Christopher J. Mayer

English

Research Papers in Economics

FRBNY ECONOMIC POLICY REVIEW / SEPTEMBER 1999 79
Commentary
 Christopher J. Mayer
I. INTRODUCTION
Policymakers and researchers have become concerned by
the increase in income inequality since the 1970s. How-
ever, some critics have suggested that these concerns are
exaggerated because the consumer price index, which is
used to calculate real income growth, is biased and does
not fully consider the quality of goods consumed by the
typical household. An alternative approach is to look at the
bundle of goods that low-income households consume.
Housing is the largest and most important of these con-
sumption goods. To the extent that the cost of housing
consumed by low-income households has not increased
with the general rate of inflation, one might argue that the
welfare of low-income households has not decreased to the
same extent as their incomes. The papers by James Orr and
Richard Peach and by Joseph Gyourko and Joseph Tracy
each argue against this hypothesis. While I mostly agree
with their interpretations of the data, I will try to put these
papers in a broader context.
Before beginning, I would like to praise the
authors and the Federal Reserve Bank of New York for
addressing an important policy issue. Declines in the U.S.
home ownership rate have heightened concerns among ana-
lysts, and raising the home ownership rate is an important
goal of the Clinton administration. Moreover, the impact of
interest rates on the housing market is an important con-
sideration in the conduct of monetary policy. Finally, as I
mentioned above, these papers shed additional light on the
debate over income inequality and measurement issues in
the consumer price index.
My comments can be organized around a number
of themes. First, I summarize the findings and make a few
technical comments. Next, I discuss some of the other fac-
tors that may have contributed to these findings, including
changes in demand, cyclical contributions, the supply side,
and changes in other amenities. I continue with a discus-
sion of the larger policy issues that these papers raise with
regard to home ownership. Finally, I present a brief agenda
for future research.
II. DISCUSSION OF THE FINDINGS
These two papers take different approaches to addressing a
common problem. Orr and Peach look at a number of long-
term trends in the housing market, documenting changes
for both owners and renters. To a considerable extent, the
news is good. They document a vast improvement in the
physical adequacy of housing and in the average number of
Christopher J. Mayer is an associate professor of real estate at The Wharton
School, University of Pennsylvania. The views expressed are those of the author
and do not necessarily reflect the position of the Federal Reserve Bank of New York
or the Federal Reserve System.80 FRBNY ECONOMIC POLICY REVIEW / SEPTEMBER 1999
persons per room, with most of the gains occurring for
households in the lowest income quintile. Neighborhood
quality has improved as well, but to a lesser degree. On the
downside, however, the authors document an increase in
the financial commitment to housing—that is, the per-
centage of a household’s income that is spent on housing.
In addition, households in the lowest income quintiles
have seen the largest increase in financial commitment,
although most of the increase occurred in the late 1970s.
Since that time, financial commitment has remained
roughly flat for this group, although year-to-year estimates
show significant variability, probably due to sampling error.
Inevitably, any study of long-term gains is subject
to certain difficulties. For example, variables such as neigh-
borhood quality and physical adequacy depend, at least to
some extent, on subjective interpretations that may change
over time depending on contemporaneous standards. If
expectations for these variables have increased over time,
reported numbers in the American Housing Survey (AHS)
might even understate actual gains. In addition, Orr and
Peach’s conclusions on financial commitment may over-
state the problem for low-income households because they
do not measure changes in the quality of housing. The
increased use of air conditioning, the elimination of sub-
standard units, and the inclusion of cable television may be
examples of unmeasured quality improvements, although a
variable for air conditioning is included in the AHS.
Gyourko and Tracy attempt to resolve this issue by
conducting a detailed study of affordability that controls
for changes in observed quality over time. They introduce a
significant technical tool to address this question: the
quantile regression. Previous studies have relied on differ-
