Sunday, March 1, 2009

The Beveridge Curve in the Housing Market: The Rental Market is more out of Equilibrium than the Owner Market

The long-run equilibrium in the Housing Market is characterized by a Beveridge Curve. In Labour Economics, the Beveridge Curve denotes the negative relationship between the unemployment rate and the number of job vacancies (Rob Shimer maintains an updated curve from the labour market). In my research (slides), I have discovered a Beveridge Curve in the Housing Market given by a negative relationship between the growth rate of households and the vacancy rate. The relationship holds in the owner-occupied market, the rental market, and the total market independent of ownership status.

The relationship for all three markets is plotted in figure 1. On the x-axis is the vacancy rate and on the y-axis is the growth rate of households for each type of market. The data source is the Housing Vacancies Survey put out by the Census Bureau (data in excel). The data have been smoothed slightly due to noise (details in slides). There is a clear negative relationship between the vacancy rate and the growth rate of households in all three markets. Currently all three markets are at their all-time highs for vacancies. (I also have a Beveridge Curve by decades).

What is most striking about the current housing market is that the rental market is significantly more out of equilibrium than the owner occupied market. This suggests that in addition to falling house prices, there is significant pressure for rents to be falling as well. In fact, there is evidence of rents falling (see CalculatedRisk, NYTimes, Guardian).What we also see is that the disequilibrium started back in 2003; the writing was on the wall even back then.

We clearly have an over-accumulation of houses. The current market imbalance is not an own versus rent problem, but a house versus household problem. The price that needs adjusting is not just the rent-price ratio. What needs adjusting is the overall cost of housing services, regardless of ownership status.

We can use the Beveridge Curve to get a deeper understanding of the long-run equilibrium in the housing market. The curve can best be thought of as a supply condition. The demand for new houses comes from household formation. Let’s assume that the cost to produce homes is increasing in the growth rate of the housing stock (as is assumed by Glaeser, Gyourko and Saiz in their papers here and here). When household formation is low, the cost to produce the homes to satisfy the market is low.

There are two adjustments to clear the market when the rate of household formation falls. The first is the standard adjustment that house prices fall. The second adjustment relates to the vacancy rate. When the cost to produce a home is low, a builder may want to produce more homes, potentially adding variety. This lowers the probability of an individual house selling, but it raises the probability that an individual builder may sell one house. In essence, builders respond to the lower costs by raising supply. The higher supply shows up in a higher vacancy rate. At some point in time the vacancy rate rises enough to stem more production and the market returns to equilibrium. Therefore, we get the following result: A lower growth rate of households lowers the costs of production to meet demand, leading to lower prices and higher vacancy rates. Thus, the Beveridge Curve.

Figure 2, illustrates how we should think of the long-run relationship in the Beveridge Curve. When the current market condition is to the northeast, there is an over-supply of homes—the vacancy rate is too high relative to the rate of household formation. High prices could drive the market into this area. When the current market condition is to the southwest there is an undersupply of housing units—the vacancy rate is too low relative to the rate of household formation.

The estimated long-run Beveridge Curve, rendered by the solid lines in figure 1, gives us a value for the current over/under supply of housing units. The best way to measure the amount of over/under supply is to find the current deviation of the vacancy rate from its long run value implied by the current growth rate of households. The deviation provides a measure of over-supply in terms of a percentage of the total housing stock. For the total market, the current over-supply is 1.04% of the total housing stock, or 1.22 million units.

A better way to measure the over-supply is to normalize it by the long-run growth rate of households. We then get a measure of over-supply in terms of years of household formation. That is, the measure is the numbers of years to erase the over-supply if household formation remains at its same rate and no more houses are constructed. This is a ‘years of supply’ measure equivalent to the ‘months of supply’ concept used in New and Existing home sales.

Figure 3 graphs the oversupply for all three markets. We clearly see a large increase in over-supply starting in 2003. Almost all of the over-supply originates from the rental market. Only recently has there been an over-supply in the owner-occupied market. Currently the total over-supply is at 1.03 years of household growth; by far the largest over-supply ever. Note that for this metric, the high rates of household formation in the 1970s kept the over-supply around 1974 low, at 0.29 years. Also, for the entire sample, the rental market is where most of the adjustment takes place—most of the over/under supply is there.

Finally, let me address foreclosures. A foreclosure does not affect the over-supply in the total market. When a household loses its house through foreclosure, the result is a vacant house and a renting household. Provided that the household remains an independent household and does not become homeless or move in with relatives, the household rents out a previously vacant house. The result is no change in the equation between houses and households. This is not to say that foreclosures are not a problem. Foreclosures are affecting the financial system, they create psychological problems for households being foreclosed upon, and a foreclosure can hurt a neighborhood just like any vacant house can hurt a neighborhood. However, foreclosures do not affect the imbalance in the overall housing market. As Glaeser and Gyourko state "the tyranny of housing supply suggests that no credit market intervention of any sort is likely to be able to stop housing price declines."

In summary, there is a Beveridge Curve in the Housing Market that defines a long-run equilibrium. Currently there is an over-supply of 1.22 million units, roughly one year of supply. What is striking is that most of the over-supply is in the rental market, not the owner-occupied market. This suggests that not only does the price-rent ratio need to adjust, but rents also need to adjust.

In a few days I will be posting about what we can expect for household formation. The data used for the Beveridge Curve suggest that this is also bleak.


  1. Thanks, very interesting. pick you up from CR comments. The other area that gets no attention is vacation home rentals. I live in the wine country and see a large number of condo building and homes marketed at the tourist business seems with the economy contracting these prior positive cash flow properties might be added to inventory sooner or later.

  2. lineup32

    That's very interesting. There is a large stock of vacant homes that are not classified as for sale or for rent. This stock has not traditionally moved much over the business cycle. I'm not sure what the stock is, I conjecture that it is typically homes that are eventually going to be demolished. However, currently these unaccounted vacant housing units have surged. One potential reason could be what you are observing. Adding them to my results would make the situation even more bleak.

    My guess is that a lot of speculators moved into these markets, treating these vacation rentals as a form of a long-term but liquid bond, such as 10 yr T-Bills. Buyers figured that they got some cash flow like a coupon and that the market was thick enough that they could sell whenever they felt like it. It turns out that these features of vacation rentals are highly cyclical. Furthermore, in places like Las Vegas it was very easy for developers to build more of these T-Bill like vacation rentals.