The forward-looking tendency of markets means that the costs of our policies tend to be captured as the policies are implemented. I have argued that the rise in Price/Rent levels in the Closed Access cities after 1995 was partly a result of the persistence of rent inflation. The expectations of future rent increases gradually fed into higher home prices, much like a growth stock would carry a higher Price/Earnings ratio than the stock of a slowly growing firm.
So, once those expectations are internalized in prices, the existing real estate owners have captured all of the gains of the policy. A transfer, based on future rent expectations, has been made from current real estate owners to those who owned real estate before these policies created rent inflation. If we can ever reverse these policies, pulling rents back down to unconstrained levels, current owners will bear the cost of that policy improvement. Market efficiency means that the costs of these policy errors are sunk costs.
One subtle takeaway from this realization is that the high cost of living in the Closed Access cities applies to both renters and owners. For new residents in these cities, it doesn't matter whether they own or rent. Their after-rent income is low either way, even when they are paying rent to themselves, because owner-occupiers have to forego the opportunity costs of the excess capital they transferred to the previous owners when they bought the unit.
Let's compare four households, based on incomes before and after rent. An owner and a renter from a Closed Access city with high and rising rents, and an owner and a renter from an Open Access city with low and stable rents. For simplicity of comparison, each household will have enough capital to own their units without a mortgage and values are in real terms and excess capital is invested in assets with returns equal to the net return to housing.
The point of this simple exercise is to help think through how, once rent expectations have been internalized in the price of a home, the high cost of rent is imposed on both renters and owner-occupiers. I have contrived the numbers to make the point, but generally these numbers reflect actual incomes and expenses of the median household in the Closed Access cities versus the Open Access cities.
With these contrived, but realistic, numbers, all four households enjoy the same incomes after the costs and capital gains of housing are accounted for. (This example is of a zero inflation economy, so the capital gains accruing to the High Cost owner reflect the realized gains that come from the effect of rising rents on the current value of the home.)
Here is a graph, as a reminder of the extreme and recent nature of this issue. Any time before 1995, there was no systematic relationship between incomes and housing expenses among US cities. (1979 is shown in the graph, but the scatterplot for 1995 is similar.) Then, a handful of cities with vibrant labor markets and sclerotic housing markets suddenly took a dramatic turn, where the Closed Access atmosphere created by those housing restrictions created high local wages which tended to flow to real estate owners. So those cities simultaneously saw a wholly unprecedented level of unusual local incomes and a rising portion of those incomes going to rent.
The table above reflects this problem. And, it does not matter whether the households in these cities are renters or owners. All else equal, incomes equilibrate, regardless of ownership status. My intention here is to use the total returns on savings, including both the house and other investments, as an easy way to understand the opportunity costs of capital, and to walk through how the sunk costs of the high priced home which were claimed by the previous owners lower the income of the high cost residents. Home ownership claimed after high rents were already established is not a way to avoid the costs of high rent. It is a way to hedge future changes in rents and to stabilize future housing costs, but it is not a way to avoid them. In effect, home buyers in those cities are exchanging the risk of rising rents for the risk of changing property values. As I have pointed out in previous posts, the problem created by the housing policies of these cities forces the residents of those cities to be exposed to those risks. Home ownership is just one way to try to hedge those risks. To label home buyers as "speculators" is an error.
In addition to being an numerical exercise in how incomes and expenses accrue to households in these cities, this table also shows how the position taken by the home owner in the high cost city must include capital gains. The expected accrual of those capital gains is a result of the persistently rising rents of the city. So, a household trying to stabilize their future housing costs by taking an ownership position has to lower their relative cash income in order to take that position. The "Housing ATM" is an inevitable outgrowth of the problem of these cities.
The typical characterization of those households as speculators, as reckless optimists using their homes as ATMs, as actors in an unsustainable bid for real estate trading profits, is a massive case of attribution error. This is a sign of efficiency. Efficient real estate markets will naturally settle where these home buyers are taking on some form of risk that is of a scale similar to the risks taken on by renters. The risks here are the risks imposed by Closed Access cities on their residents. The risks come from local policies. If we are upset by the risks home buyers and lenders were taking in the midst of the boom, then we should be just as upset by the risks taken by renters. To focus on either is to blame the grass for a drought. The source of the risk is the cities themselves. Blame the voters. Let's talk about predatory voters. Because, everything that follows when these policies are in place is as inevitable as the grass turning brown.