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Imperfect substitution in real estate markets and the effect of housing demand on corporate investment

Author

Listed:
  • J. Scott Davis

    (Federal Reserve Bank of Dallas)

  • Kevin X. D. Huang

    (Vanderbilt University)

  • Ayse Sapci

    (Utah State University)

Abstract

Changes in housing demand can affect firm investment through the collateral channel, where the change in residential real estate prices is associated with a change in commercial real estate prices, affecting firm collateral and thus firm investment. We argue that this channel is weaker when residential and commercial real estate are poor substitutes. Using cross-state heterogeneity in the strength of zoning regulations as a proxy for heterogeneity in the substitutability of residential and commercial real estate, we first show with firm level data that the strength of local zoning regulations has a negative effect on the estimated increase in firm investment following an increase in local residential real estate prices. We then construct a DSGE model where land has both residential and commercial uses and with it to match the observed correlation between residential and commercial real estate prices. We find the average elasticity of substitution between commercial and residential real estate in the U.S. to be around 0.35, but in states with strong zoning restrictions it can be as low as 0.16 and in states with weak zoning restrictions it can be as high as 0.66. Simulations of the model show how differences in substitutability affect the transmission of a housing demand shock.

Suggested Citation

  • J. Scott Davis & Kevin X. D. Huang & Ayse Sapci, 2020. "Imperfect substitution in real estate markets and the effect of housing demand on corporate investment," Vanderbilt University Department of Economics Working Papers 20-00002, Vanderbilt University Department of Economics.
    • Handle: RePEc:van:wpaper:vuecon-sub-20-00004
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Commercial real estate; residential real estate; housing demand shock; zoning;
    All these keywords.

    JEL classification:

    • R1 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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