Residential Construction Costs and the Supply of New Housing: Endogenity and Bias in Construction Cost Indexes
Journal Of Real Estate Finance And Economics, 1998
Posted: 10 Jun 1998
Changes in the level of residential construction affects macro economic conditions and is an important determinant of movements in house prices. theory teaches us that increases in the cost of construction should reduce the supply of new housing. Yet, empirical research has failed to find a consistent relationship between these costs and housing starts. This paper introduces an entirely new set of micro- data on housing construction costs to study this issue. We develop quality-controlled, hedonic construction cost series from these data. Using this series, we estimate housing supply and construction cost functions for new single family residences. This research demonstrates that bias in the commercial cost indexes used in existing housing supply studies is a likely cause of their poor performance in existing estimates of the supply of new single family housing. The bias appears to be caused by an incorrect measure of labor costs and a failure to address the endogeneity of construction costs and construction activity. In contrast, starts regressions using the hedonic cost series generate much more sensible results. We find that housing starts are quite cost elastic; construction costs are endogenous in the new housing supply function; and the cost shares of material and labor in the structure of new residences are approximately 65 and 35 percent respectively.
JEL Classification: R0
Suggested Citation: Suggested Citation