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The Effect of Land Use Regulation on Housing Prices: Theory and Evidence from California

Working paper #817
Desen Lin, Susan Wachter

Land use regulation may affect housing prices through housing supply and demand, but the empirical literature conflates both effects and finds wide variation in the estimated impact. We disentangle three channels through which regulation may affect housing prices: the production channel through housing supply, the amenity channel through housing demand, and the general equilibrium (GE) channel that captures price feedback effects on location choice. We develop a GE model with households’ choices on consumption and location and with housing developers’ choice on housing production. Our theoretical model delivers a closed-form solution to the equilibrium prices and a simple form of the estimation equations. Using property transaction-assessment data from 1993 to 2017 in California and a regulatory index compiled from the Wharton Residential Land Use Survey (Gyourko, Saiz and Summers, 2008), we structurally estimate and disentangle the supply and demand-side effects. We find that the regulatory impact on housing prices through the production channel is much stronger than the amenity channel (4.38% vs 0.32% if referenced to the average city in California) and is heterogeneous across cities. The relationship still holds, even when the GE effects are included in the two channels (3.24% vs 0.27%). The total effect of regulation will be 4 times larger, if referenced to the average regulation in the US. Our estimations point out the key roles of structural characteristics of housing and macroeconomic conditions in the prediction of housing prices. Estimations without quality adjustment underestimate land regulation’s impact on prices. Additionally, we examine the within-MSA regulatory interdependence and find significant and positive spillover effects of regulation on housing prices. Estimations without spillover consideration underestimate the regulatory impact on prices.

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