Friday, May 19, 2017

Housing: Part 229 - Public policy, behavioral finance, and attribution error

Robert Shiller has a new post up. (HT: EV)  He is discussing the housing bubble, how home prices are moving up again, and what a mystery it is:
The problem for economists is that these changes don’t correspond to movements in the usual suspects: interest rates, building costs, population or rents.
I happen to have a book or two coming out that explains how home prices were entirely explained by interest rates, building costs, population, and rents.  Anyone who reads this blog knows that the evidence in this regard isn't marginal.  In all these factors, the shocks were extreme.  (Regarding building costs, in most areas these were tame, and home prices were tame.  In Closed Access cities they mostly are related to political obstruction.  eg. How much would it cost to build a 40 unit condo in the Mission District in San Francisco?  Show your work.)

I hope this whole episode helps to bring real estate finance into the 21 century.  I have been treating housing, as an asset class, like an index.  There could be a real estate index just as there is an S&P 500 or a Dow Jones index.  Dr. Shiller, in fact, has introduced many indexes that move us in that direction.  Because we have these indexes in equities, it is very common to see that asset class treated as an entity with measurable aggregate behaviors.  The interesting thing is that we seem to need to have the indexes in order to help us think that way.

There are indexes for bond prices, so if I ask you what the going rate for 10 year bonds is, you look in the Wall Street Journal and say, "Looks like it's at 2.4% today."  Tomorrow will be different.

But, in real estate, you ask someone at a real estate fund what the current return is on new developments, they say, "Well, the investment committee has it at 5%."  Then, you see them 6 months later, and they'll say, "It looks like the investment committee will be moving the cap rate down to 4%.  This will lower our income, but it will open up a lot of new investment opportunities for the fund."  OK.

It will be a sign of progress if when I ask you what the current return on real estate is, you look it up in the Wall Street Journal.  Returns on investment aren't a policy decision in a developed market.  They emerge.  But, we are probably a long way from that possibility.  Now, many insiders would probably say this is ivory tower naivety.  But, before there was a Dow Jones Industrial Average, it would have seemed just as naïve to think that you could stick a restaurant group, a steel fabricator, and a hundred other firms into a bucket and come out with anything meaningful.  Now, there are massive parts of the investment market that hardly do anything else.

In the meantime, we have a bunch of economists looking at national data that doesn't capture any of the inter-MSA details that are defining our market.  And, the real estate sector itself is heavily focused on extremely local factors that largely determine the idiosyncratic returns of each individual project.  Localized public sentiment drives those markets, and the entry of pesky amateur investors is naturally seen as problematic.  It is very easy for those to groups, each missing the core part of the story - the difference between MSAs - to come to agreement that a bunch of speculators must be screwing up the buyers' market.

I suppose that having more developed measures of value doesn't stop every guy at the end of the bar and every Austrian Business Cycle proponent from calling the equity markets bubbles, too.  So, maybe this isn't the problem.  Although, I think the public sentiment created by attribution error in real estate markets is somewhat contagious, and is partly to blame here too.  Coincidentally (?) a favorite tool of the equity bubble mongers is Dr. Shiller's CAPE measure.


  1. Perhaps this is a semantic quibble, but…

    "(Regarding building costs, in most areas these were tame, and home prices were tame. In Closed Access cities they mostly are related to political obstruction. eg. How much would it cost to build a 40 unit condo in the Mission District in San Francisco? Show your work.)"---KE

    I think "building costs" are distinct from "property zoning."

    It is true, in addition to horrible zoning, then some cities stupidly add other costs, such as the mandated inclusion of "affordable" housing units in new apartment buildings. One could even posit that outdated codes, such as wood structures cannot be more than five floors, also add to costs. ("Glulam" beams, or laminated wood, is successfully used in some countries on structures higher than five stores)..

    But in general, it is restrictive property zoning that is propelling housing costs to the moon in closed access cities, in addition to foreign capital inflows into safe assets (mostly property).

    The price of land is prohibitive.

    As I have bemoaned many times, for whatever reason the orthodox macroeconomics profession goes mute on property zoning, despite the fact that property zoning is ubiquitous and probably a larger structural impediment than, say, the minimum wage (ever the topic of righteous indignation and sermonizing).

    1. Actually, that's what I was talking about. Zoning, I think, really plays more of an enabling role here. Zoning is one of many factors that put developers in a position of needing to ask for favors. Fees, taxes, delays, above market wages, and mandates like below market rent units have to fill the gap between the cost of building and the market price. If they didn't, developers would flood the planning department with new projects. I was being literal about the cost to build in the Mission District. If you managed to build a 40 unit condo there at market rates, it will end up costing you something near the market value, minus a reasonable return. If it is less than that, there are many mechanisms in place to allow someone to claim it. ("Lawyers for the parks department filed an objection yesterday, noting that the building would throw a shadow over XYZ park for 2 hours at dawn every October. This will devastate the quality of life for local residents for whom that park holds a central place in their community. Park officials grimace at the notion that they could let this development destroy the city they love for mere money. But, if the project absolutely can't be stopped, then a $2 million grant for Parks programming would be the least they could do. Until then, the Parks Department must seek a 6 month delay to review this issue.") Etc. Etc.

  2. Kevin:

    You are correct. I saw this a million times in Los Angeles. Developers had to ask for a variance, and that meant the city could extract its pound of flesh.

    On Robert Shiller:

    I have seen Shiller on TV, read some of his stuff. Smart guy, erudite, seems fair minded.

    Yet Shiller writes about housing prices in the US (his latest post) without even mentioning the words "property zoning." How is is this possible?

    Nor is there any reference---even if dismissive---to the idea that nations with large chronic trade deficits see housing price appreciation.

    Shiller is one of the best orthodox macroeconomists---and even he is barking up the wrong trees.

  3. KE-

    You probably saw this in Marginal Revolution Egads, if even half true.

    The estimate of lost growth due to zoning strikes even me as aggressive. Really, without zoning US incomes would be $80,000-$90,000 per capita?

    Still, this post gives a sense of the macroeconomic importance of property zoning, which I contend is very high.

    1. Yeah. Pretty crazy. It will be interesting to see what sorts of reviews and criticisms it gets. I suspect some of that comes from assumptions of extreme population shifts which may be unrealistic. On the other hand, some cities commonly grow by a few % per year. It's possible. If NYC had done even half that for a century, it would be much larger today, and it probably wouldn't really be that much different as a city. It's probably not as extreme when it happens over time, like it should have, as it seems when you compare the counterfactuals after decades of divergent trends.

  4. One could posit West Coast cities very dense along the coast, skyscraper housing and offices, very productive factories and warehouses inland a bit, mass transit subways etc. close to ports and airports….

    Tokyo is huge by American standards, and has affordable housing to boot…much as I like the libertarian model, there is something about effective mass transit…opens up areas for housing…mass transit could still be privately operated, but there has to be underground and some aboveground eminent domain, and subsidy…

    Why subsidy? Because when you ride a subway you are doing a favor to all surface commuters (shorter commutes) due to less congestion. I suppose cleaning the air too. Less noise.

  5. KE-

    Seems to me recently, either you are someone else posted that closed-access cities have net outmigration of native-borns but in-migration of foreigners.

    Was that you? Do you have link?

    1. It was the previous post to this one. The thing that surprised me was that among the largest MSAs, the foreign migration into the CA cities wasn't particularly unusual.