ences in mean characteristics across income groups to con-
trol for quality. However, all houses with similar observed
attributes are not created equal. In college, I lived in a four-
bedroom house not far from campus. More recently, my
wife and I are in the process of buying a four-bedroom
house in a suburb of Philadelphia. While both houses have
four bedrooms, I can guarantee that these houses are of
vastly different quality. While my income has increased
since college, so has the quality of my living arrange-
ments. Without getting technical, the quantile regres-
sion allows the price of the attributes of a particular house
to depend on the price of attributes of other, similarly
priced houses. For most policy discussions, the quantile
regression generates more informative estimates of house
price changes in different price ranges.
Gyourko and Tracy’s methodology produces inter-
esting findings. For example, the quality-adjusted price of
the 10th-percentile house has increased faster than the
quality-adjusted price of all but the most expensive houses
in the sample. Incomes for this group of homeowners have
not increased nearly as quickly, and home ownership rates
have declined substantially. In addition, real prices for the
same 10th-percentile house have actually fallen, leading
the authors to speculate that average quality has fallen over
time for these houses, possibly due to decreased mainte-
nance by homeowners. At the upper end of the spectrum,
both real and quality-adjusted prices have increased sub-
stantially over the entire period, although both measures
have fallen in the 1990s. Home ownership rates have
been flat, but real incomes have risen somewhat. Both real
and constant-quality prices for the median house have been
relatively steady over this period.
One limitation of the Gyourko and Tracy study is
its reliance on homeowners. From a policy perspective, the
most disadvantaged households are likely renters and thus
are excluded from the sample. Also, the home ownership
rate has declined over the sample period, suggesting that
the type of home in a given percentile may have changed
over time. New construction would also lead to the same
problem. If low-quality houses are increasingly dropped
from the sample, the regression estimates will understate
true gains in quality. The possibility that demand for low-
end houses has fallen might explain why real prices have
fallen, but quality-adjusted prices have risen.1
Another issue to keep in mind in interpreting the
results of both papers is their reliance on current, as
opposed to lifetime, income. Increases in the returns to
education mean that young, highly educated households
face a wage profile that is growing over time. As a result,
such households may consume housing that represents a
higher percentage of current income, but not as large a
percentage of lifetime income. In addition, changes in theFRBNY ECONOMIC POLICY REVIEW / SEPTEMBER 1999 81
labor market may make job transitions more frequent and
thus make current income more volatile. Finally, as Orr
and Peach show, imputed income for homeowners, not
measured in most government surveys of cash income,
can significantly affect conclusions about affordability,
especially for low-cash-income households. 
III. UNDERSTANDING THE RESULTS
Within a larger context, it is interesting to speculate on
possible explanations for these findings. The most puzzling
result from the Orr and Peach paper is the possibility that
households in the lowest income quintile face a larger
financial commitment. Without large increases in popula-
tion, and given that the supply of housing in the short run
is basically fixed, one might expect that lower real incomes
for this group would lead to decreased housing costs. A
couple of explanations are possible. First, the increase in
prices may capitalize amenities that have improved over
time. Gains in physical adequacy and neighborhoods, the
use of air conditioning, a larger number of bathrooms, and
more space per person are all amenities that suggest higher
prices for housing. Alternatively, very little new housing at
the bottom end of the price spectrum has been built over
this period. Government regulations that limit supply have
made it uneconomical to build new housing for low-income
households. Finally, the “lumpy” nature of housing may
encourage young, low-income households to over-consume
housing early in life. Changes in the labor market may
make this more likely for certain high-skill households. 
From a policy perspective, it is important to dif-
ferentiate between these alternative explanations for the
increase in financial commitment. To the extent that hous-
