Chicago Booth Review Podcast Why Are Home Prices So High?

Chad Syverson: We had a strong run of 20, 30 years after World War II where we were building houses as fast or faster than household formation. And then we started lagging somewhere in the '80s or '90s behind household formation. And it's gotten worse and worse over the decades since. And that has led to even faster increases in house prices than in the cost of building those houses.

Hal Weitzman: The median home price in the US in 1970 was approximately $23,400, less than two and a half times the median family income at the time. By last year, the median home price was more than $400,000, about five times the median family income. No surprise that people are warning about a housing affordability crisis. To what extent is that driven by the increasing cost of building homes?

Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman. And today I'm talking with Chicago Booth's Chad Syverson about his research on the weak link between building costs and home prices. What's really behind the price increases in residential real estate? Chad Syverson, welcome back to the Chicago Booth Review Podcast.

Chad Syverson: Thanks. It's good to be here.

Hal Weitzman: We're here to talk about housing costs, which everyone cares about, and building costs, which we also care about, but maybe less than... We'll find out if we care about it less than we currently do. Your main finding in this research is that increases in building costs don't explain increases in housing prices in the US, and that connection has actually weakened over recent decades. Why?

Chad Syverson: That is right. That's what we find. It's not clear exactly why that connection has weakened, but it does suggest that things that determine house prices, other than just the actual cost of putting the structure together, have become increasingly more and more important in determining what house prices are. Now those things can be like the prices of land, the legal costs involved with getting the right to build, things like permitting and those sort of associated costs. And so we've seen this disconnect now between changes in how expensive it is to actually build a structure from what that structure ends up getting sold for.

Hal Weitzman: Okay. But just to play devil's advocate, why would we expect, you go and buy a house, nobody says, well, here's how much a brick costs. There were so many bricks. I mean, that's not the way that people buy housing. So why would we expect building costs, the increase to have an effect on the increase in house prices?

Chad Syverson: In general, we think that the prices of products reflect both demand and supply factors. And for a lot of physical products, one big supply side factor is the cost of actually assembling the product. And that's true for cars. You often don't go into a dealership and get told, but you know each one of those tires costs $185 and therefore you're going to have to pay 40,000 for the car. But that's actually kind of part of what's going on. All those parts have a cost and that gets added up, and that has some determination in figuring out what the price of that car is going to be. It so happens that we're finding for houses that connection has just loosened.

Hal Weitzman: Right. And is that a surprise to you?

Chad Syverson: Yeah, I would've thought cost side stuff matters in general. And I wasn't expecting it would explain all the changes in house prices, but I thought it would explain some. It used to. But as we've found, as time has gone along, the ability of changes in building costs to explain price changes has just gone basically to zero.

Hal Weitzman: Okay. And so it's not clear why that disconnect is happening, but you talked about some of the other factors. Just list those. The increase of building costs is not driving house prices. What is?

Chad Syverson: For clarification purposes, what we're actually measuring with building costs is imagine you've got a piece of land, and it's ready to be built on. The government said, okay, go ahead. You can build a house, you have permission. Start. It's the actual cost from that point of assembling the structure. You already have the architecture and engineering done too. That's not it.

So if we're not finding that building costs explain changes in prices anymore, if costs matter at all, it must be coming from those other things. So the cost of the land, cost of permitting, costs of engineering and architecture, that kind of stuff. That has to be the cost side factors that are moving around that change prices. There can also be changes in demand too. So just holding fixed, whatever the costs are, land, everything else, if more people want more houses all of a sudden, that's going to tend to drive up the prices of houses as well.

Hal Weitzman: Okay. So you distinguish between building costs, and what you call the full cost of bringing a new house to market. Does that include some of the costs you talked about?

Chad Syverson: That's the land and the engineering and all that stuff.

Hal Weitzman: Okay. All right. And that distinction is important because it's the other stuff, as you say, that is driving the cost, presumably?

Chad Syverson: Yes.

Hal Weitzman: Right. Okay. So you note that construction related prices of all sorts grew faster than consumer price index since 1950. So what does that tell us about inflation and construction, housing market compared to the broader economy?

