Falling Star Cities

Robert Shiller says rates of return on housing in "superstar cities" do not exceed rates of return elsewhere:

Superstar cities may be investors' superstardust, by Robert J. Shiller, Project Syndicate: In a much-talked-about recent paper entitled "Superstar Cities," economists Joseph Gyourko, Christopher Mayer, and Todd Sinai argue that such high-status cities - not only London, Paris, and New York, but also cities like Philadelphia and San Diego - may show an "ever-widening gap in housing values" when compared with other cities.

The authors seem to be saying, in effect, that a housing boom in these areas can go on forever. ... Many people view the superstar city theory as confirming their hunch that, despite the current slowdown in home prices elsewhere ..., investors can expect to make huge long-term gains by buying homes in these cities, even though the homes there are already expensive.

But, as I have said in my debates with the authors, if one reads their paper carefully and thinks about the issues, one would see that there is no reason to draw such a conclusion.

Why should home values in glamour cities increase forever? Gyourko, Mayer, and Sinai justify their claim by arguing that these cities really are unique.

They have only limited land, and if one assumes ever-increasing GDP and rising income inequality, there will always be more and more wealthy people to bid up prices in these scarce areas. ...

But what do these arguments really mean for the outlook for investments in homes in superstar cities? Let us consider the fixity of land. While there is only so much land in any one of the existing superstar cities, in every case, there are vast amounts of land where a new city could be started. ...

Private developers ... tend to be ingenious at developing glamorous new areas from little towns within an hour's commute from major cities. It happens in so many places and so regularly that we take it for granted and rarely even notice it.

Indeed, since the industrial revolution, the development of such new urban areas is a central theme in the history of the world. New cities are constantly ripening like so many cherries on a tree, drawing people away from older, original cities.

And the new cities have a way of looking brighter and fresher than the old urban areas, which are often seen as jumbled and decaying.

How much might we expect a home in a famous city to outperform other real estate as a long-term investment? The answer: not much at all.

Prices in the cities that Gyourko, Mayer, and Sinai identify as superstars generally appreciated by no more than one or two percent a year more than in the average city from 1950 to 2000, and even that difference is probably largely due to an increase in the size and quality of homes. ...

Finally, as Gyourko, Mayer, and Sinai themselves note, even these small long-term differences in home price across cities have tended to be offset by lower rent-price ratios in the superstar cities. For an investor, the rate of return is the sum of the rate of appreciation and the rent-price ratio, so the low rent-price ratio reduces the advantage of faster appreciation.

Most of the popular attention that the "superstar cities" theory has received merely reflects the psychology of the housing boom that we have been seeing, as well as a wishful thinking bias. People want to believe...

Comments

[Tapen Sinha]

If we look at cities like San
Diego, it represents lot more
than the superstar city effect.
It represents movement of people
from colder to warmer climes.
With aging and mobile population,
that is inevitable. But it does
not explain why home price rise
in Boston's old neighborhoods is
far more than two percent.

Tapen

[richard]

here is a tacit, long-term assumption here: that proximate smaller cities will be competitive with large cities even as oil becomes more scarce.

If gasoline increases in price more rapidly than most anticipate, then the price of real estate outside of larger metro areas and in sprawling Southern cities might decline to reflect their higher costs of living.

[howard]

tappen, i used to live in boston, and trust me, in the early '90s, housing prices fell, painfully.

but i really wanted to post about the land issue. while it is true that (short of a city expanding its bounds), the supply of "earth" is fixed, thanks to the efforts of structural engineering, where once we fit a single-family house, we now can fit a tall condo building, which, in the terms under consideration here, is equivalent to adding more land....

[Julio]

The expansion of cities into satellite cities is also limited by the supply of water. Here in the San Francisco Bay Area, this is becoming a significant issue, and has always been in southern CA.

[cm]

richard: But then who's to say the business action is going to stay in the big city? To some approximation, even today there is a trend that most business (unless offshored altogether BTW) is outside the city and mostly big banks and other classes of intermediaries are left behind (the "job multiplier" classes of service and supportive business will always be where the "core" business is, including the city). Then there is the culture/art sector that has not expanded into the bedroom communities. But here there is also are trend of decentralization, with smaller-time municipal theaters and culture centers (FWIW).

[Lord]

'Within an hour's commute' identifies the shortcoming here. Metropolises are already beyond that size and becoming larger every day as congestion worsens. There will be new attractive communities built but these will never be as close, convenient, or desirable as existing ones for all their newness. They have to be built inland in less temperate areas.