ing quality has improved over time, it is hard to argue that
there is a problem that requires policy intervention, as
individual households could always choose to consume a
lower quality bundle. In addition, the possibility that
average housing quality has increased over time may
provide more evidence in support of those who argue that
the consumer price index is biased.
Gyourko and Tracy also find that house prices do
not track real incomes, even after controlling for changes in
observed quality. Here we need to consider other factors
that affect the demand for housing in addition to the qual-
ity of the units. For example, the user cost of housing (such
as the after-tax real cost of living in an owner-occupied
unit) has changed substantially over time. Changes in
nominal interest rates (and thus the “tilt” on mortgage
payments) and the tax code will lead to deviations in the
relative price of housing for low- and high-income house-
holds (Poterba 1991). In addition, previous research sug-
gests that high-priced trade-up homes exhibit excess
volatility over the real estate cycle relative to low-priced
units (Mayer 1993). The importance of cyclical factors is
apparent in their data, as the prices of the 90th-percentile
houses are certainly the most volatile over the sample
period. Any policy conclusions that involve intertemporal
comparisons of high- and low-priced houses should be sure
to take into account the timing of the real estate cycle.
Finally, as Mankiw and Weil (1991) suggest in their highly
controversial paper, demographics can have an impact on
longer term trends in the real estate market.
New construction is a wild card in this analysis.
We know very little about the types of houses that are
built and how new construction affects affordability, both
for renter and owner-occupied housing. While anecdotal
evidence suggests that cities erect significant barriers to
new construction—including minimum lot sizes, restric-
tions on multi-family housing and clustered development,
minimum quality standards, impact fees, and regulatory
delays—we know little about how these barriers affect the
overall price level of housing, especially for low-income
households.2 Future research is needed in this area.
IV. POLICIES TO ENCOURAGE
HOME OWNERSHIP
While a number of policy implications follow from these
papers, I would like to focus on home ownership in par-
ticular. After all, with the demise of federally subsidized
housing, many policymakers have argued in favor of
subsidizing home ownership for the poor as a way to
deal with affordability problems. Proponents argue that
homeowners are more likely to care for their houses and
neighborhoods because they have a stake in the com-
munity. Possible benefits include lower crime, better82 FRBNY ECONOMIC POLICY REVIEW / SEPTEMBER 1999
schools, cleaner neighborhoods, and even higher voter
participation. In addition, home ownership is suggested
as a natural vehicle to increase the savings of low-income
households.
Although the claimed benefits of home ownership
are many, the empirical evidence in favor of these hypothe-
ses is scant. However, that is not to say that there is evi-
dence suggesting that there are no societal benefits of home
ownership.3 It is difficult to conduct good studies of the
benefits of home ownership because of the endogeneity of
the decision to become a homeowner. Home ownership
may be correlated with improving neighborhoods. Yet, are
improving neighborhoods a direct benefit of home owner-
ship, or do they simply reflect homeowners choosing to live
in neighborhoods that are getting better? In this sense, an
influx of homeowners is a leading indicator of the direction
of a neighborhood.
While home ownership may have some benefits, it
also carries some risks for those in the lowest income
groups. Gyourko and Tracy present evidence that home-
owners in the lowest price decile may be undermaintaining
their properties. If households are encouraged to become
homeowners but they lack adequate financial resources to
do proper maintenance, the possible benefits associated
with higher maintenance might actually go in the other
direction. In addition, home ownership involves a signifi-
cant financial investment. Households who buy properties
with small down payments owing to subsidized mort-
gages face the risk that even small declines in property
values will leave them locked into their property, unable
to sell and facing possible foreclosure and the loss of
good credit.4 During a recession, low-income house-
holds—who face some of the most volatile labor markets
in terms of job duration and probability of layoff—will
face barriers to relocating when moving might present
