House Prices and Replacement Cost: A Micro-Level Analysis

According to housing investment models, house prices and replacement costshould have an equilibrating relationship. Previous empirical work|mainlybased on aggregate-level data|has found only little evidence of such a relationship.By using a unique data set, covering transactions of single-familyhouses over a 25 years period, we establish strong support for the relationshipat the micro level. In the time series context, we find that new house prices andreplacement cost align quickly after a shock. In the cross-sectional context, wefind prices of old houses and replacement cost are closely related once buildingdepreciation has been taken into account. As to be expected from these results,replacement cost information also proves to be useful for the prediction of futurehouse prices.