[James Killus]

Homes in superstar cities are a form of consumption, especially conspicuous consumption, and should be viewed as such. They are also a primary repository for asset price inflation, and are therefore indicators of imbalances in income distribution.

Which is to say that the walls in "first up against the wall when the revolution comes" will be the walls of the houses in superstar cities. Figuratively speaking, no doubt.

[anne]

http://www.nytimes.com/2006/03/05/magazine/305tulips_shorto.1.html?ex=1299214800&en=bb369c2505b1c24f&ei=5090&partner=rssuserland&emc=rss

March 5, 2006

This Very, Very Old House
By RUSSELL SHORTO

In 1625, a carpenter named Pieter Fransz built a house on the outskirts of Amsterdam. He was young, ambitious and lucky enough to belong to one of history's greatest generations: his life spanned the course of his country's golden age, when tiny Holland became an empire and Amsterdam grew into Europe's wealthiest city. Fransz walked the streets with Rembrandt; he saw a forest of masts grow in the harbor, as ships returned from the East Indies laden with pepper and nutmeg, a sack of which could make a man wealthy for life. He and his family prospered along with the city; 17 years after building his house, he was rich enough to buy the one next door, into which his daughter and her husband moved. In 1683 he was still listed as the owner of both properties. Happiness isn't registered in municipal archives, but the image of this one not terribly consequential human life that remains on the palimpsest of time speaks of contentment: a man who has lived beyond the normal life span of his era, surrounded by family, financially successful.

Most of us leave no lasting traces that recall our stay on the planet, but through accident and fate, Fransz left something that has endured the centuries. His house — an elegant redbrick step-gable, its facade ornamented with sandstone bands and wooden cross-framed windows, a building that has more of the Renaissance than the Baroque about it — still stands. Napoleon and Hitler conquered Amsterdam in their separate centuries; later, postmodern architects and the sex and soft-drug industries made their marks. Pieter Fransz's house withstood all.

The Dutch have always been meticulous recordkeepers, so it is possible to follow this house, and others nearby it on Amsterdam's famous Herengracht, or Gentlemen's Canal, as they make their way through the centuries: to watch the succession of doctors, diamond cutters, confectioners, merchants and politicians move in and out, to glimpse the births and deaths, to watch careers and families unfold. More to the point, it's possible to follow the successive property transactions in this area of Amsterdam from the time it was developed to the present.

In itself, this isn't exceptional: other European cities have land registers that date to the Middle Ages. What makes Pieter Fransz's neighborhood unique — and uniquely interesting to some economists who are studying today's global real-estate boom and wondering whether the bubble that has been expanding for the past decade and more is in the process of bursting — is what real-estate experts call a constant quality index. Cities change over time; neighborhoods fall out of favor, and new ones come into vogue. Comparing property values in Greenwich Village a century ago with those of today might be interesting as part of a study of a changing neighborhood — the transformation of a low-rent, working-class community into a tony and sophisticated enclave — but not as a way of understanding how real-estate value changes over time.

From the time the Herengracht was developed in the early 17th century, however, it has been Amsterdam's prime real estate, the place where power brokers — 17th-century merchants dealing in spices and slaves or 21st-century bankers and international consultants — have chosen to base themselves. Looking at real-estate transactions over four centuries on this canal on which Pieter Fransz built his home gives a quality constant of unparalleled duration.

This is what attracted Piet Eichholtz, a professor of real-estate finance at Maastricht University in the Netherlands, to study the Herengracht in the 1990's. Eichholtz's work — the so-called Herengracht index — has become a touchstone in recent discussions about real-estate prices. He began with a sense of frustration. "If you look at most research on real-estate markets," he said, "papers will typically say they are taking 'a long-run look,' and then they go back 20 years. I wasn't impressed with that. I thought you had to go back further to get a really good picture of what a housing market performs like."

Eichholtz's study of the Herengracht came to international attention when the Yale economist Robert J. Shiller relied on it in the second edition of his best-selling book "Irrational Exuberance," which was published in 2005. After the first edition came out in 2000, Shiller became famous for predicting, correctly, that the stock market's explosive rise was about to end. The book's title — a phrase made famous by the former Federal Reserve Board chairman Alan Greenspan — referred to Shiller's argument that the market's rise of the 1990's was based more on herd mentality than on common sense.

