Housing externalities refer to the effect that the characteristics of a house have on the value of nearby homes. They are pervasive in residential neighborhoods. As most people know, investments in one neighbor’s house affect the beauty, cleanliness and overall amenities of a block and, as a result, affect the value of other houses in the area. Therefore, the magnitude and spatial scope of these externalities is a key determinant of the social return to urban revitalization policies, like local investment subsidies or affordable housing projects, as well as events that lead to vacant housing units, like the massive foreclosure wave experienced in U.S. cities in 2007-10.
Measuring housing externalities is a complicated task because of a standard reverse-causality problem: The value of a house may be high because it is surrounded by high-value houses, but the house may be surrounded by nice houses because its value is high. So to measure these externalities, we need to investigate changes in the value of houses that are caused by external factors and unrelated to the current values of the homes.
In our research published in the Journal of Political Economy, we considered an urban revitalization program implemented in Richmond, Virginia, which subsidized housing investments in poor neighborhoods. Using this program and individual housing transactions data, we measured that housing externalities in these neighborhoods were largest in the areas closest to the homes receiving subsidies, and that these effects declined with increasing distance from the targeted homes. For example, land price increases next to the houses receiving subsidies were about 10 percentage points higher than in similar areas that did not received the subsidy. Further away -- at a distance of 2,000 feet from targeted homes -- land prices were only about 2.5 percentage points higher than in comparable areas that were not part of the revitalization program. The final outcome was that each dollar invested in the program raised total land values in a 3,000-feet radius by about six dollars in a six-year period.
The magnitude and scope of the measured housing externalities indicates that the social value of this policy was positive and large. It also suggests that the current wave of foreclosures is probably reducing the value of urban land in the U.S. way beyond its direct effect on foreclosed homes because of the negative housing externalities generated by vacant homes.
Rossi-Hansberg, Esteban, Pierre-Daniel Sarte, and Raymond Owens III. 2010. “Housing Externalities.” Journal of Political Economy 118, no. 3: 485-535.