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Houses and Apartments: Similar Assets,

Different Financials
Authors

P e te r C h i nl oy, P r ash a nt K . D as, a nd

J o n a t h a n A . Wil ey

Abstract

The demand for investment for any asset including houses and
apartments depends on a relative yield-price ratio. In an
equilibrium structure, the yield-price ratio is shown to depend
explicitly on interest rates, capital gains, and the loan-to-value
ratio. We examine U.S. quarterly data for the 1986 to 2010
period. We find that starts on houses are highly sensitive to
interest rates and capital gains, while those for apartments are
not. Apartments are sensitive to equity availability. While similar
assets, houses and apartments respond differently to each of these
financial variables.

Apartments and houses are highly substitutable in production and consumption.

With similar materials and production costs, any differences in the markets for
these two assets should have origins in financial contracts. The lessons available
from this comparison have greater urgency given evidence that investment in new
housing dominates the business cycle. Leamer (2007) shows that two-thirds of the
variation in aggregate output in the United States comes from lagged volatility in
total residential investment, which includes construction on single-family and
multifamily units. Miles (2009) points out that housing investment has become
even more important since the deregulation of the 1980s, with both aggregate
consumption and non-residential investment becoming increasingly dependent on
housing.
Between 1990 and 2006, the Department of Commerce reports that starts on U.S.
owner-intended single-family houses more than doubled to a peak at over 1.5
million units annually. New housing starts began a downturn in 2006 and
eventually fell to fewer than 500,000 annually by 2009. Starts on apartments did
not begin a sharp downturn in 2006, and declined only after the financial crisis
had taken hold in late 2008.
We examine the phenomenon that fluctuations in single-family construction have
diverged from those for apartments. The starting point is a theory of investment.
Investors in any asset, including real estate, evaluate the return as the sum of a
dividend yield and capital gain. For real estate, the dividend is the yield-price ratio

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or capitalization rate if operating expenses are subtracted. At the start of

construction, investors do not know the return outcome. They forecast the expected
yield and capital gains. The expected return is equated with the weighted average
cost of capital at the beginning of construction. The actual return involves
adjustment factors on the yield-price ratio and capital gains that were part of initial
construction expectations. The weighted average cost of capital depends on the
interest rate for debt, required return on equity, and the loan-to-value ratio. Solving
the equilibrium condition for the actual or realized outcome, the yield-price ratio
depends on interest rates, capital gains, and the loan-to-value ratio. The
dependence is based on estimated parameters for each of these three that take into
account differences in expected and actual outcomes.
The yield-price ratio is the cost to the consumer of real estate services. As a cost,
higher rents relative to prices reduce demand for space. On the supply side, higher
rents relative to prices induce construction. Weights on each of the three yield
components are allowed to differ, since the initial expectations will not always be
realized. The structure allows assets to have different cycles and responses to
interest rates, capital gains, and loan-to-value ratios.
The estimation and application is for single and multifamily housing starts using
quarterly data for the U.S. over 1986 to 2010. Prior to estimation, time series due
diligence tests are carried out. Subsequent to unit root and cointegration tests,
each asset market is estimated using a two-stage error correction model. The error
correction is the difference between the actual and fitted values for the long-run
equilibrium level of housing starts. The associated error correction is included in
the second-stage estimation, which uses first-differences.
Initial examination of the sample reveals two observations. Apartment owners have
nearly 2.5 times the equity invested per dollar in asset value than homeowners.
Capital gains dominate returns for owner-occupied single-family units. As a
consequence of these two conditions, single-family houses are potentially more
sensitive to both capital gains and interest rates on mortgage debt in opposite
directions, relative to multifamily.
The remainder of this paper is organized as follows. The Background section
provides a discussion of the literature on housing investment and the role of
financial leverage. In the Model section, a theoretical framework is constructed
for evaluating the financial determinants of housing investment. A description of
the data and the specific empirical procedures applied are outlined in the Data
and Specification section. The empirical estimations are discussed sequentially in
the Empirical Results section. In the Conclusion section, we summarize the central
findings and offer some interpretation for why the results for single and
multifamily investment differ with respect to the financial components.

Background

Keynes (1936) argued that the interest rate is the demand price of investment in
physical or financial assets. Investment falls when interest rates rise. In Tobin

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4 1 1

(1969), a higher ratio of market value to book equity is positively correlated with
investment. In Jorgenson (1960), the user cost is a demand price and negatively
correlated with investment. The user cost is an identity as the difference between
interest rates and capital gains.
The theory of investment presented offers a flexible structure. Investment depends
negatively on the yield-price ratio. The yield-price ratio has an equilibrium
relationship with interest rates, capital gains, and leverage. It is an identity when
parameters of these components are one or zero, which is a testable restriction.
The yield-price ratio has been used to analyze mispricing in the housing market.1
The model demonstrates how aggregate investment can be influenced by interest
rates, capital gains, and leverage, since each are components of the yield-price
ratio.2
Single-family owner-intended and multifamily renter-intended housing starts for
1974 to 2012 are in Exhibit 1. The two series are from the U.S. Department of
Commerce. Both series are indexed to a value of 100 in 1990:Q1. Prior to the
1990s, single-family owner-intended and multifamily renter-intended series move
together and have a correlation coefficient of 0.714. Housing starts decline in both
categories during the early 1980s following tight monetary policy and high interest
rates. When the production of single-family houses expands between 1990 and
2005, growing at a 5% annual rate, the annualized change in multifamily starts is
just 1.2%. The steep drop in single-family starts begins in late 2005, but not for
multifamily. Multifamily starts only begin to decline after the recession takes hold
in late 2008.
Exhibit 2 shows equity ratios for single-family mortgages from 1974 to 2010 and
multifamily loans from 1983 to 2012. Overall, equity shares are higher on
multifamily than on single-family loans. Single-family loan origination has a
highest equity or lowest loan-to-value ratio of 28%. Equity requirements for
multifamily mortgages are never less than 35%.
Exhibit 3 shows mortgage rates and capital gains on the separate house and
apartment assets. Single-family mortgage rates are for 1974 to 2010; multifamily
mortgage rates are from 1983 to 2012. The mortgage rates for the two assets have
a similar pattern. Capital gains differ, with those for houses experiencing an earlier
downturn after 2005.
Leverage and equity constraints have an impact on residential housing markets,
particularly for first-time homebuyers. Ortalo-Magne and Rady (1999) show that
home prices boomed in the United Kingdom after equity requirements were
drastically reduced during the early 1980s. Linneman and Wachter (1989) find
that equity constraints are more binding than income requirements.3 Duca,
Muellbauer, and Murphy (2011) demonstrate that the loan-to-value ratio for firsttime homebuyers is a relevant component of the house price-to-rent ratio. A debtoriented structure increases risk taking.4

