Home > finance, musing > Housing bubble or predictable consequence of income inequality?

Housing bubble or predictable consequence of income inequality?

May 19, 2013

It’s Sunday, which for me is a day of whimsical smoke-blowing. To mark the day, I think I’ll assume a position about something I know very little about, namely real estate. Feel free to educate me if I’m saying something inaccurate!

There has been a flurry of recent articles warning us that we might be entering a new housing bubble, for example this Bloomberg article. But if you look closely, the examples they describe seem cherry picked:

An open house for a five-bedroom brownstone in Brooklyn, New York, priced at $949,000 drew 300 visitors and brought in 50 offers. Three thousand miles away in Menlo Park, California, a one-story home listed for $2 million got six offers last month, including four from builders planning to tear it down to construct a bigger house. In south Florida, ground zero for the last building boom and bust, 3,300 new condominium units are under way, the most since 2007.

They mention later that Boston hasn’t risen so high as the others hot cities recently, but if you compare Boston to, say, Detroit on this useful Case-Schiller city graph, you’ll note that Boston never really went that far down in the first place.

When I read this kind of article, I can’t help but wonder how much of the signal they are seeing is explained by income inequality, combined with the increasing segregation of rich people in certain cities. New York City and Menlo Park are great examples of places where super rich people live, or want to live, and it’s well known that those buyers have totally recovered from the recession (see for example this article).

And it’s not even just American rich people investing in these cities. Judging from articles like this one in the New York Times, we’re now building luxury sky-scrapers just to attract rich Russians. The fatness of this real estate tail is extraordinary, and it makes me think that when we talk about real estate recoveries we should have different metrics than simply “average sell price”. We need to adjust our metrics to reflect the nature of the bifurcated market.

Now it’s also true that other cities, like Phoenix and Las Vegas are also gaining in the market. Many of the houses in these unsexier areas are being gobbled up by private equity firms investing in rental property. This is a huge part of the market right now in those places, and they buy whole swaths of houses at once. Note we’re not hearing about open houses with 300 buyers there.

Besides considering the scary consequences of a bunch of enormous profit-seeking management companies controlling our nation’s housing, and changing the terms of the rental agreements, I’ll just point out that these guys probably aren’t going to build too large a bubble, since their end-feeder is the renter, the average person who has a very limited income and ability to pay, unlike the Russians. On the other hand, they probably don’t know what they’re doing, so my error bars are large.

I’m not saying we don’t have a bubble, because I’d have to do a bunch of reckoning with actual numbers to understand stuff more. I’m just saying articles like the Bloomberg one don’t convince me of anything besides the fact that very rich people all want to live in the same place.

Categories: finance, musing
  1. FogOfWar
    May 19, 2013 at 8:32 am

    In RE there are two markets–New York and “everywhere else”. The behavior of the NY market is not correlated to the behavior of the “everywhere else” markets (and one of the big factors of that is the persistent foreign buy-side factor).

    It wouldn’t be surprising in the slightest for there to be a bubble–that’s what the Fed has been trying to accomplish for the last 5 years with ZIRP (Zero Interest Rate Policy) and buying MSB (Mortgaged Backed Securities) in a direct attempt to reduce mortgage rates and thus increase RE prices (although they were targeting both markets, not just NY).



  2. May 19, 2013 at 9:28 am

    Eventually the “enormous profit-seeking management companies” will give us Rollerball and it will all be good.

    Without a debt Jubilee there will be a need to constantly blow more bubbles or go through an actual debt depression where the debt will be eliminated. There are two real bubbles; The first is a bubble of debt that is in the shadows behind every bank, small business and person. The second the the bubble of cash that companies like Apple and Google have moved into offshore accounts and taken out of the economy and won’t put back into the economy until Congress gives in to their hostage demands.

    The bubble of debt is huge and that’s the bubble that will cause the next financial crisis.


  3. May 19, 2013 at 9:51 am

    Sounds right to me Cathy. We have the same pattern in the UK with houses in richest parts of London selling at silly prices, London generally holding or rising and prices stagnant elsewhere. We have our own Russian oligarks of course – maybe we could sell them a few gold bricks.

    Meanwhile ordinary working people in London can’t afford to buy homes unless they have parents with spare cash.


  4. Thads
    May 19, 2013 at 11:00 am

    Residences in central London are now so sought-after that no one lives there:


    For the owners are all rootless oligarchs who spend most of their time at their other homes in, say, Palm Beach, Cannes, and Dubai. In New York, where things seem to be heading in the same direction, “business leaders” are “fretting” that the next mayor will raise taxes:


    And what are the productive industries that they fear will suffer? Why, the “high-end property market,” of course!

    You’re expected to get more conservative as you age, but I feel the opposite: these times are radicalizing.


