This originally appeared in City Councilor Jake Auchincloss’ email newsletter.  

Debates about housing dynamics are often vague, anectdotal, and ad hominem. So, here’s an attempt to explain housing prices concretely, empirically, and systemically:

Housing prices in Newton are going up because demand for residence persistently outpaces the supply of housing units.

The rest of this note will unpack that sentence in three sections. (and – please join me at my office hours on Saturday from 10AM to noon at L’Aroma Cafe in West Newton to discuss in person)
 

Housing prices in Newton are going up because demand for residence persistently outpaces the supply of housing units.

On average, housing in Newton costs 45% of income. Median rent is $3K per month and the median price is $1.025M. The price per square foot in Newton has increased 13% in the last year. I’ve written extensively about the consequences of housing inflation: Newton is pricing out the middle class.
 

Housing prices in Newton are going up because demand for residence persistently outpaces the supply of housing units.

This is the most complicated aspect of the housing phenomenon. To begin with:
             residence ≠ house 

Residence is an asset that contains multiple components. Realtors frame them as “location, location, location.” Real estate economists frame them by calculating the price of land, distinct from the overall price of property. Let’s be more concrete. 

The components of value in residence are:

1. The house itself: The structure and systems that provide shelter and comfort for daily living.
2. Security of person and property: A residence is nested within municipal, regional, and national governance, patterns of criminality, norms of law enforcement, respect for property, and access to liquidity. A palace in the Democratic Republic of Congo is worth less than a modest house in neighboring Zambia.
3. Potential income from local employment: People commute for approximately one hour per day (Marchetti’s constant). The potential income from employment is thus dependent on how far the transportation infrastructure can take you in one hour, and the prevailing wages of employers within that radius.
4. Cost of mobility: The one hour of commuting can be relatively expensive if driving and parking are required, or relatively modest if public transit, cycling, or walking are pleasant and reliable options. Errands and recreation, likewise: relatively expensive if dependent on driving and parking, and relatively modest with transit, cycling, and walking. Transportation infrastructure is thus obviously critical to the cost of mobility, but so are the weather and the density and heterogeneity of surrounding development. A residence in sunny San Diego within walking distance of employment and amenities, for example, has a low cost of mobility even if surrounding transportation infrastructure is poor.
5. Childrens’ development: Raj Chetty, an economist at Stanford University, is the authority here. “In recent years, Chetty’s groundbreaking research has shown just how much the ZIP code a child lives in can define his or her future. The longer a child lives in a neighborhood of opportunity—a racially integrated area with a large middle class, with stronger family structures, more social capital, and better schools—the more likely to they are to improve their standard of living as adults.” (Misra, CityLab). It’s not just the quality of pedagogy, in other words. It’s the role models that children encounter amongst their neighbors, the family dynamics they witness at their friends’ houses, the values they imbibe at community gatherings. Hard to quantify? Certainly. But parents instinctively hone in on high-performance.
6. Subjective quality of life: Linked to many of the facets discussed in (5), this captures elements of value that each resident must define for herself. The surfing in Hawaii, the  food in New York City, the music in Nashville – for some residents they are paramount, for others unimportant. In Newton, for example, the vibrant Jewish community is attractive to many prospective Jewish homeowners, like my mother 25 years ago. 
7. Public services: The return on taxes paid. It is not just high versus low taxes, but rather the value of public services outlaid given $1 of tax collected by the state and city. Is trash picked up reliably? Is zoning regulated rationally? Do the state courts administer the law expediently? The competence of the government underpins, to varying degrees, many of the other components, including security, mobility, and pedagogy.
8. Regional price index: Location-dependent costs beyond the house itself, mobility, and public services. This includes, for example, the local prices of water, energy, food, health-care, and property insurance. As the American economy has integrated over the past century, these drivers of residential price differences have become less important. One effect of climate change, however, may be to elevate property insurance as a first-order consideration in price differentials. 

Armed with these eight dimensions of residence, we can address a retort that is often levied by those who reject that supply and demand explain the housing market. If building more residential units puts downward pressure on prices, they ask, then why is housing so expensive in New York City, which builds more units than anywhere else in America? 

The first way to answer this question is the counterfactual: what would happen to housing prices in New York City if housing were demolished, instead of constructed? If you concede that prices would go up even faster, then you are ceding that constructing more housing puts downward pressure on prices. That is not a guarantee of falling prices, because it accounts only for supply, not demand. Prices will fall only if the supply of housing grows faster than the demand for residence.

But the second way to answer the question is more interesting. And that’s to say: is residence in New York City actually as expensive as everyone assumes? Remember, residence ≠ house. Review 2 – 7 on the list above, and it becomes apparent that residence in New York City is a valuable asset: low risk of interpersonal violence; well-protected rights to the property with easy liquidity; high-paying employers within an hour’s commute; mobility without driving and parking; opportunities for economic advancement for children and adults; and well-regarded public services. 