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250

a n d

150

W i l e y

100

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D a s ,

2012q4
2011q3
2010q2
2009q1
2007q4
2006q3
2005q2
2004q1
2002q4
2001q3
2000q2
1999q1
1997q4
1996q3
1995q2
1994q1
1992q4
1991q3
1990q2
1989q1
1987q4
1986q3
1985q2
1984q1
1982q4
1981q3
1980q2
1979q1
1977q4
1976q3
1975q2
1974q1

MF renter starts
SF owner starts

200

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E x h i b i t 1 u U.S. Housing Starts Index: 19742012

50

Notes: The series are from the U.S. Census Bureaus Table Q-1. New Privately Owned Housing Units Started in the United States, by Intent and Design. Index base: 1990:
Q1 5 100.

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E x h i b i t 2 u Equity Ratios (% of property value)

80%

Plate # 0

60%

40%

H o u s e s

J R E R

20%

u
u
N o .

u
4 1 3

4 2 0 1 4

Notes: Equity ratios (one minus the loan-to-value ratio) on mortgages for single-family and multifamily properties. The equity ratio on multifamily financing is from the NCRIEF
NPI levered returns series for apartments, from 1983 to 2012. Equity ratios for the single-family series are from the Federal Housing Finance Agency (FHFA) Monthly Interest
Rate Survey (MIRS) national average for newly built homes, 19742010.

A p a r t m e n t s

Equity ratio - MF

a n d

2012q4
2011q3
2010q2
2009q1

2007q4
2006q3
2005q2
2004q1

2002q4
2001q3
2000q2
1999q1

3 6

Equity ratio - SF

1997q4
1996q3
1995q2

1994q1
1992q4
1991q3
1990q2

1989q1
1987q4
1986q3
1985q2

1984q1
1982q4
1981q3

1980q2
1979q1
1977q4
1976q3

1975q2
1974q1

Vo l .

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15.0%

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E x h i b i t 3 u Mortgage Rates and Capital Gains

a n d

0.0%

W i l e y

-5.0%
-10.0%
-15.0%
-20.0%
2012Q4
2011Q3
2010Q2
2009Q1
2007Q4
2006Q3
2005Q2
2004Q1
2002Q4
2001Q3
2000Q2
1999Q1
1997Q4
1996Q3
1995Q2
1994Q1
1992Q4
1991Q3
1990Q2
1989Q1
1987Q4
1986Q3
1985Q2
1984Q1
1982Q4
1981Q3
1980Q2
1979Q1
1977Q4
1976Q3
1975Q2
1974Q1
SF mortgage rate

MF mortgage rate

SF capital gains

MF capital gains

Notes: Mortgage rates (solid lines) and capital gains (dashed lines) for single-family and multifamily properties. MF mortgage rate is total interest divided by loan balance
(annualized) in the NCREIF NPI levered returns index, 19832012. MF capital gains are measured as the average capital return component of the NCREIF NPI levered
returns index for apartments, 19832012. Mortgage rates for the single-family series are from the Federal Housing Finance Agency (FHFA) Monthly Interest Rate Survey
(MIRS) national average contract mortgage rate for newly built homes, 19742010. Capital gains for the single-family series are from the S&P / Case-Shiller, calculating
the quarterly percentage change in the house price index provided by Davis, Lehnert, and Martin (2008), 19742012.

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Model

In the model, we develop housing starts and investment as a function of interest

rates, expected capital gains, and underwriting standards. Housing starts separate
single and multifamily markets. Since these markets are subject to different
financial conditions, the model allows for testing different aspects of the business
cycle. One specific goal is to test whether investment in single and multifamily
housing is impacted similarly by underwriting constraints on the loan-to-value
ratio.
The investor evaluates the rate of return to holding one type of housing as an
asset. As with any asset, the rate of return is the sum of capital gains and a
dividend yield. The housing asset has price A and capital gain p 5 D A/A. Its cash
flow including from the equivalent rent of an owner-occupier is Z, so the yieldprice ratio is c 5 z/A. Whether the owner or user pays operating expenses
determines whether rents are measured on a gross or net basis. If net rents are
used, then the yield is the capitalization rate or ratio of net operating income to
the asset price. The total realized return is the sum of the yield and capital gain,
or c 1 p.
The asset market for houses or apartments has an existing stock Q. Additions to
the stock constitute investment. Investment, I, depends on the yield-price ratio, c,
with:

DQ 5 I(c, X)I 9 , 0.

(1)

Here X denotes other shift factors that affect investment. The variables in X that
shift investment include zoning rules, land use, geographical restrictions, and
building costs on the supply side. For example, Chichernea et al. (2008) provide
evidence of a strong relationship between local supply constraints and market
capitalization rates. They include demographic composition, employment, output,
and migration on the demand side, along with tax policy.
Homebuyers and apartment investors cannot operate based on the realized return,
which does not occur until construction is completed and the unit is either rented
or sold. The investment decision occurs prior to construction. Investors form
expectations about the yield and capital gain. The expected return is:

r 5 lc c 1 lp p.

(2)

Here lc is an adjustment factor for the yield. When the yield adjustment is one,
buyers accurately forecast the subsequent yield-price ratio. The capital gains
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adjustment is lp . Jin, Soydemir, and Tidwell (2014) find that an irrational

component to investor sentiment affects housing prices. When subsequent capital
gains are forecasted accurately by those signing the contract for construction to
proceed, lp 5 1.
The investor equates the expected return on capital with its cost. The cost of capital
depends on the mortgage interest rate, m, for debt. The target rate of return on
equity is k, which can vary across assets. Single-family housing need not have
the same return on equity as multifamily. The loan-to-value ratio, or capital
allocation, is v. The weighted average cost of capital is:

w 5 vm 1 (1 2 v)k 5 m 1 (1 2 v)(k 2 m) 5 m 1 (1 2 v)u.

