Reinvestment in the housing stock: the role of construction costs and the supply side

While rational real estate entrepreneurs generally will not redevelop if asset values are below replacement costs, we investigate whether homeowners who have investment and consumption motivations behave similarly. We use a house’s average ratio of value-to-construction cost to proxy for the value-to-cost ratio of marginal investments in renovation and find a strong negative impact on housing reinvestment for units with ratios below one. Owners of homes with market values below replacement costs spend up to 50 percent less on renovation than do owners of similar homes with market values above construction costs. Given the economically meaningful impact on reinvestment in housing that we find, urban scholars and policy makers should begin to pay more attention to the supply side of the housing market.

Joseph Gyourko and Albert Saiz

Journal of Urban Economics

March 2004

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