Chad Syverson: It tells us something interesting that was also raised by earlier work I did with Austan Goolsbee on productivity in the construction industry. If you were to do that same comparison, not for construction or houses, but for manufactured products, say how have the changes of goods that we make in manufacturing, how have those changed over the last 75 years compared to average price changes? Those in general have seen slower price increases. And the reason why is we've gotten better, we've become more productive at the manufacturing process. So we can make physical goods more cheaply than we used to. So their real cost, relative to everything, else has gone down.

That's not what has happened, as you've noted, in construction and housing in particular. So what's a bit of a mystery, I think, and this was something we were grappling with in the earlier work with Austan too, is that you might think, now putting together a manufactured good isn't that different from putting together a house or some other structure that the construction sector puts together. Yet in that first case, we seem to get better and better at it decade after decade. Costs falling. But with construction, not only are costs not falling, they're actually rising faster than other prices in the economy are. So this result of this 75 year run of higher than average cost growth is sort of reflecting that.

Hal Weitzman: And we talked in a previous podcast about productivity in the construction sector. And we've got videos on Chicago's Booth Review website where we talk more about your research on poor productivity in construction. But this divergence that you talked about between the increase in construction costs and the increase in house prices, you trace back to the late 1970s. And then by the late 1990s, house prices overtake the construction costs. How do you explain that? Why did we get that divergence starting then? What was happening?

Chad Syverson: Yeah. So one thing to remember is the cost growth was sort of continuing throughout that period, and as we were just saying, it was kind of growing faster than inflation. What really happened was, on top of all that, house price growth in the late '70s started growing even faster than those already increasing construction costs were rising. Why that is, it's probably related to the fact that, quite simply, we're not building housing at the same rate we were in decades prior to that.

So we had a strong run of 20, 30 years after World War II where we were building houses very quickly, as fast or faster than household formation. That is where someone wants to go with their family and buy a house. And then we started lagging, somewhere in the '80s or '90s, behind household formation, and it's gotten worse and worse over the decades since. And that has led to even faster increases in house prices than in the cost of building those houses.

Hal Weitzman: Okay. And there were two periods that you identify where this divergence really ramps up. House prices grow significantly faster than building costs in the mid-2000s before the financial crisis, subprime mortgage crisis of course, and then from the mid-2010s to today. So what's happening in those two periods?

Chad Syverson: I think you could say in both of those periods, there was a sudden increase in the demand to buy houses. The first one, I think people would say the conditions required to get a mortgage, a loan to buy a house, became loosened relative to prior periods. And maybe there was something in the air, an excitement about buying houses, maybe for personal use or investment property, when combined with easier access to credit, that led to a big increase in demand for houses. And so you saw this large spike in house prices. That was the first period that you mentioned.

The second is actually just the past five years, coming out of COVID. There it's, I think, less because of credit conditions, but it is related to the desire to buy a house. And probably because desired household formation changed a lot because of the pandemic. I think a lot of people wanted either... Not just household formation, just amount of housing went up. So people realized their house had a lot of uses they didn't think about until they had to stay there all day long, or felt like they had to stay there. And so there was this big increase in the demand for space. And then a set of young adults who were living at home during the pandemic wanted to move out afterwards. And so you had this rather sudden shift in the desire for housing. And when you put that-

Hal Weitzman: And they want big houses too.

Chad Syverson: They want big, everyone-

Hal Weitzman: ... because they're all working from home.

Chad Syverson: Exactly. Everyone wants bigger houses than we had before. People want houses who didn't have houses before. We hadn't been building houses very quickly before, and we certainly weren't building houses very quickly during the pandemic. And so you get this big spike in demand with very limited supply, and it drives up the price of houses.

Hal Weitzman: So we talked earlier about what's driving this. Is it those demand factors? Because that makes a lot of sense. People want bigger houses, that suddenly they're going to be working from home, or there's loose credit and suddenly anyone could buy a house. Or I'm thinking about things like Airbnb. Suddenly you can buy a string of properties, and actually make money from them, or more money than you could just by renting them out in the old days. So there's a whole lot of stuff driving the demand side. What about the cost size that you talked about earlier, like the permitting and the architecture? I mean, is that really going up that much?

