In this working paper, my co-authors (Allen Head, Derek Stacey) and I study the implications of cross-city differences in the level and inequality of income for home-ownership and the relative costs of owning, using a model in which heterogeneous households choose the quantity of housing services to consume and whether to own or rent the dwelling that provides them.
A theory of the distribution of housing tenure in a city is developed. Heterogeneous houses are built by a competitive development industry and either rented competitively or sold to households which differ in their income and sort over housing types through a directed search process. In the absence of either financial or supply restrictions, higher income households are more likely to own and lower quality housing is more likely to be rented. The composition of the housing stock and the rate of home-ownership depend on the distribution of income, the age of the population and construction costs. When calibrated to match average features of housing markets within U.S. cities, observed differences in these variables account well for the variation observed across cities in home-ownership and the price-rent ratio. A policy designed to improve housing affordability significantly raises home-ownership among lower income households while lowering the quality supplied to high income households. (Read More)