Thursday, October 19, 2017

Housing: Part 264 - Rent is how we consume housing services!

Chris Dillow at Stumbling and Mumbling has a post up about housing where he claims that added supply in London won't make housing much more affordable.

This post is an excellent example of how confusion between owning and consuming is such an important source of error in housing markets.  To be fair, his treatment of the issue is conventional here.  As he writes: "Changes to the flow of the asset are generally too small to have much effect. For this reason, many economists have traditionally modeled house prices as if only demand matters".

This is absolutely, sadly, true.  As with his post, pick up any random academic article about the causes of the housing bubble and it is likely that "rent" is not mentioned in the paper at all, even as a factor to be dismissed.  It is widely treated as a factor not relevant enough to even bother dismissing it.  Not only is housing treated as if only demand matters, but it is treated as if this is demand for owning, rather than demand for consuming.

I wonder if the single most useful policy we could enact regarding housing markets would be to force all homeowners to actually write themselves a check each month for the market rental value of their homes.  I think the fact that we don't do this, so that many homeowners equate their cash expenses with the cost of housing, is a significant reason why this error is so widely committed.

The cost of housing is rent.  Period.  The crazy thing is that about half of the residents of the large urban centers are renters!  For them, this is not complicated.

Dillow writes:
If supply doesn’t affect prices, what does? Lots of things: demographics, incomes, debt levels, expected incomes and the availability of credit. My chart shows another influence: real interest rates.
Now, in order for interest rates to affect home prices, rental value must be an input, as Dillow's chart implies.  But, by removing rent as an explicit input, notice how much easier it becomes to dismiss supply as a factor in price.  Supply won't affect any of the remaining factors Dillow cites.

Imagine if we conceived of other markets the way we conceive of housing.
Families are finding it increasingly difficult to feed their families.  But, the proposed solution - to harvest more grain - is a non-starter.  There is only so much land, and adding to the available acreage is a slow process that can't begin to keep up with the problem.  And, acreage continues to be very expensive.
Acreage is expensive mostly because of low interest rates, loose lending to farmers, and high farmer incomes.  So, the question is, how do we reduce the value of acreage to make food more affordable?  Maybe we could pass laws so that farmers must allow gleaning.  Maybe we can put more obstacles up so that banks aren't so eager to lend to local farmers.  Maybe we can regulate the harvest so that farmers only sow the grains that we have determined are most in need.

PS. It could be that Dillow's claim about supply not bringing down prices is somewhat accurate in practice, which I discuss here.  It depends on whether high prices in constrained cities are more sensitive to interest rates or to expectations of rising rents.  If constrained supply makes prices more sensitive to low interest rates, then the rate of new supply in the worst cities would, indeed, need to double, triple or more in order to stop the flow of low-income out-migration and to introduce enough supply to create a regime shift in rent expectations so that they are actually expected to decline.  I have been moving toward this point of view.


  1. Egads, this puts me in a state of catatonic hysterics.

    Yes, marginal increases in the supply of housing, or anything, might not bust down prices. Even oil markets (a commodity) act in odd ways for seasons at a time.

    But to say the supply does not affect rents?

    Yet the macroeconomics profession has ossified around wage-watching, What is driving inflation (and driving down living standards) in Hong Kong, or Los Angeles?

    Not wages! It is housing! Yes, it would take a bunch of housing to fix matters. And that is what the US should be doing. Building forests of luxury condo towers in closed access cities. Same in Hong Kong.

  2. Your last remarks seem to place closed access cities in a conceptual rut, as each modest wave of supply growth is accompanied by the social outcomes its opponents predicted. Policymakers and the public, if not outright hostile to supply growth, will turn indifferent to that variable and feel justified in their focus on demand side solutions. Meanwhile the rut deepens and the traction needed to get out of it (4x growth, say) is harder to generate. Might this be the historical pattern that turns open access cities closed, or do contingencies of law and local politics have more to do with it?

    1. I think this is correct. I like to look at this through the North, Wallis, and Weingast prism of "limited access" vs. "open access" - I have sort of borrowed their terminology. Even without the problem you are talking about, I think these cities would be in a tough bind, because, as NWW note, we really don't know how to transition from limited access to open access governance. Once governance becomes focused on claims on rents instead of on universal access, a collective action problem ensues, and all parties must play within the perverse rules of limited access in order to keep from being taken advantage of. It's a miracle that any society ever moved from limited to open access governance. These cities have happened a sort of strange new version of limited access governance where access is limited, but it is available to the highest bidder. So, I would expect their options to be rather dim in any case. This is why the solution probably entails imposing open access from a higher level of governance, like the state or federal level. That creates its own problems, because if that is the solution, and it works, no city will sit idly by and watch its collective net worth drop by 50% without fighting.

      So, this problem, that it might take a tripling or quadrupling of current production to actually move prices much, is an additional headwind on top of a hurricane's worth of headwinds already in place.

  3. "This is why the solution probably entails imposing open access from a higher level of governance, like the state or federal level. That creates its own problems, because if that is the solution, and it works, no city will sit idly by and watch its collective net worth drop by 50% without fighting."--Kevin Erdmann

    Yes---and perhaps not just the city and its property owners. Lenders too. That why I alway say there is a propertied-financial class addicted to tight property zoning.

    I am reading more on Hong Kong, where there is an obvious and screaming need to up zone everything everywhere (or simply unzone). BTW, Hong Kong has land zoned for farming.

    Here is a glimpse into HK land values: "Li Ka-Shing’s CK Asset Holdings sold its 75 per cent holding in The Center to a Chinese-led group for $HK40.2 billion ($6.56 billion), a record for a Hong Kong office tower, the Hong Kong Economic Journal reported."

    Yes, buying 75% of a single office tower in HK costs $6.5 billion. The whole building will set you back $8.6 billion

    Why does not HK unzone? I don't know yet, but I surmise property owners and lenders are trapped.

    A version of this is underway in closed-accesss cities in the US.