Will your hometown be a boomtown again?
Harvard economist Edward Glaeser studies the forces that make some regions thrive and others die ... and what that has to do with the weather in January.
(Money Magazine) -- Since the crash, we've gotten used to thinking of real estate as a market shaped by national forces: Interest rates went down, Wall Street and homebuyers went nuts, regulators fell asleep at the switch, and -- voilà -- we had ourselves a bubble.
But Edward Glaeser, an economist at Harvard University, finds that real estate is still a local business driven by local conditions. In studying the rise of the Sunbelt, Glaeser has found that winter temperatures were one of the best predictors of a region's population growth, but that this has as much to do with regulations as sunshine.
He's stirred controversy by arguing that many "older, colder" cities will never roar back. (By the way, he'd like to scale back the tax break you get on your mortgage too.) Senior writer Lisa Gibbs spoke with Glaeser about what really drives real estate markets, and what that means for prices; edited excerpts follow.
First, let's talk about the big question on everyone's mind. Where do you see real estate going from here?
There are two basic approaches to thinking about this. One is looking at past price patterns, like the long-run tendency to give back price gains and the short-run tendency for prices to have momentum -- that is, to keep moving in the same direction. We've now given up at least a third of the previous gains, and the recent price changes have been positive. From that perspective, it looks like we're close to having hit bottom.
The other approach is to ask, What is the supply and demand? That approach is easiest to use in Sunbelt cities like Phoenix and Las Vegas, where you basically have unrestricted supply.
The price of a home should be the cost of construction plus land plus reasonable developer profit. We're getting there, but it wouldn't be crazy to see more declines just because there was so much overbuilding. The same is true for the Miami condo market, where there were no constraints on building up.
Those places are still growing, though. You've found that January temperatures can predict a region's population growth. So how did those nice warm cities get hit so hard by the crash?
Let's step back a bit. When we talk about the long-term growth of the Sunbelt, it is partly about the demand for housing. The first generation of booming American cities, like Detroit and New York, was built around waterways because of the enormous advantages of moving goods by water. Before the railroads, it cost more to move goods 32 miles over land than to cross the Atlantic Ocean. The big change of the 20th century was the decline of transportation costs. Industry moved, and with that came the rise of cities built where people wanted to live. The rise of California's cities is the first great example of this.
People just followed the weather?
Not exactly. The other part of the story is the supply of housing. In the 1970s in California, a variety of constraints were put on development. Some were wise, some were not, but they made it increasingly difficult to build. Other areas -- Atlanta, Dallas, Houston, and Phoenix -- may have had a less vibrant economy and less comfortable summer temperature, but they had a building environment that could not have been more lenient. Developers built a vast amount of housing that was incredibly affordable.
So low prices actually help drive a lot of the growth. Does that mean you won't necessarily make a lot of money on real estate when an area is booming?
Healthy population growth does not imply that prices will always go up at all. A good climate and a robust economy tend to push housing prices up, but meanwhile an elastic housing supply keeps prices moderate. If housing supply outstrips demand, prices can fall.
And that's what happened in the Sunbelt after 2000.
The bubble hit the Sunbelt in different ways. Dallas basically had no big price increase during the boom and no bust. That's what you expect in a place that had no constraints on building. I would have thought the same logic should have held in Vegas. But perhaps because of Las Vegas's proximity to California, people thought it would become like California. That was belied by the huge amount of building going on.
The harsh reality is that real estate prices that go up come down. I've found that for every real $1 increase in local market prices over a five-year period, prices go down 32¢ over the following five years.
What should the government be doing to stabilize the U.S. housing market?
It's not the job of government to make housing more expensive. Its job is to get rid of distortions in the market that make housing too expensive.
The government has set up an $8,000 tax credit for buyers, which was motivated to push prices up. I'm not crazy about more subsidies for homebuying, but I don't think tax credits would necessarily be such a terrible thing -- especially if you could use them to reform the mortgage-interest tax deduction.
What's wrong with the mortgage-interest deduction?
It's very strangely designed. If the goal were to encourage homeownership, you'd want to target the people on the margin between renting and buying, people early in their lives. But because a tax deduction is worth more to higher earners, we have a policy that gives 10 times more benefits to Americans earning more than $250,000 than to households earning less than $75,000. It's an enormously regressive policy. And its benefit rises with the size of the house and the debt you take on. Why should the government be complicit in urging people to buy larger homes?
Can something so popular actually be taken away?
A not-so-politically-impossible fix would be to lower the cap on what's deductible, currently $1 million of mortgage debt. Reducing it to between $200,000 and $250,000 would eliminate the most regressive aspects of the tax, and it wouldn't touch the majority of Americans. And do it over time, given the delicate condition of the housing market. Ideally you'd get rid of the deduction and replace it with a buyer tax credit. If you want a pro-homeownership incentive, keep it small, keep it targeted.
What's the role of property taxes in the real estate market?
In places that have completely screwed up their assessment processes, like California with its Proposition 13 that freezes assessments, you're creating an incentive for people not to move.
Many places are going to have big fights over those assessments this year, given how much prices have dropped.
We are seeing these fights over assessments because there's a lot of uncertainty over what houses are worth. We could move toward a system where assessments are tied to benchmarks like the Case-Shiller index. Then we don't have to waste countless hours arguing.
The broader issue is that many places are highly dependent on taxes from assets, which has made paying for government harder. Boston is at 8.4% unemployment -- bad, but not Armageddon. But the perspective from the state government is awful because of the precipitous decline in tax revenue.
I was recently in Detroit, where I saw a decent house sell for $6,900. Can Detroit and other industrial cities come back?
Detroit can make itself a more livable, comfortable city and make life better for children growing up there. The mistake is to try to attain some long-held ideal about what Detroit once was. It probably needs to shrink: Focus on which abandoned neighborhoods can be torn down and replaced with more productive space. And consolidate services. Detroit is fascinating, beautiful, and challenging. I recently visited Detroit Dry Docks, one of the places Ford got its start. It's now an empty hulk.
That's the story behind your $6,900 house. This was a city that was one of the most productive on the planet, and they built housing and infrastructure accordingly. Even though the business leaves, the houses and infrastructure remain.
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