(3)
In the first equality, the weighted average cost of capital is vm 1 (1 2 v)k. The
loan-to-value ratio multiplied by the mortgage rate, vm, is the cost of debt per
dollar of added capital. The equity proportion multiplied by the return on capital,
(1 2 v)k, is the contribution of the down payment.
The second equality in (3) rearranges the first as m 1 (1 2 v)(k 2 m). The
weighted average cost of capital is the mortgage rate plus a margin. The margin
is the equity proportion (1 2 v) multiplied by a premium, (k 2 m). The premium
is a required return on equity in excess of the mortgage rate. In the third equality,
the weighted average cost of capital is m 1 (1 2 v)u. This is the mortgage rate,
m, plus the leveraged equity premium, (1 2 v)u. The leveraged equity premium
is the equity ratio multiplied by the difference between the equity and debt costs,
u 5 k 2 m.
At the construction start date, the investor knows the cost of capital but is uncertain
about the rate of return. Using the expected rate of return and equating with the
cost of capital:
r 5 w 5 lc c 1 lp p 5 m 1 (1 2 v)u.

(4)

Investment is triggered by the yield c. Solving for this yield:

c5

lp
1
u
m 1 (1 2 v) 2
p 5 gm m 1 gv(1 2 v) 1 gp p.
lc
lc
lc

(5)

In the second equality of (5), the sign on the capital gains coefficient gp is negative,
causing the term gp p to be included with a positive sign on the right-hand side.

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The adjustment rates for the two components of the return are on the yield as lc
and the capital gains with lp . The first condition in (5) follows from the return
on capital being equal to its cost. The yield in (5) depends on the mortgage rate,
m, the equity ratio, (1 2 v), and capital gains, p.
Each of the three components has a coefficient reflecting its weight in the yield.
The weight of the mortgage rate is gm , the assets weighted leverage is gv , and
capital gains contribute gp . The mortgage rate is multiplied by the inverse of the
yield adjustment, or 1/ lc . The equity ratio (1 2 v) has a coefficient of the yieldadjusted premium u / lc . The coefficient for capital gains is 2lp / lc the ratio of
expectation adjustments for capital gains relative to the yield. Higher interest rates,
m, raise the required yield and dampen investment demand. Greater equity-tovalue requirements increase the required yield. Increased capital gains lower the
required yield.
The first equality in (5) is nonlinear. The second is a linear parameterization.
Maximum likelihood estimation in linear form yields the nonlinear adjustments
and equity premium. This correspondence is:

lc 5

1
gm

u5

gv
gm

lp 5

gp
.
gm

(6)

The three parameters are recovered by estimation. The equity premium u is the
expected margin an investor requires over the mortgage interest rate. That
premium can differ across assets, including property types. The adjustment lc is
the degree to which investors accurately forecast the yield-price ratio. The forecast
accuracy on capital gains is lp .
If equity is not a binding constraint, then the use of leverage is irrelevant and
u 5 0. When u 5 0, the equilibrium condition becomes similar to a more
conventional user cost. The rent-price ratio is equal to the interest rate less capital
gains, but both of these are weighted by parameters instead of having unit
coefficients. When u 5 0, the investor does not value having additional leverage
available. With a zero coefficient there is no constraint in obtaining a down
payment, and the equity ratio can be removed from the yield equation.
The yield also depends on a weighted difference between interest rates and capital
gains. When the adjustment on the yield-price ratio is immediate or investors
forecast accurately, then interest rates affect the yields on a one-to-one basis. A
percentage point increase in interest rates translates into a similar rise in the
required yield-price ratio. Under the two conditions that the down payment is not
a constraint, and the yield adjusts immediately, the yield-price ratio will be linear.
When adjustments on capital gains and the capitalization rate are also immediate
and equal to one, then c 5 m 2 p. This is the user cost. The user cost of capital
is the interest rate less the rate of capital gains. In this case, the user cost equality
is a testable restriction as opposed to being a direct calculation.
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The investment, I, can be divided into different classes for single and multifamily,
with a separate yield for each. Any differences between the single and multifamily
markets become testable after substituting for the yield-price ratio from (5) in the
investment demand of equation (1). For the use of leverage to be irrelevant, the
equity ratio should not enter. Investors can borrow an unlimited amount, or tap
the equity market without constraint. In practice, there are limits on the loan-tovalue ratio. When constrained borrowers target reaching that limit, the implication
is that underwriting constraints are relevant. Investors do not necessarily forecast
subsequent returns accurately. If they do, then there is no adjustment differential
between the going-in capitalization rate and its realized outcome.

Data and Specification

The data are housing starts for single-family and multifamily units in the United
States quarterly from 1986:Q1 through 2010:Q4, from the U.S. Census.5 The data
are selected to have a complete and matching series on mortgage interest rates,
capital appreciation, and loan-to-value ratios. Housing starts are distinguished
between single-family units intended for ownership and multifamily intended for
rental. The purpose of this identification is to match the type of housing investment
with the appropriate source of financing. Excluded from the analysis are singlefamily units intended for rental and multifamily intended for ownership. The
single-family and multifamily series are complemented with data on interest rates
and credit spreads. The data are described, along with the sources, in Exhibit 4.
Single-family mortgage data, including interest rates and loan-to-value ratios are
from the Federal Housing Finance Agencys (FHFA) monthly interest rate survey.6
The loan-to-value ratio is for conventional single-family mortgages. The rate is
the FHFA contract interest rate on newly constructed single-family homes. The
rate is measured as a premium over the 10-year Treasury note. Capital gains on
single-family homes are from the S&P/Case-Shiller house price index.7
Multifamily mortgage contract data are from the National Council of Real Estate
Investment Fiduciaries (NCREIF).8 NCREIF collects information for its leveraged
series on mortgage contracts, including the interest rate and loan-to-value ratio.
The multifamily mortgage rate is total interest, annualized, and divided by the
loan balance in the NCREIF levered returns index, and measured as a premium
over the 10-year Treasury note rate. Capital gains on apartments are from the
NCREIF database.
Non-mortgage financial rates are from the Board of Governors of the Federal
Reserve System (FRB).9 These nonfinancial rates are evaluated as determinants
of the loan-to-value ratios contingent on macroeconomic variables, as in
Grovenstein et al. (2005). The long bond rate is the average market yield on 10year constant-maturity U.S. Treasury securities, calculated for each quarter based
on daily rates. The yield curve slope measures the difference between the 10-year
constant-maturity rate and the quarterly average market yield on 1-year Treasuries.

