Josh on Housing – Part 1

Wandering around the web, I found this article on the economics of housing:

Home Economics – New York Times

In 2000, Glaeser took a sabbatical from Harvard and began to spend a few days a week in Philadelphia working with Joseph Gyourko, a real-estate economist at the Wharton School of the University of Pennsylvania. Glaeser had already been thinking about the relationship between housing and urban poverty when one day he and Gyourko began to discuss why cities like Philadelphia and Detroit — places with poor future prospects, both economists believed — weren’t doing even worse in terms of population. Why didn’t everyone leave, Gyourko wondered, and go to a place like Charlotte, N.C., that had a fast-growing economy? This question addresses a puzzle of urban economics. Cities (think of Las Vegas or Phoenix) can grow at a very fast rate, exploding overnight with businesses and residents. Some can increase in population by 50 or even 60 percent in a decade. But cities lose their residents very slowly and almost never at a pace of more than 10 percent in a decade. What’s more, when cities grow, they expand significantly in population, but housing prices tend to rise slowly; even as Las Vegas grew by leaps and bounds in the 1990’s, for instance, the average home there cost well under $200,000. When cities decline, however, the trends get flipped around. Population diminishes slowly, but housing prices tend to drop markedly.

Fascinating observation: When a location becomes undesirable, house prices collapse quickly – but the affordability of housing keeps people living in them. Rural Australia exhibits this kind of behaviour in droughts, and generally. Basically, only poor people live where noone really wants to:

Glaeser and Gyourko determined that the durable nature of housing itself explains this phenomenon. People can flee, but houses can take a century or more to finally fall to pieces. “These places still exist,” Glaeser says of Detroit and St. Louis, “because the housing is permanent. And if you want to understand why they’re poor, it’s actually also in part because the housing is permanent.” For Glaeser, this is the story not only of these two places but also of Buffalo, Baltimore, Cleveland, Philadelphia and Pittsburgh — the powerhouse cities of America in 1950 that consistently and inexorably lost population over the next 50 years. It is not just that there were poor people and the jobs left and the poor people were stuck there. “Thousands of poor come to Detroit each year and live in places that are cheaper than any other place to live in part because they’ve got durable housing still around,” Glaeser says. The net population of Detroit usually decreases each year, in other words, but the city still attracts plenty of people drawn by its extreme affordability. As Gyourko points out, in the year 2000 the median house price in Philadelphia was $59,700; in Detroit, it was $63,600. Those prices are well below the actual construction costs of the homes. “To build them new, it would cost at least $80,000,” Gyourko says, “so there’s no builder who would build those today. And as long as those houses remain, the people remain.”

So, houses can be bought for less than they be constructed for – kind of paying full price for the house, then getting a discount because of the dirt they’re built on. The prices are very attractive, but they’re that cheap for a reason – you don’t want to live there. The only people who will live there are those that can’t afford to live elsewhere. You get a massive supply of housing (that doesn’t get smaller – not quickly anyway) that is insensitive to price, so basically demand drives prices in a falling market. If the demand is falling because the place is no good to live in, prices will fall like a stone as everyone who can afford to live elsewhere does.

Buying in an environment like this, the price you pay needs to work on the assumption of $0 residual value at the end of the economic life of the house on the property. So rental returns have to compensate you for the forgone income (i.e. provide a return on your investment) and holding costs (rates, insurance, etc) plus compensate you for the depreciation of your investment. This would imply that rents in these kinds of environments have high yields compared to markets where the property is expected in increase – or at least not decrease – in value.

What I’m taking away from this is that old adage – you’re buying the dirt, not the house. Also, location location location. Plus, yield alone is a bad thing to chase.

As a guide for purchasing, the article seems to say that you want to go where there’s a natural upper limit on housing, and better yet a rapidly depreciating house stock.

Glaeser likes to point out the close correlation between a city’s average January temperature and its urban growth; he also notes that cars per capita in 1990 is among the best indicators of how well a city has fared over the past 15 years. The more cars, the better — a conclusion that seems perfectly logical to Glaeser. Car-based cities enable residents to buy cheaper, bigger houses. And commuters in car-based cities tend to get to work faster than commuters in cities that rely on public transit. (The average car commute is about 24 minutes; on public transportation, it is around 48 minutes.) While many of his academic peers were looking at, and denigrating, how the majority of Americans have chosen to live, Glaeser (though no fan of the aesthetics of sprawl himself) didn’t think an economist should allow taste to affect judgment. “You shouldn’t go around thinking that all these people are just jackasses for deciding to drive an automobile,” he says.

I wonder if Melbourne commuting is longer because it’s difficult to move house closer to your job? Also, Melbourne is a huge city compared to many US cities, there’s only a handful of American cities larger than a couple of million people, and most are sub 500K.

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2 thoughts on “Josh on Housing – Part 1

  1. daniel

    “And as long as those houses remain, the people remain.”

    That’s a good point. I suppose you don’t really see many urban areas that have been genuinely deserted (Mary Celeste-style). Maybe Wittenhoom and others like it.

    “The more cars, the better — a conclusion that seems perfectly logical to Glaeser. Car-based cities enable residents to buy cheaper, bigger houses.”

    But is access to cheap, big houses in and of itself a good outcome, even ignoring sustainability and looking exclusively at economics? Those cities that are car dominated are also the most exposed to the continuing climbs in petrol prices, which economically is expected to bite some areas badly in the next few years. (See the report on oil vulnerability by Jago Dodson et al). Let alone the health and social isolation implications from car dependence.

  2. daniel

    Age report today:

    Cheap housing on Melbourne’s fringes was not as cheap as it seemed, Dr Newman said yesterday, because poor public transport access in many recently built areas of the city imposed massive fuel and car costs.

    Residents in Melbourne’s “affordable” areas, in suburbs such as Beaconsfield, Pakenham or Officer, were spending up to 36 per cent of their income on fuel, he said.

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