Residential buildings and the cost of construction: new evidence on the efficiency of the housing market

Present value studies of asset market efficiency are controversial because they compare asset prices to unobserved discounted streams of future rents. As an alternative, if housing markets are efficient, then the price of residential capital or buildings should satisfy the following two conditions: (i) deviations between new building prices and construction costs should disappear faster than construction lags and have no effect on construction, and (ii) temporary building price shocks should dissipate at a similar rate for different vintage buildings. Results from an error-correction model support both hypotheses for single-family housing in Vancouver, British Columbia. This implies that the implicit market for residential buildings is efficient and that any inefficiencies in the housing market must lie in the market for land itself.