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E x h i b i t 4 u Variable Descriptions

Source

Availability

10-yr Treasury rate

Quarterly average market yield on 10-year U.S. Treasury securities

FRB

19622013

Yield curve

Quarterly average yield on 10-year minus qtr average yield on 1-year

FRB

19622013

Volatility of 1-yr Treasury

Standard deviation of daily 1-yr Treasury rates over prior 12 months

FRB

19632013

Credit spread

Moodys yield on seasoned corporate bonds: BBB minus AAA

FRB

19862013

SF owner starts

Table Q-1. New Privately Owned Housing Units Started in the United States, by Intent and Design

Census

19742012

Census

19742012

MF renter starts
Quarterly percentage change in S&P / Case-Shiller house price index

Case-Shiller

19602012

SF mortgage rate

MIRSTable 18: SF mortgage terms, monthly national average, newly built homes [mortgage
rate 5 contract interest rate]

FHFA

19732010

FHFA

19732010

NCREIF

19832012

MF mortgage rate

NCREIF

19832012

MF LTV ratio

NCREIF

19832012

SF LTV ratio
J R E R

MF capital gains

NCREIF NPI leveraged returns for apartments. [mortgage rate 5 interest / loan balance,
annualized]

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Notes: Non-mortgage financial data including 10-yr Treasury rate, Yield curve, Volatility of 1-yr Treasury, and Credit spread, are from the Board of
Governors of the Federal Reserve System (FRB). The Federal Reserve Board provides historical data on Selected Interest Rates (Daily) H.15, from http: / /
www.federalreserve.gov / Releases / h15 / data.htm. Single-family (SF) owner-intended and multifamily (MF) renter-intended starts are from U.S. Census
Bureau Table Q-1. New Privately Owned Housing Units Started in the United States, by Intent and Design, from http: / / www.census.gov / construction / nrc /
pdf / startsusintentq.pdf. SF capital gains are from the S&P / Case-Shiller index. The quarterly average house price index is in Davis, Lehnert, and Martin
(2008). The source of the house price data is the Lincoln Institute of Land Policy at www.lincolninst.edu / subcenters / land-values. SF mortgage rates and SF
loan-to-value (LTV) ratios are from Federal Housing Finance Agency, quarterly average from the Monthly Interest Rate Survey Data http: / / www.fhfa.gov /
Default.aspx?Page5252. The series is reported at a monthly frequency from 1973 to 2010. MF mortgage rates, MF LTV ratios and MF capital gains are
from the National Council of Real Estate Investment Fiduciaries (NCREIF) database is available by subscription at www.ncreif.org. Multifamily mortgages are
involved in generating the National Price Index (NPI) of leveraged returns for apartments in the NCREIF data. The NPI Leveraged Returns series can be
accessed through the NCREIF Custom Query Screen and refined according to property type criteria.

H o u s e s

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The volatility of the 1-year Treasury bill is the standard deviation of daily rates
during the prior 12 months, calculated at the end of each quarter. The credit spread
is the difference between average yields on BBB-rated corporate bonds and those
with a AAA rating from Moodys.
Exhibit 5 presents the summary statistics. From 1986 to 2010, the correlation
between the FHFA for single-family and NCREIF multifamily loan-to-value ratios
is 0.159. The average 10-year Treasury note rate is 5.9%, and 1.4 percentage
points greater than 1-year Treasuries. The credit spread ranges from 60 to 300
basis points. Single-family, owner-intended housing starts average 275,600 per
quarter as compared with 57,800 for multifamily targeted as rentals.
Time series due diligence tests are carried out prior to estimation. The tests take
into account the two separate and concurrent series on single-family and
multifamily starts. The test for the time series being stationary is based on
augmented Dickey-Fuller (ADF) specifications. The null hypothesis is a unit root.
The alternative in that series is integrated of order zero, or I(0). The ADF unit
root tests consider zero mean, single mean, and trend types with 1 and 2 lags for
each variable. The reported ADF values are t from the version of these six
different tests that resulted in the highest p-value. Based on the reported outcomes,
there is insufficient evidence to reject the unit root for all variables at the 5% level
of confidence. The analogous results for ADF in the first-differences are presented
in the far-right columns of Exhibit 5. The first-difference of each variable is
stationary.10 Each time series variable considered is integrated of order I(1). The
presence of a unit root on each variable cannot be rejected until after first
differencing, resulting in 99 quarterly observations from 1986 to 2010.
Since the time series data for housing investment and its proposed determinants
are first-order integrated, the next step is to test for cointegration. Cointegration
rank tests using trace statistics are carried out. The tests confirm the presence of
at least one cointegrating vector for the sets of single and multifamily variables
between those in the yield and starts.11 The two-stage error correction model is
used to estimate the relationships between the variables.
In (5), rearranging to include the coefficient of the equity ratio in the intercept
results in:

c 5 gm m 2 gv v 1 gp p.

(7)

From equation (1), investment I in single or multifamily houses is a function of

the yield, c, and other variables, X. As a time series specification, investment is
subject to partial adjustment. Investment cannot be completed during one period,
implying that its lag appears among the X variables.

