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Title: Endogenous Gentrification and Housing Price Dynamics

Citation Type: Working Paper

Publication Year: 2009

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Abstract: In this paper, we explore differential changes in house prices across neighborhoods withina city to better understand the nature of house price dynamics across cities. We do so byproposing a previously unexplored mechanism where individual utility is increasing in theincome of one's neighbors. Instead of proximity to jobs, it is proximity to "richer" peoplethat drive differences in land prices within and across cities. In the model, segregation byincome occurs: richer households are concentrated together with poorer households livingin the periphery. In response to a positive increase in housing demand (e.g. a decreasein the interest rate, an increase in city-wide income, an influx of richer households), richerhouseholds expand into adjacent poorer neighborhoods. This is what we term "endogenousgentrifcation". As the richer households expand into poorer neighborhoods, the land valueincreases due to the externality, driving house prices up. The model also predicts that thecity-wide responsiveness of house prices to a given demand shock will depend on the incomedistribution within the city. As a result, richer cities are predicted to respond more to thehousing demand shock, even if housing supply is perfectly elastic, because they experiencea higher degree of gentrifcation. Using a variety of different data sources, we show that thedata are consistent with many predictions of our model. In particular, we find that thoseneighborhoods whose house values increase the most during city wide housing booms are thepoor neighborhoods that are in close proximity to the richer neighborhoods. This patternis robust to controlling for distance to jobs. Additionally, we find that these neighborhoodsthat experience the highest price increases also show strong evidence of gentrifcation (largeincreases in income, large reductions in the poverty rate, and an influx of new residents).We formally assess the mechanism of the model by showing that house prices increase substantiallyin a poorer neighborhood when the surrounding neighborhoods receive a positiveshock to income. Lastly, we assess how much of cross city differences in price appreciationrates during the 1990s and the 2000s can be explained by our mechanism.

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Authors: Hurst, Erik; Guerrieri, Veronica; Hartley, Daniel

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Institution: NBER

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Data Collections: IPUMS USA

Topics: Housing and Segregation, Poverty and Welfare

Countries: United States