Chad Syverson: Well, certainly a lot of debate now about building restrictions, zoning and the like. And just what a lot of folks view, and fairly I think in many places is a general reluctance on the part of local governments to allow home building. And so that's raised the non-construction costs of building a house. So some of it's just literal permitting and government-related legal costs to build.

But also just the restrictions on building get priced into the land itself. And so if you want to find an empty lot in Venice Beach, LA, something, a place that's hard to build but people would like to build in, the lot is extremely expensive because in part it embodies the fact that it's really hard to build anything there, even though a lot of people want to build it. So it gets very expensive to buy a house there. Not because it's necessarily expensive to construct a house, but because to get the land that gives you the right to construct that house has gone up.

Hal Weitzman: Okay. So the permitting, the freeing up the land for property is still as big a deal?

Chad Syverson: Yeah, that's the cost side factor that I think has been moving around prices much more than the construction costs themselves.

Hal Weitzman: Okay. But the demand is the thing that's driving this divergence.

Chad Syverson: Demand certainly matters, and that changes in demand get capitalized into the land prices. Yes.

Hal Weitzman: So you mentioned your research on productivity, but I just wanted to get you to recap, remind us what you actually found there. And then that stagnant productivity, how does that affect the cost of building and house prices?

Chad Syverson: Sure. So productivity is efficiency in productions. Basically how much output you get from a given set of inputs. What Austan and I found looking over the last 75 years in the construction sector is productivity growth has been very poor. In fact, it's actually been negative, which is really unusual for the last 50 years. That means, if those statistics are correct, the amount of inputs that the construction sector needs to build whatever it's building has actually been going up. They need more and more inputs to build the same thing as they used to do. In other words, they've become less efficient at building stuff. Well, when you're less efficient and you need more inputs per unit of output, that means your cost of building a unit of output has gone up. So productivity growth is like the inverse of cost growth.

So what Austan and I found about construction productivity says there's been a lot of increase in building costs over the last 50 years because of poor productivity growth in the construction sector. Now what we're finding in this paper is, despite all that, there's also this other movement in house price growth that's not being explained by those rising construction costs. There are other things going on. And those other things are becoming even more and more important in explaining house prices than these construction costs are. Construction costs are still going up and they're still going up faster than overall inflation. That's not a good situation. But on top of all that, there are these other things that are going into house prices driving up the price.

Hal Weitzman: So basically you told us things were bad and now you're telling us they're even worse.

Chad Syverson: If you're in the house buying market, yes, things are getting worse and worse. It's more and more expensive all the time.

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Chad Syverson, in the first half we talked about your research about building costs and how the increase in building costs does not necessarily drive an increase in housing costs. And those two things have actually diverged in recent decades. And I want to get into talking about where you've kind of observed some of these phenomena. And say, for example, there's a big price cost disconnect in coastal cities like LA, San Francisco, New York, Boston. Why? What makes those cities different from places that have a smaller gap like Dallas and Houston?

Chad Syverson: Well, we were talking about the potential role of land prices, and I think a lot of the coastal phenomenon is variations in the cost of land moving around being a huge part of what's explaining house prices. And there, I think the academic and the broader policy debate has settled on a big factor is it's just really hard to build houses in those areas. One in part, there are some natural barriers. Certainly on the West Coast, you've got mountains near the coast in some of those metro areas. It's simply more expensive to build houses in mountainous areas.

But probably actually most of it is coming from legal restrictions on building. Local governments in those areas tend not to be very encouraging about building new houses. And that makes it very expensive to build because the right to buy or the ability to buy the right to build a house means you got to buy a patch of land where it's allowed. And so many people wanting only so many patches of land drives up the price of land, and therefore the price of houses on top of it.

Hal Weitzman: Okay. And in Dallas and Houston, it's just easier to build.