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E x h i b i t 5 u Summary Statistics

0.092

Yield curve

99

0.014

0.011

20.004

0.034

22.68

0.246

23.63

0.032

Volatility of 1-yr Treasury

99

0.005

0.003

0.001

0.011

21.67

0.089

26.00

,0.0001

Credit spread

99

0.030

SF owner starts

99

275.6

85.3

MF renter starts

99

57.8

22.2

SF capital gains

99

0.009

0.019

20.057

0.047

SF mortgage rate

99

0.014

0.006

20.003

0.024

21.31

0.175

25.83

,0.0001

SF LTV ratio

99

0.766

0.022

0.721

0.810

21.85

0.672

27.73

,0.0001

MF capital gains

99

0.002

0.045

20.163

0.080

22.46

0.345

25.43

0.0001

MF mortgage rate

99

0.016

0.007

0.00001

0.044

21.27

0.188

27.45

,0.0001

MF LTV ratio

99

0.449

0.079

0.273

0.641

1.30

0.950

23.69

0.028

25.54

Pr , t

Plate # 0

0.027

,0.0001

21.32

0.171

26.90

,0.0001

77

477

0.06

0.997

210.52

,0.0001

16

148

22.13

0.525

28.31

,0.0001

22.23

0.466

25.51

,0.0001

a n d

N o .

u
4 2 1

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A p a r t m e n t s

Notes: The number of quarter observations (N) are for the 19862010 horizon. The ADF {variable} statistics and p-values are for the unit root tests of the
level variables. The Augmented Dickey-Fuller (ADF) unit root tests consider zero mean, single-mean, and trend types with 1 and 2 lags for each variable.
The reported ADF values are t from the version of these six different tests that resulted in the highest p-value. The analogous results for the first-difference of
the variable, ADF {Dvariable} and Pr , t, are also presented. SF owner starts and MF renter starts are reported in thousands of units.

H o u s e s

J R E R

0.017

3 6

0.836

0.059

0.006

Max

20.72

99

0.004

Min

ADF
{Dvariable}

10-yr Treasury rate

0.010

Std. Dev.

Pr , t

Vo l .

Mean

ADF
{variable}

Variable

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Substituting for the lagged yield in (7) and adding a time subscript, investment in
housing is, in logarithms:

lnIt 5 g0 1 g1 lnIt21 1 gm mt21 1 gv vt21 1 gp pt21 1 ut .

(8)

Here is an error with zero mean. With the partial adjustment and logarithmic
investment, the elasticity with respect to interest rates is gm /1 2 gI . Separate
estimations for single and multifamily starts are used to evaluate whether the
financial contracts for the two assets has a distinctive impact in investment.
Given the unit root and cointegration results, a first-difference specification of the
investment equation for each type is:

DlnIt 5 g0 1 gI DlnIt21 1 gm Dmt21 1 gv Dvt21

(9)

1 gp Dpt21 1 gz zt21 1 t .

Here zt 5 lnIt 2 lnIt , the residual between the actual and fitted value of investment
in the estimation in levels from (8). This is the error correction, added as an
explanatory variable in the first-difference of investment.12

Empirical Results

Exhibit 6 presents results for single-family, owner-intended housing starts. Panel

A has the estimation in levels corresponding to (8). Panel B has first-differences
of single-family starts from (9). The first set of results is without the loan-to-value
ratio. Without the loan-to-value ratio, the variables of interest are interest rates
and capital gains. The predicted signs for interest rates are negative, while those
for capital gains are positive.
The upper panel of Exhibit 6 has the results for the level of single-family housing
investment. Since the unit root tests indicate that first-differences are required, the
upper panel is reported for presentation purposes. These level regressions form a
first stage that is used in generating the error correction. The error correction is
included as an explanatory variable in the first-difference of single-family
investment, which is the dependent variable in the lower Panel B of Exhibit 6.
The first-difference results are the focus, since the empirical issues have been
resolved.
A one basis point increase in the 10-year Treasury note rate leads to a decline in
single-family starts 6.2 times as large, from the results on the left side when the
loan-to-value ratio is excluded. Even with leverage included, the elasticity of starts
with respect to interest rates is 25.5. Single-family starts are highly elastic to

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E x h i b i t 6 u Single-family, Owner-intended Housing Starts: 19862010

No LTV

Variable

With LTV

Coeff.

t-Stat.

Coeff.

t-Stat.

(1)

(2)

(3)

(4)

Panel A: Level
Constant

0.749***

4.4

D Quarter 1

20.351***

214.7

20.332***

213.8

D Quarter 3

20.500***

221.8

20.485***

221.3

D Quarter 4

20.358***

216.4

20.356***

216.9

0.920***

29.6

0.870***

24.9

lnIt21 ln(SF owner startst21)

0.153

0.6

mt21 10-yr Treasury ratet21

20.466

20.8

20.360

20.6

SF mortgage premiumt21

20.520

20.3

20.144

20.1

pt21 SF capital gainst21

2.499***

4.6

vt21 SF LTV ratiot21

2.998***

5.4

1.106***

2.8

Trace statistics
0 vectors

64.4**

90.8**

1 vector

26.4

44.1

Panel B: First-difference
Constant

0.343***

18.4

0.343***

19.8

D Quarter 1

20.236***

26.2

20.239***

27.1

D Quarter 3

20.641***

28.5

20.634***

29.8

D Quarter 4

20.509***

224.8

20.510***

225.5

DlnIt21 Dln(SF owner startst21)

0.803***

4.0

0.785***

4.6

zt21 Error correctiont21

20.867***

23.7

20.935***

24.4

Dmt21 D10-yr Treasury ratet21

26.193***

23.2

25.506***

22.9

DSF mortgage premiumt21

25.237**

22.0

25.583**

22.2

D pt21 DSF capital gainst21

3.847***

4.3

Dvt21 DSF LTV ratiot21

Adj. R2
DW statistic
Observations

3.953***

4.6

0.710

1.4

88.9%

89.4%

2.15

2.13

97

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E x h i b i t 6 u (continued)
Single-family, Owner-intended Housing Starts: 19862010

