What Do Hedonic House Price Estimates Tell Us When Capitalization Rates Vary?

This paper demonstrates theoretically and empirically the conditions under which estimated implicit prices from hedonic equations using house value reflect implicit willingness to pay for housing attributes. Implicit prices obtained from rental hedonics, consistent with theory, reveal the willingness to pay for current housing services. Therefore hedonic equations relating asset prices to current characteristics only reveal willingness to pay for current structure and neighborhood services if cap rates (rent to value ratios) are constant. Several new results demonstrate how theory can be used to identify situations in which cap rates are unlikely to vary. In cases where cap rates are likely to vary, methods for determining the bias inherent in using asset rather than rental prices are developed. Rules and tests for situations where cap rates are constant are developed and practical examples demonstrated. Fortunately, application of economic theory facilitates finding cases where variation in cap rates creates empirical problems and identifying ways to avoid potential bias in using house value hedonics