Edward L. Glaeser is an economics professor at Harvard.
For the fifth month in a row, the Case/Shiller Standard & Poor’s Housing Price Index figures for January that came out last week showed essentially flat prices.
It has been 10 months since prices stopped their free fall, and there is a lot to like in price stability — not only relative to prices crashes but also relative to price booms. For years, many American homeowners had persuaded themselves that real housing prices should rise year in and year out, but there is no reason to either expect or hope for perpetual price gains.
One reason that people may have come to expect consistent housing price appreciation is that houses are assets, like stocks, and stocks should, on average, appreciate.
People who buy stocks are giving someone else the use of their money. The only way that deal persists is if investors get a decent return on their money, either in the form of hefty dividends or rising stock prices.
Houses are assets, too, but it’s a mistake to expect them to offer a regular rise in price. Houses pay hefty dividends to their owners in the form of living space — that’s the real return on housing investment – and the basic economics of housing doesn’t point to perpetual price growth.
Some pundits look at the ratio between housing prices and income as if that should remain stable, which would mean that prices should at least rise with incomes.
But that doesn’t make much more sense than expecting a constant ratio between income and either computer or car prices. Declining construction costs, and rising incomes, led the ratio of housing value to income to drop by 40 percent or more between 1980 and 2000 in places like Houston, Minneapolis and Phoenix.
Like any other well-functioning industry, the construction industry experiences technological improvements and increased efficiency. In the computer industry, technology has meant that affordable laptops have computing power that would have been exorbitantly expensive in 1980. As a result, no one ever buys a computer thinking that it would rise in value. The real cost of building a home declined by about 3 percent in both the 1980s and the 1990s.
In principle, declining construction costs could also lead homes to become more affordable year after year.
Declining construction costs have not always led to declining home prices because homes have two other crucial ingredients: land and permits. When those factors aren’t scarce – and they aren’t in much of America – then construction prices dominate and price should be expected to stay flat or fall.
Indeed, there are plenty of major metropolitan areas where real housing prices barely rose between 1980 and 2000. Even Census Self-Reported Home Values, which don’t adjust for generally increasing housing quality, suggest that prices stayed flat between 1980 and 2000 for many of America’s fastest growing cities, like Las Vegas and Miami. In expanding Houston, prices dropped dramatically.
There are, however, a number of metropolitan areas – New York, San Jose, San Francisco, Boston – where prices have risen more steadily over time. Joseph Gyourko, Christopher Mayer and Todd Sinai have called such places “Superstar Cities.” These areas have also, not coincidentally, maintained high housing prices despite the bust. According to recent data from the National Association of Realtors, San Francisco and San Jose remain the two most expensive metropolitan areas in the continental United States.
Places like Boston, New York, San Francisco and San Jose experienced exploding housing prices between 1980 and 2000 because they had both space-specific factors that increased housing demand and increasingly draconian limits on housing supply.
In the Northeast and California, high demand was created by economic vitality, which in turn reflects that magic that results when smart people work together in close geographic areas. The California cities also benefited from their comfortable Mediterranean climate.
High prices occur when rising demand collides with restricted supply of land and housing permits.
Manhattan genuinely has little land. Albert Saiz has presented convincing evidence that the hilly topography and water in the San Francisco Bay region makes building difficult. Man-made limits on construction, like huge minimum lot sizes and vast preservation districts, have played an even more important role.
But the long-run price growth in these areas is more anomaly than norm.
The cautious home buyer should reflect on the fact that few places have the two preconditions for booming prices: restricted supply and a durable anchor for robust demand. Moreover, even if supply is restricted in one area, the odds are that some other place has similar assets and a greater willingness to supply homes.
Boston is a skilled metropolitan area and its restricted supply has led to high prices. But Atlanta is now a skilled metropolitan area as well, and its housing supply seems virtually unlimited. Why is it obvious that Boston can maintain a permanently higher price level than Atlanta?
America is filled with empty land. We have a remarkable transportation network that enables people to commute vast distances. We have an efficient construction industry that, when unfettered, is capable of producing vast numbers of high quality, affordable units.
Those are the fundamentals of the housing market. I wouldn’t count on your home getting more valuable over time.