/10.2139/ssrn.570323

Joseph E. Gyourko (Contact Author)

University of Pennsylvania - Real Estate Department ( email )

Philadelphia, PA 19104-6330
United States
215-898-3003 (Phone)
215-573-2220 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Albert Saiz

MIT Department of Urban Studies and Planning ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States
617-252-1687 (Phone)
617-258-6991 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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