Abstract: Paper No. 168

In Search of Empirical Evidence That Links Rent and User Cost

Dixie M. Blackley and James R. Follain

January 1995 

Most models of the rental housing market assume a close linkage between the level of residential rents and the after-tax user cost of rental housing capital. However, little empirical evidence exists to establish the strength of this linkage or the speed with which rents adjust to changes in user cost or tax policy. This paper develops and estimates an econometric model of the rental housing market in order to shed light on both of these issues. United States annual data for 1964 through 1993 are used to generate two-stage least squares estimates of a four equation structural model. Although the results are generally consistent with expectations and reveal several interesting relationships among the system variables, the estimates fail to identify a strong relationship between rent and user cost. Only half of an increase in user cost is ultimately passed along as higher rents. The adjustment process also takes a long time, with only about half of the long-run effect realized within ten years of a user cost shock. The fundamental reason for this result is that our estimate of the user cost series, based upon widely accepted procedures with by to calculate user cost, is much more volatile than the residential rent series. In a recent paper, DiPasquale and Wheaton also find a slow adjustment process. Nonetheless, such sluggishness is surely different than many economists believe. We offer several possible explanations for this result. Among these is the possibility that the linkage between rent and user cost is too complex to be identified using 30 years of national data.  

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