Chad Syverson: Yeah. And like I used to say, if you want to build another 1,000 houses in Houston, you just shove the cows out another mile and go ahead and build them. Now you're further and further from the center of Houston, which makes a longer commute. But after the pandemic, not as many people have long commutes anymore anyway. So yeah, it's easier to build in those flat areas.

And also not just the terrain, but also local government attitudes towards building are probably looser. But even that said, actually Texas, the Texas state legislature just passed a bill that basically forces local governments in Texas to allow more building than they were willing to before. So even in those metro areas, we were seeing restrictions on building that people felt were starting to drive up land and therefore house prices.

Hal Weitzman: Okay. Talk about some of the other regional variations that you found. Because in some cases, house prices are way off what building costs would predict? So in Miami, San Jose, LA, you've got very high house prices compared to what you would predict from the building costs. And then in Chicago, a market we know well, Minneapolis, Philadelphia, they've got lower house prices than building costs would predict. What's going on there. That's good for those of us in Chicago, I guess. But what is going on?

Chad Syverson: Yeah, it's kind of interesting. Those cities you named, the first three all have big gaps between prices and costs, but they're actually for different reasons. So San Jose, for example, is I think it's the highest price metro area in the US, but it doesn't have a big gap between prices and construction costs because prices are so high and construction costs are low, actually it has very high construction costs as well. It is not cheap to build anything in San Jose. It's just that house prices are so high that they still have an enormous gap between costs. That's not what's going on in say Miami. Miami actually has relatively low building costs, but a big gap between costs and prices because prices are high relative to those low building costs. So that's sort of an interesting contrast.

And then on the opposite side, those cities you mentioned, there's also variation. The ones that have small gaps between prices and costs, some have that because they have low prices and relatively low costs. Chicago, on the other hand, actually has low prices and relatively high costs. You don't have much of a gap at all between prices and costs. But it's not because house prices are low and costs are low, it's actually because costs are high and they're so high, they're actually close to what house prices are. On the other hand, some of the other low gap cities you mentioned have both low prices and costs.

Hal Weitzman: I mean, I'm wondering if there's a pattern here, and I'm reluctant to get into politics, but these places you're naming that have high costs all sound like Democrat run areas. Is it more expensive typically to build in a Democratic run city?

Chad Syverson: That's a good question. It's not something we looked at directly in the paper. If you just, whether it's causal or not, it's probably true in correlation because a lot of the coastal cities are run by Democratic mayoral administrations. On the other hand, we were just talking about cities in Texas where actually I don't know what the parties of the mayors are in some of those areas.

Hal Weitzman: Well I was thinking more you said the state legislature is forcing some of the cities to open up. And in California, we know there's a lot of restrictions put on by the state for all sorts of-

Chad Syverson: California is having a crisis right now at the state level about how much to loosen restrictions on buildings. So there has been some effort at the state level to loosen, I think it's SB 79, but don't quote me on that, although I just said it on record. That is basically that law would force localities to allow a certain amount of house building under certain conditions, even if they wouldn't normally want to. But it's been a much more vigorous debate than say the Texas law, which I think was pretty smoothly put into place at this state level.

Hal Weitzman: They've got other problems in Texas.

Chad Syverson: Everyone's got problems everywhere these days. Yeah.

Hal Weitzman: Okay. So let's dig into a little bit more on the building costs. Because there's also another nuance, which is installation costs and material costs. So there's some interesting dynamics there. Tell us about that.

Chad Syverson: Yeah. So our construction cost data can be broken out into two components, installation and building or installation and material. So materials are like it sounds, it's the Sheetrock, the lumber, all this stuff, the physical stuff. The installation costs are essentially mostly labor costs. What you have to pay the Sheetrockers to put the Sheetrock on the wall, the plumbers to plumb the house, the electricians, and so on and so forth. So broadly speaking, you can think of them as being materials costs on one hand, labor costs on the other.

One interesting pattern is that. As you look across cities, there's less variation in materials costs than installation costs. And that kind of makes sense because materials are much more tradable than people are. So if for some reason. There's a shortage of lumber in one part of the country relative to another that starts driving up the price of lumber, you can put lumber on a truck or a train and move lumber to where it's needed. It's a little harder to do that if there's a shortage in plumbers in one part of the country relative to another. So you see less variation in the prices of materials.

