The effect of maintenance expenditures on the measurement of depreciation in housing

Abstract

This paper has two objectives: (i) to construct a model of durable good depreciation applicable to housing, inclusive of maintenance effects; and (ii) to indicate problems of misspecification if maintenance is ignored. The depreciation rate for housing has been estimated by examining price data on units of various ages.’ The rate of change of observed house prices with respect to age is interpreted as a depreciation rate. When this is applied to actual data, paradoxical results have been obtained. Negative estimates of depreciation rates for rental apartment units arise in Gillingham (1975), and for nonresidential structures in Hulten and Wykoff (1977). Negative results are possible because the “log price on age” regression measures net depreciation, after maintenance and addition. Gross depreciation, which cannot be negative, is the sum of net depreciation and maintenance. If more repair expenditure is allocated to a house, it will depreciate less than one of similar quality but unrepaired. This paper incorporates an explicit treatment of expenditure on repair. Homeowners have control over this expenditure, the product of an implicit price of repair services and an efficiency index of capital added. In Section 2, the basic model is derived, which constructs the expected current selling price of a house as the discounted present value of housing services consumed less those added by maintenance. This house selling price, under certain assumptions, is expressible as the product of a hedonic price index