The capital gains effect in the demand for housing

Recent concerns about speculation in housing markets have underscored the fact that housing is not only a consumption good but is also an investment asset with uncertain potential to generate capital gains. We present a theoretical model of housing demand, under uncertainty, that captures these dual characteristics. Emphasis is placed on the formulation of expectations about housing prices and the role that potential capital gains may play in the demand for owner-occupied housing services. The model is then taken to the data. Econometric analysis of data from Florida, a state known for periodically dynamic housing markets, is carried out. We find that an increase in housing prices increases the demand for owner-occupied housing services. Thus, housing's role as investment asset with its potential for capital gains dominates its role as consumption good, which alone would produce a downward sloping own demand curve rather than one which is upward sloping. Our theoretical model fully rationalizes this econometric result.