In terms of dynamics, one thing that we saw coming out of COVID, which was part of a much broader pattern, is that materials costs started growing much faster than it had before. In part, materials costs used to have much lower cost growth than installation costs, maybe related to that point about manufacturing productivity growth. We've gotten better at making physical stuff than we used to. So we've seen those prices haven't gone up as fast as the average price level in the economy. That changed since COVID in part because of all the supply chain disruptions. So you saw big spikes in material costs post-2020 that you hadn't seen before. And a bigger share of the growth rate of construction costs came from material costs than it used to be the case.

Hal Weitzman: Okay. So Chad, I'm wondering what all this means for housing affordability, which is what many people will be thinking about. And I guess one big lesson is even if we were to make buildings super productive, like the actual process of the productivity that you described in that earlier paper, it wouldn't make much difference. Really what's driving this is something else. So do you think the answer is the easier permitting like they're trying to do in Texas? Is it trying to do, I don't know, just building more? What is it? What is actually going to make a big difference?

Chad Syverson: Yeah, I think that is a big part of it. I think the ability to build housing at a density commensurate with the demand for it is just something we have let lag for decades in this country, and we're going to have to start making changes to accommodate that increase in demand. And I think until that happens, it's going to be hard to see any sustained decreases-

Hal Weitzman: You don't think we have to change expectations. Because other people will say, in America, you get a mortgage tax. Well, traditionally you get an itemized mortgage deduction. Now it's standardized. But Americans, from the outside, people would say Americans buy too much house, they don't need that much house.

Chad Syverson: The beatings will continue until morale improves. Sure, that'll work.

Hal Weitzman: So you don't think it's about lowering our expectation of what it means to have the American dream, that you have a smaller house or you have an apartment.

Chad Syverson: I should say, for a given size house, if we can figure out how to make that more cheaply, that's still good. Now, our data shows that's unlikely to show up at least in the short run in changes in house prices because of these other factors. But it's always good if you can do more with fewer inputs. That makes us all richer.

Colorado recently changed its law about the size of buildings that could allow single staircase apartments, which are common in Europe and much less common in the US. So most jurisdictions in the US require, at least for apartments over a certain size, two staircase, you have to have two ways of getting down from the top of the building basically. And if you actually lay that out on a piece of paper, what that does is it greatly decreases the amount of housing units you can get in a given floor plan. And it makes it hard to build apartments that are large enough to accommodate families. Two bedrooms, certainly three and four bedroom sizes.

Whereas if you have one single staircase apartments, you can have much larger individual units and you can accommodate larger families in a given floor area. And so actually people have started to recognize this, Colorado just changed their law. There's some other discussions about law changes regarding that. That moves us in the Europe direction, but not necessarily you got to live in a smaller place. It just makes it easier for families to find apartments, as opposed to requiring them to go find a detached house if they need, say, three bedrooms or four bedrooms, something like that. Which would allow a given amount of space to be sold at a lower price, presumably, than in a detached unit.

Hal Weitzman: But for the moment, we're all going to be living in our big mansions or not. We won't be able to afford them.

Chad Syverson: People say the only thing worth building for builders these days are large, which is true to some extent-

Hal Weitzman: Single family homes.

Chad Syverson: But every time they build a new large house, there's some medium-sized house that would become cheaper because now there's a substitute for the house that the rich people who want to live in a big house had to settle for the medium-sized house. If you build a big house, they'll move out of the medium-sized house. The middle-class family who wanted a medium house but had to settle for the small house can move. And so all these tear down. As long as you're building housing of any type, you're going to tend to reduce the prices of all houses. But we made it hard to build houses of any type, much less middle-class housing.

Hal Weitzman: Okay. Chad Syverson, great conversation as always. Thank you very much for coming back on the Chicago Booth Review Podcast.

Chad Syverson: Enjoyed it. Thanks.

Hal Weitzman: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research.

This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.