Some factors contributing to the decline in homeownership rates and surge in home and rent prices

In California’s Silicon Valley, software engineers and senior-level executives feel they are scraping by on six figure salaries:

‘I didn’t become a software engineer to be trying to make ends meet,” said a Twitter employee in his early 40s who earns a base salary of $160,000. It is, he added, a “pretty bad” income for raising a family in the Bay Area.

The biggest cost is his $3,000 rent – which he said was “ultra cheap” for the area – for a two-bedroom house in San Francisco, where he lives with his wife and two kids. He’d like a slightly bigger property, but finds himself competing with groups of twentysomethings happy to share accommodation while paying up to $2,000 for a single room.

“Families are priced out of the market,” he said, adding that family-friendly cafes and restaurants have slowly been replaced by “hip coffee shops”.’

This Twitter employee’s lament echoes that of numerous Americans nationwide, especially those residing in metropolitan areas. The FRED graph to the right shows real disposable personal income, and the S&P/C-S home price indices for San Francisco and 20 major U.S. metropolitan areas all adjusted to January 1st, 2000. Many Americans judge that salaries are not commensurate with housing prices. Housing prices are accelerating at a greater pace than real personal income and wage growth. The San Francisco Bay Area (SFBA) is a particularly extreme case where median home prices are greater than that of any other state, and cities within SFBA dominate reports about priciest U.S. cities for rent.

In 2009, shortly after the housing bubble burst, Nobel Laureate Economist Dr. Robert Shiller argued that Americans still hold dear the misconceptions that precipitated the bubble in the first place. Shiller, whose name you may recognize from the Case-Shiller Price Indices, had this to say:

“Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates. That misunderstanding encouraged people to buy homes for their investment value—and thus was a major cause of the real estate bubbles around the world whose collapse fueled the current economic crisis. This misunderstanding may also contribute to an increase in home prices again, after the crisis ends.”

Despite this pronouncement, homeownership rates are at nearly all-time lows, hovering around 62 percent, and home prices continue to rise. Standard microeconomic theory necessitates that things will cool off, and the housing market will readjust. However, the following questions remain: To what will the housing market readjust? And, which factors at play obstruct this readjustment?

This motivates some discussion of the forewarned speculative bubble. I defer to Dr. Barkley Rosser’s definition of a speculative bubble from From Catastrophe to Chaos: A General Theory of Economic Discontinuities: “A speculative bubble exists when the price of something does not equal its market fundamental for some period of time for reasons other than random shocks. […] The most fundamental is determining what is the fundamental (107).”

Determining the fundamental in markets like SFBA’s poses a challenge. The S&P/C-S home price index shows that San Francisco home prices have surpassed pre-financial crisis levels. Given the area’s consistent history of accelerating home prices and monthly rents, and its status as a thriving tech and venture capital hub, it is difficult to ascertain if this represents a mis-specified fundamental, something else entirely, or a combination of the former two.

So, it is my view that the sole root of these misunderstandings about home prices is not irrationality or an excessive optimism about future value growth. But, rather, we should look to the idea that discerning the housing market fundamental requires a deeper look into the culture of homeownership. It is likely we have a system where national and personal identity are tied to homeownership. Homeownership, for many, signals the natural, linear extension of a person into full-fledged adulthood. I see the case for this. Homeownership enables a sense of community, a wider social network, and may enhance to the stability of the nuclear family.

The U.S. federal government and local governments also see the social value in homeownership. Government-sponsored entities, like Fannie Mae and Freddie Mac, incentivize homeownership through subsidized mortgage rates. Federal and local tax codes enable homeownership to, for example, not pay taxes on rental income from their homes, and deduct mortgage interest and property tax payments. From 2013-2017, the Federal government spent more than $120 billion annually to promote homeownership.

Thus, when homeowners, after years of conscientiousness saving, sign the deed, they have incentive to protect the future value of their homes and neighborhood amenities. What does this look like in practice? It looks like regular maintenance of their properties and an active Parent-Teacher-Association, for one. But, it can also look like battle cries in favor of restrictions on the construction of new housing, pedestrian infrastructure, and public transportation. All things that could lower home prices and monthly rents as well as erode the physical and political boundaries between “people like me” and “people not like me”. This is commonly referred to as NIMBYism (Not In My Back Yard).

San Francisco Bay Area’s zoning policies place prohibitive restrictions on single-family home, and multi-famiy unit construction. This tells a classic story. The homeowners and renters who, by luck or calculation, laid claim to affordable housing now wish to prevent others from enjoying the spoils. Instead, these homeowners and landlords wish to heighten and extract profits. (Perhaps, not considering that these spoils would be put at risk were they to be stuck with the hot potato when the bubble pops.)
This history of supply restrictions has led to a situation where demand is outstripping supply, current homeowners receive favorable treatment, and the voting decisions of a few are affecting the livelihoods of many. This statistic from The Economist comparing California’s dearth of new housing to Houston’s clarifies the point:

Unlike most other big cities in America, Houston has no zoning code, so it is quick to respond to demand for housing and office space. Last year authorities in the Houston metropolitan area, with a population of 6.2m, issued permits to build 64,000 homes. The entire state of California, with a population of 39m, issued just 83,000.

Overall, it looks like the policies local communities and the federal government have proposed and passed are somewhat to blame for these high prices and long commutes. Yet, hope is not lost for Californians as economists and other domain experts have proposed reasonable solutions like relaxing the housing permit restrictions. Local preferences for low density development, building codes and standards mandating the use of more expensive materials and labor, and a demand for unobstructed views led to the situation they’re in. But, the policies derived from those preferences can be undone.

What gets in the way of having a place to stay in California?