Notes: This table presents results from the estimation of the two-stage error correction (ECM)
model specified in equations (8) and (9). In the first-stage, the dependent variable is ln(SF owner
startst), and the maximum likelihood estimation results using level measures for the variables and a
multi-equation system with a co-integrating vector are presented in Panel A. Least squares results
using the first-differenced measures for each variable, along with the error correction term
(collected from the first-stage), are presented in Panel B. Columns two and three present results for
two-stage ECM with the LTV variable excluded in both stages of the estimations. Columns four and
five present results with the LTV measure included in the two-stage ECM estimation. Quarterly
indicator variables are included in all estimations. The adjusted R2, Durbin-Watson (DW) statistic,
and number of observations are for the second-stage estimation of first-differences.
** Significant at the 5% level.
*** Significant at the 1% level.

capital gains. The elasticities of starts to expected capital gains are positive but
greater than one. They range between 3.85 and 3.95 depending on the
specification. Leverage is not a determinant of single-family starts. In the second
set of results on the right side of the lower panel, LTV is positive but not
significant in affecting the first-difference of single-family starts.
The values reported above are short-term elasticities. The coefficient on lagged
starts is positive and less than one. The long-term elasticities are consequently
even larger. Using the short-term elasticities as conservative estimates, singlefamily starts are highly sensitive to both interest rates and expected capital gains.
The error correction term ranges between 20.867 and 20.935. This estimate
indicates that between 87% and 94% of the difference from the level of actual
starts and equilibrium is made up within one period. Since the coefficients are
negative, the adjustment is toward equilibrium or mean-reverting.
Exhibit 7 reports results for apartments. The focus is on Panel B for firstdifferences in multifamily starts to generate a stationary time series. While singlefamily starts are highly sensitive to interest rates and capital gains, multifamily
shows zero elasticities in both. The short-run elasticities in interest rates and
capital gains are not significantly different from zero. A major difference between
the behavior of single-family and multifamily investments lies in their
responsiveness to credit availability. In Exhibit 7, apartment investors are
responsive when more equity is available. With the first-difference estimation in
Panel B, a percentage point increase in the equity ratio raises multifamily starts
by 3%.
Both single and multifamily housing starts follow their seasonally-adjusted lagged
values, while multifamily coefficients are closer to one. In addition, both single

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E x h i b i t 7 u Multifamily, Renter-intended Housing Starts: 19862010

No LTV

Variable

With LTV

Coeff.

t-Stat.

Coeff.

t-Stat.

(1)

(2)

(3)

(4)

Panel A: Level
Constant

0.746***

3.9

0.302

0.7

D Quarter 1

20.167***

23.9

20.174***

23.7

D Quarter 3

20.248***

25.3

20.257***

25.4

D Quarter 4

20.361***

27.6

20.368***

27.7

lnIt21 ln(MF rental startst21)

0.833***

16.8

0.862***

15.6

mt21 10-yr Treasury ratet21

1.366

1.2

3.102

1.6

MF mortgage premiumt21

0.859

0.3

2.059

0.7

pt21 MF capital gainst21

1.168***

2.8

vt21 MF LTV ratiot21

1.134***

2.7

0.478

1.2

Trace statistics
0 vectors

48.9**

1 vector

27.5

122.7**
43.9

Panel B: First-difference
Constant

0.376***

5.7

0.368***

5.9

D Quarter 1

20.481***

28.4

20.465***

28.5

D Quarter 3

20.552***

24.5

20.516***

24.3

D Quarter 4

20.455***

26.3

20.436***

26.2

DlnIt21 Dln(MF rental startst21)

zt21 Error correctiont21

0.886***

3.1

0.803***

2.9

21.142***

23.6

21.117***

23.6

Dmt21 D10-yr Treasury ratet21

4.401

0.8

3.322

0.6

DMF mortgage premiumt21

2.111

0.5

1.051

0.3

Dpt21 DMF capital gainst21

0.678

1.2

Dvt21 DMF LTV ratiot21

Adj. R2
DW statistic
Observations

0.816
22.999**

46.7%

52.0%

1.86

1.96

97

1.5
22.3

97

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E x h i b i t 7 u (continued)
Multifamily, Renter-intended Housing Starts: 19862010

Notes: This table presents results from the estimation of the two-stage error correction (ECM)
model specified in equations (8) and (9). In the first-stage, the dependent variable is ln(MF rental
startst ), and the maximum likelihood estimation results using level measures for the variables and a
multi-equation system with a co-integrating vector are presented in Panel A. Least squares results
using the first-differenced measures for each variable, along with the error correction term
(collected from the first-stage), are presented in Panel B. Columns two and three present results for
two-stage ECM with the LTV variable excluded in both stages of the estimations. The fourth and
fifth columns present results with the LTV measure included in the two-stage ECM estimation.
Quarterly indicator variables are included in all estimations. The adjusted R2, Durbin-Watson
(DW) statistic, and number of observations are for the second-stage estimation of first-differences.
** Significant at the 5% level.
*** Significant at the 1% level.

and multifamily housing starts behave with error correction terms that are near
unity, indicating that investment corrects almost entirely in one quarter when
production in the preceding is above or below the predicted trend. Multifamily
development projects typically require lengthier permitting and approval periods,
although there is a difference between permits and housing starts. The latter is
the measure used here. In Somerville (2001), 100% of permits on single-family
houses convert to starts within three months of issuance, compared to less than
two-thirds of permits issued for apartments. In a representative quarter, this lag
leaves a large number of apartment permits issued but not yet started that are
available to deploy in the event that prior construction falls below the predicted
trend.
Exhibit 8 presents the tests for equality of coefficients in the two investment
models, when the second stages are estimated as seemingly unrelated regressions.
F-test results confirm the significance of different component roles in the
investment demand price. Single-family housing starts are significantly more
sensitive to changes in capital gains. Only multifamily housing starts are affected
by leverage. In the multifamily market, it is equity availability that leads to
increased investment.
The loan-to-value ratio can alternatively be specified endogenously to depend on
a series of financial variables. In Somerville (2001), new construction is based on
a real option, measured by the volatility of house prices. When the leverage ratio
is included as a component in the yield-price ratio, the transmission to housing
starts begins with the amount of leverage allowed. Grovenstein et al. (2005) treat
the loan-to-value ratio as endogenous to the financial system by including the tenyear Treasury rate, the yield curve, the volatility of one-year Treasury bill rates,

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E x h i b i t 8 u Equality of Coefficients

