Commentary

Reason.org
October 12, 2005

Forget the Bubble. Housing Shortage is the Real Crisis
By Leonard Gilroy

The rapid increase in national housing prices has spawned growing fears that a housing bubble is about to burst, which doomsayers claim will then drag the country into a recession and leave a glut of unwanted housing.

But concerns over a national housing bubble are completely overblown, as housing markets are an inherently regional phenomena. Most coastal states experienced double-digit growth in housing prices over the last year, with price increases in California, Florida and Maryland exceeding 20 percent. By contrast, price appreciation in many Southern and Midwestern states was far below the national average, with housing prices remaining near or below the national median of $208,500.

So a more accurate picture might be a series of regional 'bubbles,' and even that's a stretch. While prices in some areas experiencing huge price increases like San Jose or Boston may be due for a market correction, history shows that property values rarely freefall without an accompanying economic shock. Defense sector cutbacks in the early 1990s triggered a recession that rocked Southern California, leading to over 500,000 lost jobs and prompting Los Angeles housing prices to plummet 21 percent over 7 years. Other than potential fallout from the current military base closure decisions, most US areas will not experience the kind of traumatic economic downturn that would blow up a regional housing bubble.

The Mortgage Banking Association tried to calm bubble fears in a recent report that highlighted numerous indicators of sustained strength in the housing market, including a strong national economy, solid job gains, rising household incomes, a healthy banking sector, and liquid financial markets.

None of this is news to homebuilders, who view the bubble hysteria as diverting attention from the real challenge we face: meeting the housing demand of a growing U.S. population.

Industry representatives warn that the current level of two million annual housing starts is not enough to meet projected housing demand in coming decades, as high immigration levels, the coming-of-age of echo boomers, and second-home purchases by baby boomers keep demand for housing high.

Builders fear an undersupply -- not an oversupply, or bubble -- of housing. Viewed in this context, the high housing prices we're seeing in many areas are the inevitable outcome of a mismatch between high demand and low supply.

Recent Harvard University research supports this view. Three Harvard researchers found that high housing prices in the most expensive regions -- mainly along the two coasts -- are due largely to the increasing difficulty of getting new homes built there. Put simply, new construction has declined sharply in these locations due to restrictive zoning and other land use regulations. The basic laws of supply and demand then drive up housing prices.

Look no further than California -- home to 16 of the top 20 most "overvalued" metro housing markets, according to a recent National City Corp. study -- for an example. While the state projects an average annual need of approximately 220,000 new housing units, housing production has lagged far behind, with an average of 170,000 new residential construction permits issued each year since 1999. And given California's stringent local land use and environmental controls and public support for growth curbs, no narrowing of the gap is in sight.

Long-time homeowners in high-cost areas like California have certainly benefited from supply-induced price appreciation. But the projected housing shortage in these areas paints an ominous picture for the "have nots" at the bottom of the housing ladder - prospective first-time homebuyers, middle- and low-income households, and recent immigrants that are rapidly being priced out of the market.

For many families still trying to buy their first homes, their only hope lies in politicians waking up to the reality that the best way to keep housing affordable and to avoid the looming housing shortage is to stop passing land use and housing regulations and start approving more housing construction.

Leonard Gilroy is a certified planner and policy analyst at the Reason Foundation