the best alternative to finding a new or higher paying
job. Finally, from a portfolio perspective, low-income
households may want to choose a more diversified port-
folio, rather than simply putting all of their money into
a house.
Despite the above-mentioned risks, proponents
still argue that home ownership provides a good vehicle
to encourage savings. The correlation between savings
and home ownership is particularly strong in the data. A
problem with this argument, however, is that the historical
correlation may not be causal. First, homeowners are
wealthier, and thus by definition should save more.
Also, financial markets have changed over time. While
it may have been costly to refinance a house a few years
ago, today there are a large number of banks and mort-
gage brokers encouraging households to refinance and to
use home equity loans to pull equity out of their houses.
In fact, some lenders appear willing to lend more than
the amount of equity in the property. To the extent that
owning a home has historically provided a commitment
mechanism to a higher savings rate, that link is probably
less strong today.
V. CONCLUSION
As is always true of good research, the Orr and Peach and
Gyourko and Tracy papers raise as many questions as they
answer. While there has been a vast improvement in the
living standards of those in the bottom income quintile,
both studies suggest that housing affordability remains a
problem. However, it is still difficult to know whether
improvements in the quality of housing (Orr and Peach) or
in the types of owner-occupied units (Gyourko and Tracy)
can explain some of these findings. Data availability
problems make it difficult to fully address this issue in a
nationally representative study. The quantile regressions
developed by Gyourko and Tracy make a very good start,
but additional questions remain.
From a policy perspective, we need to know more
about the contribution of supply restrictions to afford-
ability, and the implications of encouraging home owner-
ship for low-income households. Even in the absence of
such studies, however, one thing is clear: If policymakers
want a sure-fire way to encourage home ownership and
make housing more affordable, the reduction of restric-
tions on new supply is a good place to start.ENDNOTES
NOTES FRBNY ECONOMIC POLICY REVIEW / SEPTEMBER 1999 83
1. One might be able to test for this effect by using repeat observations
of the same unit in the American Housing Survey.
2. See Fischel (1990) for a more complete summary of the issues and
empirical evidence.
3. Green and White (1997) and Glaeser and DiPasquale (1998)
document some benefits of home ownership.
4. See the discusion in Gyourko and Tracy, as well as Genesove and
Mayer (1997).
REFERENCES
Fischel, William. 1990. “Do Growth Controls Matter? A Review of the
Empirical Evidence on the Effectiveness and Efficiency of Local
Government Land Use Regulation.” Cambridge, Mass.: Lincoln
Institute of Land Policy.
Genesove, David, and Christopher  J.  Mayer. 1997. “Equity and Time to
Sale in the Real Estate Market.” AMERICAN ECONOMIC REVIEW 87,
no. 3: 255-69.
Glaeser, Edward L., and Denise DiPasquale. 1998. “Incentives and Social
Capital: Are Homeowners Better Citizens?” NBER Working Paper
no. 6363.
Green, Richard, and Michelle White. 1997. “Measuring the Benefits of
Home Ownership: Effects on Children.” JOURNAL  OF U RBAN
ECONOMICS 41, no. 3: 441-61. 
Mankiw, N. Gregory, and David N. Weil. 1991. “The Baby Boom, the
Baby Bust, and the housing Market.” REGIONAL S CIENCE  AND
URBAN ECONOMICS 19: 235-58.
Mayer, Christopher  J. 1993. “Taxes, Income Distribution, and the Real
Estate Cycle: Why All Houses Do Not Appreciate at the Same Rate.”
NEW ENGLAND ECONOMIC REVIEW (May-June): 39-50.
Poterba,  J. M. 1991. “House Price Dynamics: The Role of Tax Policy and
Demography.” Brookings Papers on Economic Activity, no. 2.

Do Growth Controls Matter? A Review of the Empirical Evidence on the Effectiveness and Efficiency of Local Government Land Use Regulation.”

Equity and Time to Sale in the Real Estate Market.”

House Price Dynamics: The Role of Tax

Incentives and Social Capital: Are Homeowners Better Citizens?” NBER Working Paper no.

Measuring the Benefits of Home Ownership:

Taxes, Income Distribution, and the Real Estate Cycle: Why All Houses Do Not Appreciate at the Same Rate.”

The Baby Boom, the Baby Bust, and the housing

Commentary on two papers on the affordability of housing for young and poor families

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Commentary on two papers on the affordability of housing for young and poor families

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