Equality of Coefficients on Variables

No LTV

With LTV

Dln(SF owner startst ) Model

F-test

F-test

Dln(MF rental startst ) Model

Constant

Constant

2.06

0.69

D Quarter 1

D Quarter 1

8.99***

6.39***

D Quarter 3

D Quarter 3

1.66

0.21

D Quarter 4

D Quarter 4

0.37

1.80

Dln(SF owner startst21)

Dln(MF rental startst21)

Error correctiont21

Error correctiont21

D10-yr Treasury ratet21

D10-yr Treasury ratet21

4.03**

2.50

DSF mortgage premiumt21

DMF mortgage premiumt21

1.16

0.59

DSF capital gainst21

DMF capital gainst21

6.10**

DSF LTV ratiot21

DMF LTV ratiot21

7.51***

3.57*

18.50***

12.25***

5.46**
8.31***

Notes: This table presents results from the F-test for equality in coefficients. The first-difference
estimations in Exhibits 6 and 7 are run as seemingly unrelated regressions. The first column lists
the variable from the estimation where Dln(SF owner startst ) is the dependent variable that is
tested for equality with the variable on the same row in the second column from the estimation
where Dln(MF rental startst ) is the dependent variable. The third and fourth columns report the
F-tests for equality of coefficients from the estimations when LTV is excluded and included,
respectively.
* Significant at the 10%
** Significant at the 5% level.
*** Significant at the 1% level.

and the credit spread as group risk factors.13 The utilized series are integrated of
order one or I(1), but not cointegrated. These variables generate the fitted loanto-value ratio, after allowing separate asset pricing to occur for single and
multifamily mortgages.
Exhibit 9 reports the first-difference loan-to-value ratio estimations, with Panel A
for single-family starts. Leverage ratios for single-family houses are insensitive to
the term structure and all of the financial variables. Instead, loan-to-value ratios
on single-family mortgages are mean reverting, based on the short-term negative
autocorrelation between leverage and its lag. Leverage allocations in the
multifamily market are different. Multifamily loan-to-value ratios rise with the
yield curve and fall with interest rate volatility. Higher long-term rates shift
developers to less expensive short-term financing, allowing greater leverage under
conventional underwriting standards. Higher volatility of Treasury rates lowers
leverage ratios in the multifamily market, increasing the demand for equity.

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E x h i b i t 9 u Determinants of Leverage Ratios

DSF LTV Ratiot

Variable

Coeff.

t-Stat.

Panel A: Single-family LTV ratio

Constant

20.002

20.9

D Quarter 1

0.002

0.4

D Quarter 3

0.003

0.7

D Quarter 4

0.005

1.2

DSF LTV ratiot21

20.388***

24.0

D10-yr Treasury ratet21

20.101

20.3

DYield curvet21
DVolatility of 1-yr Treasuryt21
DCredit spreadt21
2

Adj. R

DW statistic
Observations

0.034

0.1

20.822

21.0

0.617

0.9

10.6%
2.07
98

Panel B: Multi-family LTV ratio

DMF LTV ratiot

Variable
Constant

Coeff.
0.003

t-Stat.
1.3

D Quarter 1

20.0002

20.1

D Quarter 3

20.002

20.5

D Quarter 4

20.002

20.5

DMF LTV ratiot21

0.230**

2.1

D10-yr Treasury ratet21

0.166

0.5

DYield curvet21

1.214***

DVolatility of 1-yr Treasuryt21

DCredit spreadt21
Adj. R2
DW statistic
Observations

21.431*
0.367

3.1
21.8
0.6

11.0%
2.08
98

Notes: This table presents results from the least squares estimation of DLTV ratio t 5 b0 1 b1 z DLTV
ratiot21 1 b2 z D10-yr Treasury ratet21 1 b3 z DYield curvet21 1 b4 z DVolatility of 1-yr Treasuryt21 1
b5 z DCredit spreadt21 1 . Panel A presents results for the estimation with DSF LTV ratio t as the
dependent variable, and the results for DMF LTV ratiot as the dependent variable are shown in
Panel B.
* Significant at the 10%
** Significant at the 5% level.
*** Significant at the 1% level.

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Conclusion

Houses and apartments are substitutable in production and consumption, yet

the series of aggregate production for these two assets reveals few empirical
similarities. Single-family housing starts are sensitive to interest rates and capital
gains, while apartment development is not. Instead, apartments are sensitive to the
use of financial leverage and construction begins when equity is available. Even
though a much higher degree of financial leverage is persistent in single-family
mortgages, it is nearly constant in expansion and contraction phases of the housing
cycle. As a consequence, changes in aggregate loan-to-value ratios on singlefamily mortgages fail to contribute to changes in the aggregate production of
houses.
An explanation of these differences in investment behavior for the two assets has
origins in financial markets. For apartments, an equity market exists whereby
multifamily investors can attract capital through institutional channels and private
equity networks. In the owner-occupied single-family housing market, no similar
access to external equity exists, apart from gifts and intergenerational transfers. A
portion of new apartment development includes tax credits for low-income
housing that are awarded in local contests, which can then be sold to corporations
and the proceeds used as initial equity. Even without tax credit awards, a
precondition in the debt market for apartment finance is that the equity investment
piece must already be established so that the debt component serves as residual
financingthis is reversed from what pecking-order theory would suggest. Houses
are produced by a distinct, debt-oriented contract where borrowers pursue
maximum loan amounts and equity down payments are the residual, which is
consistent with conventional pecking order theory. Government guarantees on
agency-sponsored home mortgages enable lenders to be indifferent with regard to
higher leverage ratios, so long as they satisfy agency standards.
For the borrower on an owner-occupied investment, there are other differences
that shift incentives in favor of debt including tax incentives and nonrecourse
lending. Interest on mortgage debt for an owner-occupant can be deducted against
other sources of income with few limitations, extending gains to the homeowner
from taking on incrementally high amounts of mortgage debt. In roughly onethird of states in the U.S. and from certain lenders, such as the FHA, construction
loans on houses are structured as nonrecourse. Apartment construction debt is
more frequently issued in the form of a recourse loan. Recourse conditions on
multifamily construction loans encourage equity investment to discipline the
apartment market.
Another difference is revealed by the dominant role of capital gains in equity
returns for homeowners. While an apartment investor considers both operating
income and capital gains components to the overall return, the equity return to
the homeowner is predominantly in the form of capital gains. In general, using
positive leverage shifts returns relatively away from the income component and
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toward capital gains. At consistently elevated quantities of aggregate leverage,

