Housing Markets in a Simple Pure Consumption Economy∗

This paper studies different housing market arrangements in an intertemporal pure consumption economy, consisting of a desirable and an undesirable housing location. Economic agents are heterogenous with respect to the utility premium they derive from living in the desirable location. This utility premium, or match, is drawn independently in every period, and also the popularity ranking of the locations may be reversed between periods. Under owner-occupation, the opportunity cost of living in a desirable location takes the form of random capital losses, and forgone capital gains. The rental arrangement corresponds to owner-occupation, with capital gains and losses taking place with probability one. We show that under the rental arrangement the agents have strong incentives to choose their location according to the current match, while under owner-occupation these incentives are weaker, and borrowing constraints play a larger role in clearing the housing market. We demonstrate that there is more residential mobility under rental markets than under owner-occupied housing. According to a utilitarian social welfare criterion, the rental arrangement outperforms owner-occupation.