The Fallacy of Eternal Home Price Appreciation

A while back a debate began on the question of whether or not a house is an investment. Even if it is an investment, then Harvard economist Edward Glaeser explains why it's a particularly poor one in a piece by from the New York Times Economix blog today. He argues that it's pretty plausible that your house's value won't rise.

First, it's Glaeser actually does appear to believe that a home is a sort of investment, as he refers to houses as assets. He says that it pays the owner back dividends in the form of living space. But that may be all that some owners get back: there's no economic reason why the price should generally increase:

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.

In principle, declining construction costs could also lead homes to become more affordable year after year.

So prices would actually decline. Glaeser notes that scarcity also matters. If housing in some area is in low supply, then it's more likely prices could increase there. Thus, in rural locations, where scarcity is less of a factor, construction costs likely drive price.

Those are supply-side effects, but demand matters too. If an area is seen as extremely attractive due to its climate and or economic condition, then more people will want to move there. When housing growth can't keep up with the population growth, home prices increase. That's why you saw booming real estate markets in places like Florida even before the housing bubble began.

Both supply and demand effects demonstrate the importance of demographic changes to home prices. For example, if people begin suddenly flooding cities from rural areas, then the cities would experience greater demand, and given their relative scarcity of homes, prices would increase. Meanwhile, the price of houses in rural areas would decline. But if people begin leaving cities to move to more rural areas, then the opposite effect would occur, though it's likely that the appreciation of homes in those rural areas wouldn't be as rapid as it would be in cities, given the relative scarcity.

You can also apply this logic to the areas that were first helped but ultimately hurt most by the housing bubble. Places like Florida and Arizona might take even longer to rebound if people are leaving to seek economic opportunities elsewhere. (There's some evidence of that happening in Florida.) After having built too many homes during the bubble, those markets would have to experience significant population growth to bring back housing appreciation. Instead, the opposite may occur, which could actually result in house values declining further.