  5. Allen K.
    May 19, 2013 at 12:31 pm

    Yglesias’ take is interesting: http://www.slate.com/blogs/moneybox/2013/05/19/exporting_housing_services_a_huge_economic_opportunity.html

    Basically, if we have caps on unit sales of something (in this case NYC apartments, because developers aren’t allowed to build taller, but in an earlier case Japanese cars), expect the market to gravitate to more expensive units (in this case penthouses, in the earlier case Acurae and Lexi).


  6. May 19, 2013 at 1:00 pm

    How about this:

    1. Most newspapers are on the verge of extinction and desperate for cash
    2. Most newspapers derive a significant proportion of their revenue from property advertisements
    3. Newspapers will do what their advertising paymasters say

    Now – if I wanted to avoid debate on *whether* normal house prices are rising I would stick in the press a load of stories decrying the appearance of another bubble. This way people talk about the rights and wrongs of another bubble, whilst the actual “fact” that prices *are* rising is undisputed as it’s in the subtext.

    It’s the same in the UK. Ordinary houses bought by people on regular wages are not going up. What is going up is the average house price. How? As volumes drop only the upper end sells. The median goes up but the capitalisation falls.

    None of the above is ever talked about in the media because they have a vested interest in property “booming” again.

    ps you know who else is dying on their arse right now? Estate agents / realtors. Low volumes are killing them.


  7. May 19, 2013 at 1:58 pm

    Your logic excellent, thanks. Comments on London (by you and by many of those commenting) are always tricky to make because the unit of measurement is ‘the dwelling’ or rather whatever mix of dwellings makes up the transactions in the period concerned. Only rarely are price data standardised for the mix, and even then they don’t take precise account of size. Everyone else in Europe has data on prices (and rents) per m2 of net floor area but we Brits still don’t. Some quantitative rigour would be welcome here.

    In the London case we suspect that the size-mix is polarising: more tiny units being created by construction or subdivision while the luxury market booms with huge apartments. Can anyone confirm?


  8. May 19, 2013 at 4:41 pm

    > Judging from articles like this one in the New York Times, we’re now building luxury sky-scrapers just to attract rich Russians.

    The same can be said of Asian cities, whether Beijing, Jakarta, or Mumbai. Huge boxes in the sky, all for aliens.

    With 6,000 sq ft in some of these condos, 12,000 in the penthouse, the aliens could build a skating rink in them!

    These boxes are 80% unoccupied, waiting to be unloaded to The Greater Fool^H^H^H^HAlien.

    And so I’m puzzled by what you write here:

    > I’ll just point out that these guys [private equity firms] probably aren’t going to build too large a bubble, since their end-feeder is the renter, the average person who has a very limited income and ability to pay, unlike the Russians.

    I don’t know what you mean by their ability to build a bubble. Typical of financiers, based on expectations of rising prices, they’re trying to turn a buck here. Gotta be quick, because last one in gets zilch. Does that amount to bubble-making?

    Quote from the wsj link: “Blackstone and other firms are expanding rapidly partly because the housing market is firming up. In some markets, home prices have risen to the point that firms might not be able to achieve their initial return objectives from renting them out.” Also quote: “Like other investors in this market, the firm is planning to fix up the homes, rent them and eventually sell them after the market rebounds.”

    More importantly, I really don’t think the end-feeder with limited income ever factors into their equation. It certainly didn’t the last round when banks gave credit to the uncreditworthy.

    So finally, isn’t this v2.0 of Subprime Mortgage all over again? Private equity firms are leveraging (read: borrowing from banks!) to buy up the houses. How and to whom will they unload them?


  9. David18
    May 19, 2013 at 6:45 pm

    The high housing costs in Manhattan, London, SF, … is caused by politically induced land use scarcity (antiquated zoning laws in Manhattan and SF, the “Green Belt” of London) meant to benefit wealthy landlords at the costs of everyone else. Fixing the zoning laws to eliminate the false land use scarcity would stimulate the economy with more construction jobs and with renters and home purchasers having more disposable income.


    • David18
      May 19, 2013 at 6:58 pm

      Regarding, Yglesias (in Slate Mag), David Ricardo discussed politically induced scarcity in 1817. Ricardo pointed out that The Corn Laws, which prohibited the import of cheaper corn into the UK, caused land prices to increase as higher priced corn was planted land that would otherwise be used for other purposes. The overly restrictive zoning laws are like The Corn Laws causing scarcity to benefit the wealthy over everyone else.


    • benfitzg
      May 20, 2013 at 2:31 am

      The lungs! The lungs of the city! If you build on the green belt it will cause less oxygen to get to the centre, leading to a fatal aneurysm. It’s science.


