House Sizes Shrinking
I found this post on a USC professor's real estate blog interesting. It talks about the disconnect between median income and housing size. As I look at the homes we are building out here in the central valley, I'm very concerned that we are over consuming housing--which in the long run diverts dollars from other parts of our economy. I'm worried that our retail sales will suffer in the long run as many of our homeowners will be forced to put a disproportionate amount of their income into maintaining homes they can't really afford in the long run--particularly after the kids leave home.
In addition, large homes on large lots typically means more miles of roads, water lines, sewer lines and storm drains to maintain. At an time when we seem to be getting less income per household instead of more, this is a disturbing trend. We need to look at what size home and housing subdivision is sustainable for both the city and the residents. In any case, here is the post:
One thing that has led me to believe that the housing market in Southern California is largely at bottom is the fact that many houses are selling at less than replacement cost. While such a discrepancy can exist for a long time in places with declining population, replacement cost is a pretty sound fundamental for determining the minimum sustainable house price in areas with growth.
The report on median incomes released yesterday, though, suggests to me a flaw with my line of reasoning. While the average new house has grown about 20 percent in size over the past ten years, median household incomes have actually fallen a bit. If house size is a proxy for house quality (and we have good statistical evidence to think that it is), then house quality has outstripped the ability of people to pay for it.
When comparing market prices to replacement cost, we really need to think about depreciated replacement cost. Depreciation comes in three flavors: physical, functional and economic. Physical depreciation happens because things wear out as they age--it is what Congress is thinking of when it allows depreciation deductions for investment property and plant and equipment.
Functional depreciation happens when a component of a capital asset does not perform its function well by current standards. Think of a furnace that uses lots of energy, and could be replaced by something more efficient. It is possible that it could work as a furnace for years, but it still would be best replaced by something more efficient.
Finally, there is economic depreciation, which happens when the demand for something (like Detroit real estate) disappears. It is possible that large houses have incurred economic depreciation because people lack sufficient income to afford them. If this is true, values can fall below original construction cost and stay there for some time.
Such considerations do not, of course, apply to reasonably well located, modest homes--I continue to believe that 1500 square foot houses in the San Fernando Valley and the central part of the San Gabriel Valley are reasonably priced now. But the market for larger houses may be troubled for some time yet to come.One other implication: builders should construct smaller houses in the years to come. This vindicates a prediction I once made. Unfortunately, I made it in 1990.
In addition, large homes on large lots typically means more miles of roads, water lines, sewer lines and storm drains to maintain. At an time when we seem to be getting less income per household instead of more, this is a disturbing trend. We need to look at what size home and housing subdivision is sustainable for both the city and the residents. In any case, here is the post:
One thing that has led me to believe that the housing market in Southern California is largely at bottom is the fact that many houses are selling at less than replacement cost. While such a discrepancy can exist for a long time in places with declining population, replacement cost is a pretty sound fundamental for determining the minimum sustainable house price in areas with growth.
The report on median incomes released yesterday, though, suggests to me a flaw with my line of reasoning. While the average new house has grown about 20 percent in size over the past ten years, median household incomes have actually fallen a bit. If house size is a proxy for house quality (and we have good statistical evidence to think that it is), then house quality has outstripped the ability of people to pay for it.
When comparing market prices to replacement cost, we really need to think about depreciated replacement cost. Depreciation comes in three flavors: physical, functional and economic. Physical depreciation happens because things wear out as they age--it is what Congress is thinking of when it allows depreciation deductions for investment property and plant and equipment.
Functional depreciation happens when a component of a capital asset does not perform its function well by current standards. Think of a furnace that uses lots of energy, and could be replaced by something more efficient. It is possible that it could work as a furnace for years, but it still would be best replaced by something more efficient.
Finally, there is economic depreciation, which happens when the demand for something (like Detroit real estate) disappears. It is possible that large houses have incurred economic depreciation because people lack sufficient income to afford them. If this is true, values can fall below original construction cost and stay there for some time.
Such considerations do not, of course, apply to reasonably well located, modest homes--I continue to believe that 1500 square foot houses in the San Fernando Valley and the central part of the San Gabriel Valley are reasonably priced now. But the market for larger houses may be troubled for some time yet to come.One other implication: builders should construct smaller houses in the years to come. This vindicates a prediction I once made. Unfortunately, I made it in 1990.
Labels: Economy, Real Estate
posted by City Manager @ 7:13 AM
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