Rochesterians comprehend and typically appreciate two facts about real estate in the area. First, homes here are generally affordable and people can buy “a lot of house” with their dollars. Second, because the Rochester real estate market is not a speculator’s paradise, home prices do not fluctuate much so there is little risk associated with buying a home.
This halcyon state of affairs stands in sharp contrast with the market for homes in many other U.S. cities. New York City on the East Coast and San Francisco on the West Coast are the prime examples of desirable urban areas that also have very high home prices. In both of these cities, one has to be quite wealthy to afford a single-family dwelling and even renting is expensive. So, are very high home prices in desirable cities good for the United States? Let’s investigate.
A desirable city is one in which there exists a core of highly skilled workers. Because of globalization and what the economist Ed Glaeser has called the revolution in information and communication technologies, since the early 1980s such cities have seen declines in the reduction of their populations and an uptick in both local economic growth and property prices.
In addition, research by Glaeser and Matt Resseger shows that in desirable cities, there is a strong positive relationship between city size and productivity per worker. Hence, even though there are some disadvantages such as congestion and higher costs in desirable cities, skilled people enjoy the many advantages of living close to other skilled people in such cities. This explains the significant growth in the demand for housing in cities like New York and San Francisco.
Even though the demand for housing in desirable cities has grown over time, supply has not kept pace primarily because of zoning regulations. To see the effect of this, consider the following example from The Economist. In Harris County, Texas, which includes the Houston metropolitan area, the median household income is about $53,000 and the median value of an owner-occupied home is $128,000. In contrast, in Santa Clara County, which includes Silicon Valley and lies just south of San Francisco, the median household income is about $90,000 but the median price of an owner-occupied home is $657,000. Why is this the case? Houston approved the construction of more than 51,000 new homes in 2013, whereas in the same time period, San Jose in Santa Clara County approved the construction of just under 8,000 homes.
Elementary economics teaches us that when the demand for a good greatly exceeds its supply, the price tends to rise. This explains the above numbers and also what has been happening in many desirable cities in the United States.
In interesting new research, the economists Chang-Tai Hsieh and Enrico Moretti have convincingly shown that this artificial curtailment of housing supply has non-trivial and negative impacts on the trinity of employment, worker productivity and output. Of particular note, they found that between 1964 and 2009, increased constraints on housing supply in desirable cities were responsible for a 13 percent decline in aggregate output in the United States.
Clearly, high home prices in desirable cities are great for homeowners and landlords in these cities. However, the effects of such exorbitant prices on the economy are insalubrious. What we have seen in the last three decades is that although the economic return to living in desirable cities has risen, this return is increasingly beyond the reach of many skilled individuals who simply cannot afford to live in such cities. It’s time to increase housing supply by implementing policies that permit greater density—particularly near public transit centers—and to develop new units by renovating existing buildings and developing empty lots.
Amitrajeet A. Batabyal is the Arthur J. Gosnell professor of economics at Rochester Institute of Technology. These views are his own.
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