      • David18
        May 20, 2013 at 10:13 am

        Hyde Park and Kensington Gardens are about 2/3 the size of Central Park. Of course you want green, but to make a “Green Belt” was simply a method of causing artificial scarcity of land which was to the benefit of the wealthy landowners over the rest of the population. Parks like Central Park and Hyde Park, Kensington Gardens provide the green without the artificial scarcity.


        • benfitzg
          May 20, 2013 at 3:02 pm

          Yes, artificial scarcity is where it’s at. The UK economy:

          * restrict new builds
          * open up your housing market to the world
          * provide near-unlimited credit in the form of
          – liar loans => bank runs!
          – lending scheme after lending scheme, each one “temporary”
          – tax breaks for buy to let

          The UK is *utterly* screwed. It didn’t add up *before* the last housing bubble. Now they are trying to put a bubble on a bubble. Luckily the population clamour for more, social mobility has ground to a halt except for the new rich, who have £2MM in loans and £2MM in properties and live off the yield so long as interest rates stay at 1%. What could go wrong?


  10. Richard Séguin
    May 19, 2013 at 11:46 pm

    “… you’ll note that Boston never really went that far down in the first place.” Actually, I’ve heard that property taxes in the Back Bay and Beacon Hill areas rose enormously because property values there did not fall much, but the rest of Boston crashed, and so the mill rate had to be adjusted upwards by a large amount.


  11. albrt
    May 20, 2013 at 1:37 am

    Two points:

    I can’t believe you said the private equity guys are planning to make money from renters. The private equity guys, as always, are looking to put together a package of whatever is trendy and sell it to your pension fund at a vastly inflated price. Some degree of bubblocity is implied, if not guaranteed. Only the slowest private equity guys will get stuck holding a bunch of houses and waiting for individual rent checks to come in.

    Second, houses being sold to ordinary people in places like Phoenix (where I live) are in a minor bubble because they are selling for the maximum amount the bank will lend based on the monthly payment the worker can make at current (extremely low) interest rates. The prices will have to go down when interest rates go up, which will eventually happen. And that’s without allowing for anything to go wrong, such as another major round of job losses.


    • benfitzg
      May 20, 2013 at 3:07 pm

      Oh god – has everyone moved to “affordability” in the US as well? In the UK we have moved seamlessly from:

      * how much does a house cost to build + cost of the land


      * how much are the interest payments on an interest only mortgage

      How did people move from one to the other without questioning it? Why are people not demanding that houses drop in price as technology improves, as in other products? Why can they not see that prices are driven by available credit as a function of the interest rates?

      The banks are playing people like a fiddle – promising them asset growth to be paid by their own kids – and they jump right in. Every time.


  12. May 21, 2013 at 12:26 pm

    You are definitely right about the bifurcated market. The wealthy tend to have a large number of homes which skews things if one tries to equate homes and households. On the other hand, the banks are starting to lend again, albeit slowly and cautiously, so people who really need to buy a place can do so again.

    Meanwhile a lot fewer people can afford to own, so rents are rising. Meanwhile interest rates are low and prices are soft. Investing in rental properties makes sense. Of course, as others have noted, the rents are going to come down as more properties become available for renters which will bring prices down. My guess is that we are transitioning back to being a society of renters.


    I’m amused that people think that Manhattan real estate prices are inflated by synthetic scarcity. One of the things you’ll notice is that Manhattan is already crowded. The streets are full of pedestrians and vehicles. The buses and subways are often at capacity or what seems well beyond. Yes, Manhattan could allow a lot more building, but that kind of building requires more infrastructure – perhaps multi-level sidewalks, more subway lines, even better traffic management. Even then, there are limits to what infrastructure can do, and there are limits to what can be built where. These kinds of projects take time, money and riding roughshod over parties with legitimate reservations and interests. Actually building enough housing to soften prices would take a lot more than finishing the 2nd Avenue line and the Number 7 extension.

    I remember, back during the recent boom in Seattle, one journalist complaining about the zoning and regulation laws holding back development. They certainly did, which is one reason Seattle did not suffer as much as other cities during the bust.


    • David18
      May 21, 2013 at 3:20 pm

      > I’m amused that people think that Manhattan real estate prices are inflated by synthetic scarcity. One of the things you’ll notice is that Manhattan is already crowded.

      Well, of course there is politically induced scarcity through arbitrarily low zoning code density restrictions which other cities (e.g. Houston, ….) do not have. The point of these restrictions on zoning is to simply ensure wealthy landlords get artificially high returns at the expense of people who live and work in New York.
      Manhattan has less than 2 million residents but swells to several times that each day as people commute into the city for work and pleasure which of course is true for subway use as well. The trains are full because of budget cuts in the MTA so that trains are not run as frequently as before. The system is also being converted to automatic signaling which will allow for greater subway train throughput.


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