Are the rents too damn high more a function of limited supply or strong demand? The first post in a new series.

New York City. (Photo: Chris Isherwood/Flickr)

To set the geography, playwright Tennessee Williams supposedly said, “America has only three cities: New York, San Francisco, and New Orleans. Everywhere else is Cleveland.” In a similar vein, I once wrote, "There is Greater Greater New York. And then there is the rest of the United States." Replace "United States" with "Cleveland" and Tennessee Williams draws the same kind of map I do. Williams describes urban cultural distinctiveness, a real city. I'm referencing national (and global) economic hegemony. Hence, I take notice when someone tweets, "And the Global City shatters into a million pieces." Ben Schulman's playful hyperbole (my interpretation) is in reference to this New York Times article titled, "Affordable Housing Draws Middle Class to Inland Cities":

Rising rents and the difficulty of securing a mortgage on the coasts have proved a boon to inland cities that offer the middle class a firmer footing and an easier life. In the eternal competition among urban centers, the shift has produced some new winners. ... ... For decades, Americans have flocked to the Sun Belt in search of a better life, first abandoning failing industrial centers like Detroit and Pittsburgh and then increasingly expensive superstar cities like New York and San Francisco, which have been replenished by immigrants. But during the housing bubble, when even people with modest salaries could get loans to buy staggeringly expensive homes, the cost of housing was less of a concern. Now that getting a mortgage has become harder, the wage stagnation that has hobbled the middle class for years has deeper consequences. “People have no choice,” Mr. Kelman said. “They can’t move across the street; they have to move across the country.” During the bubble, people coming from the most expensive places viewed even moderately expensive housing in places like Phoenix as a bargain, especially if they expected the value of such housing to rise, says Edward Glaeser, a Harvard economist who studies cities. But, Mr. Glaeser says, there is also a historical trend driven by severe restrictions on building new housing in highly regulated cities like San Francisco, Washington and New York. Whereas high housing prices were once a sign of growth because they indicated strong demand, now they are more a function of limited supply. Midlevel prices (as opposed to rock-bottom values in places like Detroit) have become a better predictor of growth.

Emphasis added. Glaeser makes a strong assertion. Supply constraints are driving people away from New York and San Francisco, into the waiting lap of "Cleveland." And by "Cleveland," I mean not New York or San Francisco. In those alpha dog cities, atop the urban hierarchy, housing supply is more important than demand. Don't shoot the messenger.

Glaeser is wrong. Sure, constraints on housing supply push up rents and home values. But the dominant story for the market in global cities such as San Francisco and New York is the quality of demand. Choke the unique demand and the drag on supply ceases to matter.

If Glaeser has over-interpreted the results of his own research (I contend he has), then I'm guilty of yanking the debate too far in the other direction. I'll cop to that critique. The middle ground sits as cities with exceptional demand with different supply constraints, and thus different housing prices. If I'm right, then cooling this "exceptional demand" should help make housing more affordable in global cities:

Global economic trends, such as the U.S. economic recovery, are also spurring migration of high-earning expatriate executives away from Hong Kong. Simon Smith, senior director for research and consultancy at Savills, said that a lot more American professionals are leaving than coming in. "A lot of the international financial services companies are still downsizing," he said. "It just hasn't been a great year." Some real-estate executives said that underlying these trends were a pair of taxes, enacted in 2012, designed to deter property speculators from mainland China and cool Hong Kong's real-estate market. Any buyer who isn't a permanent city resident has to pay more than 15% in taxes on any property purchase. The taxes, however, also limited property sales and drove up the supply of apartments available for rent. Because they affect only foreign buyers, they have a disproportionate impact on the high-end market. "A lot of these expats would have been looking to buy, but they've had to reconsider," Mr. Ma said. "The guys that are here long-term, they're not looking at the HK$200,000, HK$300,000 rental properties, they're looking at HK$50,000. Again, it's more affordable luxury."

Don't shoot the messenger. Rents are going down, in the luxury rental market. I think that's a distinction worth making. I'll have more to say about disaggregating real estate markets in a future post. Housing in Hong Kong is very expensive. I assert that distinction is largely a function of demand, not supply constraints (Glaeser). Regardless, Hong Kong is an example of how attacking the demand side of the equation can significantly impact prices. That outcome strikes me as rational as expecting rents to come down thanks to greater supply.

Are the rents too damn high more a function of limited supply or strong demand? I pose that as an open question I endeavor to answer over the next few posts (instead of the usual polemics). Preemptively, I concede that increasing supply (e.g. greater density) will lower the cost of housing. I hypothesize that demand is the more vexing issue.