Why Housing Supply Cannot Dampen Housing Prices?

Many people simply take it for granted that high housing prices can only be solved by increasing housing supply. They claim that this is the Law of Supply and so it must be true.

However, on one hand, they cannot provide any empirical evidence, and on the other hand, they cannot answer how many more housing supply can help reduce how many percent in housing prices, other things being equal.

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In fact, there have been many studies confirming that housing supply is the response to the housing price change, rather than the cause. For example, both Glindro et al. (2007) and Belke & Keil (2017) found a positive and significant association between land or housing supply and housing prices. If it is the so-called Law of Supply, then the hypothesis should be a negative sign, as more supply would make prices down. In other words, a positive and significant result is a strong refutation of the hypothesis.

For example, Belke & Keil (2017) analyze a panel dataset of nearly 100 German cities, with both supply-side and demand-side factors. They found that, among others, “construction [activity] enters with a positive sign [on ln(apartment prices)](see Figure 1)…. The positive relation between construction activity and real estate prices could reflect a supply-side reaction of increasing construction in cities with strong demand.” (p. 14)

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Figure 1 construction [activity] enters with a positive sign [on ln(house prices) in the Fixed Effects Panel Estimations with log house prices as the dependent variable (1995–2010). Source: Belke & Keil (2017)

More recently, Anenberg & Kung (2020) find by a neighborhood choice simulation that “marginal reductions in supply constraints alone are unlikely to meaningfully reduce rent burdens.” The reason is straightforward, where to live is not solely determined by where the houses are available. Residential location choice is largely determined by neighborhood characteristics, such as the provisions of amenities, school zoning, job opportunities, and accessibility, etc., not housing supply.

Consider two neighborhoods, one is good and the other is bad as far as the amenity is concerned. If a lot of housing units are supplied in the bad neighborhood, it would only result in a higher vacancy rate there. That is why Anenberg & Kung (2020) concluded that “rents are more closely determined by the amenities in a neighborhood than by the supply of housing.”

Then how about if new housing is supplied in the good neighborhood? Unfortunately, it would attract people from the bad neighborhood to move into the good neighborhood, resulting in higher demand, and thus no effect on prices. This is what Bramley & Watkins’ (1995) circularity theory predicts “building X number of houses in a given location would result in that number of households moving to the location.”

Even if ignoring the amenity effects, as Aura and Davidoff (2008) tried to answer how much new supply of housing is required to cut housing prices by 15%. Their simulation result showed that “even if every building in Manhattan grew to 100 stories tall, prices would fall by less than 15%” and “conclude that individual jurisdictions are unlikely to increase ‘affordability’ by encouraging more supply and recent housing price increases most plausibly reflect demand changes.”

#HousingSupply #HousingPrices #Neighborhood #Amenities


Anenberg, E. & Kung, E. (2020) Can more housing supply solve the affordability crisis? Evidence from a neighborhood choice model, Regional Science and Urban Economics, 80, 103363. https://www.sciencedirect.com/science/article/pii/S0166046217304283#fn3

Aura, S. & Davidoff, T. (2008) Supply constraints and housing prices, Economic Letters, 99, 275–277.

Belke, A. & Keil, J. (2017). Fundamental determinants of real estate prices: A panel study of German regions, Ruhr Economic Papers, №731, ISBN 978–3–86788–851–6, RWI — Leibniz-Institut für Wirtschaftsforschung, Essen, http://dx.doi.org/10.4419/86788851

Bramley, G. & Watkins, C. (1995) Circular projections: household growth, housing development and the household projections, Council for the Protection of Rural England, London.

Glindro, E.T., Subhanij, T., Szeto, J. & Zhu, H. (2007) Are Asia-Pacific Housing Prices Too High For Comfort? Research and Policy Analysis, Bank for International Settlements, Basel, Switzerland.

Written by

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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