In the new edition, Shiller applies the same thinking to global real-estate prices and argues that the phenomenal increases of recent years — especially in places like New York, San Francisco, Sydney, London and Paris, but also more broadly — amount to another instance of irrational exuberance. Taking the long-range view, he says, led him to conclude that real-estate prices are destined to fall. "The data just are not there to support the idea that housing prices will continue to soar out of sight," he said....

[Bruce Webb]

"Robert Shiller says rates of return on housing in "superstar cities" do not exceed rates of return elsewhere:"

Which is just another case of building assumptions in to your argument. Who exactly made "rate of return" into the central value? Back in the day the reward for success was being able to buy into the "best neighborhood". You lived on the "best block" and nobody noticed who exactly was earning the best return. Because mostly values weren't returning anything at all.

Make the right choice, buy into the right market right as it gentrifizes and you can make great "rates of return". Or you can buy an overprized house in a stellar school district and have your kid have a supersized school experience.

Shiller is an idiot. Not everything is about return on value.

[cm]

Bruce Webb: Why the damning assessment? Based on the quote I see Shiller only commenting on the ROI argument, not endorsing it.

[John]

It may not be all about rate. If you start at a higher value level, and apperciate even at slightly above the average market rate , you end up creating more absolute asset value. With leverage you accelerate the creation of dollar net equity to the household . After all we don't work for rate of return , but to create absolute value for our households

It is also a truism in real estate that better locations protect value on the downstroke . You are definitely seeing that in this cycle

[Bruce Webb]

Schiller has commented on real estate in ways that show he really doesn't get it, or doesn't want his audience to. He presents the rates of return on real estate and compares them to other asset categories without visibly taking into account economic variables. For example taxes. Homeownership is tremendously advantaged compared to other investment because of the exemption. Few people who sell an owner-occupied house will owe any taxes at all on the gain. Similarly the property tax deduction significantly increases your net return on the asset. As does the discount for rent.

Near as I can see he doesn't price any of this in or let it factor into his thinking. Whether or not moving from rent to own depends like everything in real estate on your local market, but generally the math works out.

I found this current piece profoundly shallow. This was practically painful.
"Private developers ... tend to be ingenious at developing glamorous new areas from little towns within an hour's commute from major cities. It happens in so many places and so regularly that we take it for granted and rarely even notice it."

A gated subdivision doesn't substitute in any way shape or form for a city, It provides a totally different function. Which is why in the past wealthy people had a country house and a town house. The notion that New York City isn't special because you can buy a big new house in Westchester is just loony on its face.

[Bruce Webb]

Housing is almost unique because of leveraging. You can and people do borrow 100% of the cost of a house. I am a veteran and so eligible for a 100% LTV with no money down. In my circumstances does rate of return even make sense?

But take a more standard scenario. Your credit is good enough to qualify for a 90% LTV on a $300,000 house. That is $30,000 down. That house appreciates 4% a year for three years and it is worth about $360,000. Is your return 12% or did you triple your money? Shiller would likely say the former, I suggest the latter, in that you could extract that $60,000 without having to sell the asset. And another $60,000 three years after that.

Find a stock that will take a cash investment of $30,000 and turn it into $90,000. Or find someone willing to lend you money at standard mortgage rates to put into the market. It can't be done.

You can't generalize about residential real estate from national aggregates and you can't get an idea about what your return will be without taking into account your access to leverage, what Loan to Value you qualify for, and multiplying that by your rate of appretiation. I qualify 100% LTV and condos in my area are averaging 20%. The math breaks one way, and hugely in my favor. Prices in Detroit are off 6.5% year over year, not your path to riches. Telling me that prices are up nationally by 1.5% tells me exactly nothing and I don't have alot of patience with people who misrepresent or worse don't understand the basic fundamentals of real estate.

[calmo]

A nice, even domestic, lesson Bruce, but I'm in the mood for something esoteric, something without shingles or carpets or grass cuttin', you know?

And now can we hear from the regulated (see people you were improperly regulated) HF manager that made that $1.7B (works out to 27 $20bills/second for you guys with the printing press in the basement) in that pool of 100 managers that averaged some measly couple of hundred million dollars? [Which is why we don't hear from them: HF opinion affordability --we don't have the microseconds to pay for their wits.]
Did he have to wait 3 years? Did he have to bank on a 4% annual appreciation of some real estate? No, he takes 2% as soon as you fork him several million and then again 20% of the profits a year later.
But with your millions and other similar clients', this fellow (I am so charitable if pressed.) still leverages his bets...and, like that proud $1.7B take last year, enough to make the typical housing leverage story look a little shabby.
We know how it works with the house mortgage more or less, but with the HF access to the banks, way less.