investment in houses is highly sensitivity to changes in capital gains.
The model and empirical results contribute to the theory of investment. In
equilibrium, the yield on capital is its cost. Rather than the traditional user cost
with capital gains and interest having coefficient restrictions of positive and
negative one, a flexible form is introduced, which includes the use of financial
leverage in investment demand along with interest rates and capital gains, each
with estimable parameters. Houses have more leverage, and are highly sensitive
to interest rates. Houses are also much more sensitive to capital gains, and in the
opposite direction. A percentage point decrease in interest rates leads to singlefamily starts rising by more than 5%, and a percentage point rise in capital gains
increases single-family starts by 3%, as compared to virtually no effect for either
on apartments. Unlike houses, equity availability in the apartment market
effectively limits investment.
The results have implications for macroeconomic and stabilization policy. The
aggregate production of houses will be affected by low interest rate policies and
asset price targeting, while the apartment market is largely unaffected by these
actions. While houses are sensitive to monetary policy, apartments respond to
fiscal policy. Tax credits for low-income housing are targeted at multifamily
construction, allocating equity in a stable flow and with regional constraints.
Jurisdictional land use regulation is typically more restrictive for multifamily uses.
Allowing bonuses or added densities over the allowed zoning is a strategy applied
by local governments.

Endnotes
1

Brunnermeier and Julliard (2008) argue that fundamental changes, such as demographic
shifts or adjustments in land and building costs, should impact rents and prices
symmetrically. Changes in the yield-price ratio that do not belong to fundamental
changes in the product market represent an irrational component in asset returns. In
Clayton (1996), the yield-price ratio is applied to illustrate deviation from fundamental
values during real estate cycles. Empirical evidence indicates that these differences may
be an overreaction to income growth (Capozza and Seguin, 1996), or an irrational
response to changes in nominal interest rates (Brunnermeier and Julliard, 2008).
An alternative approach to forecasting expected returns on housing is the consumptionwealth ratio introduced by Kishor and Kumari (2014).
Related studies for the role of borrowing constraints in the residential housing market
include Duca and Rosenthal (1994), Haurin, Hendershott, and Wachter (1997),
Engelhardt (2003), and Ortalo-Magne and Rady (2006).
Brander and Lewis (1986) argue that the limited liability effect of debt leads to more
aggressive behavior in product markets. Leverage leads to higher returns in good states
and worsens the loss in bad states. As support for the Brander and Lewis (1986) model,
highly levered firms lose market share during industry downturns (Opler and Titman,
1994), or following a negative demand shock (Campello and Fluck, 2006). Losses are
more severe in sectors holding illiquid assets. Liquidity-constrained firms raise product

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prices relative to wages and input costs during recessions, causing markups to be
inversely related to investment (Chevalier and Scharfstein, 1996). The countercyclical
behavior of markups is more severe in highly leveraged industries (Campello, 2003).
Table Q-1. New Privately Owned Housing Units Started in the United States, by Intent
and Design is made available by the U.S. Census Bureau at: http://www.census.gov/
construction/nrc/pdf/startsusintentq.pdf.
The FHFA historic data are from the Monthly Interest Rate Survey Data, made available
at: http://www.fhfa.gov/Default.aspx?Page5252. The series is reported at a monthly
frequency from 1978 to 2010.
The S&P/Case-Shiller index is from the Lincoln Institute of Land Policy, made
available at: http://www.lincolninst.edu/subcenters/land-values/rent-price-ratio.asp.
The quarterly average home price is calculated by Davis, Lehnert, and Martin (2008)
from 1960:Q1 to 2012:Q3. The S&P/Case-Shiller index is used to standardize and hold
the actual house constant. While house price indices are positively correlated, there is
the potential of producing different results with alternatives. One such alternative is the
FHFA index, which does not appear to be as closely related to the path of single-family
investment as the Case-Shiller index. For the sample horizon, the correlation between
logged single-family housing starts and capital gains from the FHFA index is 0.186,
compared to capital gains from the Case-Shiller index with correlation of 0.611.
The NCREIF database is available by subscription at www.ncreif.org. Accessed on:
March 29, 2013. The NPI Leveraged Returns series can be accessed through the NCREIF
Custom Query Screen and refined according to property type criteria.
The FRB provides historical data on Selected Interest Rates (Daily)H.15, made
available at: http://www.federalreserve.gov/Releases/h15/data.htm.
ADF tests for single-family owner starts and multifamily rental starts were conducted
on logarithmic transformations of these variables, as well as first-differences of the
values in logarithms.
Yunus (2012) provides evidence that stock markets and securitized property markets are
cointegrated in 10 developed nations.
There are other aspects to time series testing, including autoregressive (AR) and movingaverage (MA) processes in the error term. Tests on the residuals, t , generated from the
estimation of single and multifamily investment in Equation (9), reveal that AR(1),
AR(2), MA(1), and MA(2) coefficients are individually insignificant from zero. The
autocorrelation check of the residuals from each model indicates white noise in the error
term, with chi-square statistics up to 24 lags that fail to reject zero autocorrelation.
Grovenstein et al. (2005) also include the credit spread volatility as an additional
measure. In the time series version of this data, which we use in this study, the credit
spread is highly correlated with its volatility, so the credit spread volatility measure is
suppressed.

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We are grateful to John Benjamin, Daniel Winkler, and two referees for their comments
and suggestions. Seminar participants at the American Real Estate and Urban
Economics Association, American Real Estate Society, and Georgia State University
provided comments.

Peter Chinloy, American University, Washington, DC 20016 or chinloy@

american.edu.
Prashant Das, Ecole hoteliere de Lausanne, Switzerland 1000 or prashant.das@
ehl.ch.
Jonathan A. Wiley, Georgia State University, Atlanta, GA 30303 or jwiley@gsu.edu.
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