The Amplifying Effect of Capitalization Rates on Housing Supply

We provide empirical evidence that increases in the periodic costs of housing lead to a larger supply response than price increases of the same magnitude. We rationalize this differential in supply responsiveness with an amplification mechanism arising from adjustments of capitalization rates to changes in the periodic costs. Buyers expect further periodic cost increases at places that have experienced a positive demand shock. We document that the amplification of the housing supply price elasticity is less pronounced in geographically constrained and tightly regulated neighborhoods and in areas having more sophisticated buyers. Our findings hold important lessons for public policies affecting the periodic cost of housing, such as rent control and housing subsidies.