Housing Supply and Rent Prices
Many developed countries are undergoing a housing crisis, with many families having difficulty finding an affordable hope — and with housing prices showing no sign of a decline. There is much discussion regarding the causes of this imbalance. A natural candidate is the lack of proper supply of new housing.
From a public policy point of view, a critical piece of information is the impact on housing prices of an increase in the supply of housing. Estimating this parameter is complicated for the same reasons that estimating supply and demand is difficult: to the extent that both supply and demand are subject to constant shifts, historical data on quantity and price are insufficient to estimate the actual shape of the supply and demand curves. Actual estimates of the critical parameters is remarkably scarce.
A recently-published paper estimates the impact of new housing supply on the distribution of rents. Methodologically, the paper takes two different approaches. First, it explores delays in housing completion caused by weather shocks as a means to estimate the causal impact of a supply increase on rents. Specifically, it estimates that a 1% increase in new supply lowers average rents by 0.19%.
Additionally, the paper develops a model of the housing market that explicitly considers quality levels and the difference between new and second-hand units. The model explains why and how a positive shock in the supply of new houses propagates through the entire housing system. Empirically, we observe that for each new house that enter the market, as many as second-hand rental units become available. This is consistent with the idea that many people “upgrade” from lower quality to high quality units as new, high-quality houses become available.
The model and the empirical evidence suggest that the impact of a supply shock is not uniform across different quality levels of housing. The figure below illustrates the idea. The horizontal axis measures housing quality (10 different bins). The vertical axis measures the elasticity of price with respect to changes in supply.
As can be seen, price sensitivity is highest (in absolute value) for the lowest-quality units, with elasticity levels as high as -0.8.
As the author points out, these estimates are “highly policy relevant, since it helps local governments to assess by how much rental prices are going to decrease when issuing a larger number of building permits.”
Andreas Mense
The Impact of New Housing Supply on the Distribution of Rents
Journal of Political Economy Macroeconomics, volume 3, number 1, March 2025.