Another way to say this is that the millions of people living in New York City (or San Francisco, or Boston, or Boulder) paying huge sums for tiny houses are not irrational. They are paying for an asset that is more than four walls and a roof. Does this mean all’s well? Of course not – residence really does cost too much. But keep these eight components of value in mind for the next section.
 

Housing prices in Newton are going up because demand for residence persistently outpaces the supply of housing units.

Back to Newton. To explain rising prices, we need to explain both why demand is rising and why supply is lagging. Demand is rising because of one macro and three micro trends: at the macro level, a global abundance of savings relative to investment, boosted by cheap money, is fueling asset inflation. At the micro level, components 3 – 5 of residential value, above, are acutely attractive in Newton: potential income, cost of transportation, and economic mobility. 

Asset inflation at the macro level
In general, assets everywhere are expensive relative to historic averages. Stocks, bonds, real estate, private equity, venture capital are all spiking. The Economist explains the phenomenon as more dollars chasing fewer investment vehicles. The supply of savings is increasing because China’s development and integration into the world economy added a thrifty population to the global pool of savers; at the same time, the rich world is greying, with relatively more workers in their prime earning years setting aside money for retirement, as opposed to younger citizens, who tend to borrow more. In the decade since the Great Recession, moreover, central banks have pumped $11 trillion into capital markets.

Just as more money is being set aside by the Chinese, the baby boomers, and the central banks, the opportunities to invest it productively have become more scarce. The secular growth rate of the American and European economies is dropping. And in the industries that are growing, the most valuable assets are increasingly intangible – Facebook’s network effects, for example – while the real cost of tangible assets like factories and hardware has fallen. Tech titans like Google may seem like behemoths, but relative to revenue their capital needs are stunningly low. In the 19th century, the railroads needed millions of acres of land from the federal government to get started; in the 21st century, entrepreneurs need a laptop. 

Micro drivers of demand in Newton
Real estate in Newton is rising on a global tide of asset inflation, but it also has significant local drivers of growth. Revisit the eight components of value within residence and see that Newton fares exceptionally well. Numbers 3 – 5, in particular, are most differentiating for the Garden City: potential income, cost of transportation, and economic mobility. 

Newton residents can conveniently commute to one of the world’s most productive metropolitan areas. Greater Boston’s median salary is fourth-highest in the nation, leading New York City and trailing only Washington, D.C. and the metros within Silicon Valley (Martin, et al, Business Insider). That prosperity is priced into Garden City real estate.

Related to adults’ income potential, but perhaps even more valuable, is the effect on children’s potential. There is an increasing premium to raise a family within Mr. Chetty’s “neighborhood of opportunity”, described above as “a racially integrated area with a large middle class, with stronger family structures, more social capital, and better schools.” As inequality widens in the United States, parents are motivated to compete earlier and more ferociously to ensure their children are included in “the meritocracy of professionals and academics and upper-white-collar workers [that] has ossified in recent years into something that looks to people on the outside more like a… hereditary meritocracy.” (Traub, The Atlantic) 

How do you make sure your child is part of the “hereditary meritocracy”? Move to a neighborhood of opportunity, like Newton. These incoming, engaged parents then enhance the family structures, social capital, and schools that they initially found attractive. The cycle self-perpetuates, inflating demand for residence and slowed only by the zoning that restricts supply.

Supply of housing is lagging because of restrictive zoning
In most markets, when demand surges and prices go up, more suppliers are enticed into the marketplace, which then brings prices back down. That equilibrium does not emerge in American residential real estate, though, because supply is regulated by existing homeowners, who have different incentives than the potential homeowners who represent the demand curve. Homeowners adjacent to new development are often skeptical about that development’s effect on all eight components of their residential value, especially numbers 1, 4, and 5: namely, will this undermine the aesthetic of my home? will this worsen traffic? will this crowd schools? And even homeowners buffered from change indirectly benefit by restricting supply, since that raises the re-sale value of their most valuable asset.

Zoning is thus generally biased towards less density (fewer occupants per square foot of land) than the market would attain under neutral regulations. Newton, specifically, codified its zoning in 1953 to limit newcomers surging in on the tide of postwar posterity. Written at the height of the automobile era, it also expressly separated commercial and residential uses, which made the villages less walkable. Although lightly revised in 1987, the ordinance is so outdated that 87% of houses in the city are nonconforming.

City Hall is drafting a new zoning code to reflect a new era. I’m advocating formore walkable village centers with more diverse housing stock, to help reduce prices, while protecting neighborhoods from oversized development. 

Sign up here to participate.

Onwards,

Jake

p.s. Please join me at my office hours on Saturday from 10AM to noon at L’Aroma Cafe in West Newton (2nd floor)