Shocks and Valuation in the Rental Housing Market

Abstract

This paper develops and analyzes a complete structural model of the rental housing market to assess the impact of major shocks like tax reform on the asset value of rental housing. Proper assessment of the impact of shocks on asset value requires specification of such a structural model of the rental market; included in the dynamic system of simultaneous equations is a demand equation, a supply equation, a construction equation, and an asset price equation. The basic model is solved analytically, and comparative static results are obtained for the steady-state values and the adjustment paths of the endogenous variables (rent, capital stock, construction, and asset price). The model is also analyzed numerically. Various modifications to the basic model are then introduced, in order to generate theoretical and numerical results that are more consistent with recent housing market developments. The model makes several contributions. It represents an alternative to the standard approach used in much of the real estate literature, in which a discounted cash flow model with ad hoc assumptions about the speed at which rents adjust to equilibrium is used to generate asset price estimates. It also serves as a guide to how much needed econometric analysis of the rental housing market might proceed.