Why the house prices remains high?

Introduction

Housing markets operate through a complex web of interrelated forces that ultimately reach various states of equilibrium. These equilibriums determine everything from housing prices and rents to building heights and development speeds. Understanding these equilibrium mechanisms is essential for homebuyers, investors, policymakers, and urban planners who wish to navigate housing markets effectively.

This article examines Cameron Murray’s five critical equilibrium mechanisms that shape housing markets: asset price equilibrium, rental equilibrium, spatial equilibrium, density equilibrium, and absorption rate equilibrium. In his book, The Great Housing Hijack, he explains how each represents a distinct balancing act between supply and demand factors that collectively determine how housing markets function and evolve over time.

Asset Price Equilibrium: Where Housing Prices Come From

Housing, unlike many consumer goods, functions both as a place to live and as an investment asset. This dual nature creates a unique pricing mechanism governed by fundamental economic principles.

The Fundamentals of Housing Valuation

At its core, housing prices reach equilibrium when the quantity of homes buyers want to purchase equals the quantity sellers are willing to offer. This balance point determines market prices, but several factors influence this equilibrium:

  1. Present Value of Future Benefits: Housing prices reflect the net present value of all future benefits of ownership, including:
    • Rental income (actual or imputed)
    • Expected capital appreciation
    • Tax advantages
    • Utility derived from occupancy
  2. Supply Constraints: Unlike many goods, housing supply is relatively inelastic in the short term due to:
    • Limited developable land
    • Regulatory restrictions (zoning, permits)
    • Construction timelines
    • Existing housing stock durability
  3. Demand Drivers: Housing demand is influenced by:
    • Population growth
    • Household formation rates
    • Income levels
    • Mortgage interest rates
    • Consumer preferences
    • Investor speculation

The Role of Interest Rates

Interest rates play a crucial role in asset price equilibrium. When rates fall, the present value of future housing benefits increases, pushing prices upward. Conversely, rising rates decrease the present value of these benefits, creating downward pressure on prices.

This relationship explains why housing markets often boom during periods of low interest rates and contract when rates rise. The formula for this relationship can be expressed as:

Price = Net Annual Benefit / Discount Rate

Where the discount rate is influenced heavily by prevailing mortgage interest rates plus risk premiums.

Market Efficiency and Information

Housing markets approach price equilibrium less efficiently than financial markets due to:

  • Information asymmetry between buyers and sellers
  • High transaction costs
  • Limited liquidity
  • Heterogeneity of housing stock
  • Local market variations

These inefficiencies can create temporary price distortions, arbitrage opportunities, and lagged market responses to changing conditions.

Rental Equilibrium: Why Income Determines Rents

While asset prices reflect long-term investment value, rental prices operate under a different equilibrium mechanism more directly tied to current income levels.

The Income-Rent Relationship

Rental equilibrium occurs where the supply of rental units meets demand at a price point tenants can afford. Several key principles govern this equilibrium:

  1. The 30% Rule: Historically, housing economists have observed that households typically spend approximately 30% of their income on housing. This creates a natural ceiling on sustainable rent levels.
  2. Income Elasticity: Rent levels strongly correlate with local income levels. When incomes rise in an area, rents tend to follow, as residents can afford to spend more on housing.
  3. Supply Response: Unlike asset prices, rental markets can adjust more quickly to changing conditions, as property owners can modify rents at lease renewal or when securing new tenants.

Market Segmentation

Rental markets segment into various price tiers that align with income distribution:

  • Luxury rentals target high-income households
  • Mid-market rentals serve middle-income households
  • Affordable housing serves lower-income households

Each segment reaches its own equilibrium based on the income profiles of the tenant population it serves.

Regulatory Influences

Rent control and other regulatory interventions can disrupt natural rental equilibrium by:

  • Artificially capping price increases
  • Reducing supply incentives
  • Creating excess demand at controlled prices
  • Potentially deteriorating housing quality due to reduced returns

These interventions aim to address affordability concerns but often create secondary market effects that can undermine long-term rental housing supply.

Spatial Equilibrium: Why Location Matters

Housing markets don’t operate uniformly across geographic space. Instead, they reach spatial equilibrium through price variations that reflect location value.

The Bid-Rent Theory

Spatial equilibrium is well-explained by the bid-rent theory, which predicts that housing prices and rents decline with distance from centers of economic activity. This creates a gradient where:

  1. Central Locations Command Premium Prices: Areas with better access to jobs, amenities, and transportation networks command higher prices.
  2. Transportation Costs Create Trade-offs: Households trade housing costs against commuting costs and time. The total cost of housing plus transportation tends toward equilibrium across locations.
  3. Amenity Values Capitalize into Prices: Desirable neighborhood features (schools, parks, safety, views) are “capitalized” into housing prices, creating price premiums.

Equilibrium Across Markets

Spatial equilibrium also operates between cities and regions:

  • Areas with higher wages tend to have higher housing costs
  • Areas with better amenities command housing premiums
  • Lower-cost areas attract residents seeking affordability
  • Migration flows respond to these differentials until utility equalization

This explains why housing in productive, amenity-rich cities like San Francisco or New York commands significantly higher prices than in less productive or amenity-poor locations.

Modern Influences on Spatial Equilibrium

Several trends are reshaping traditional spatial equilibrium patterns:

  • Remote work reducing the importance of commuting distances
  • Technology enabling greater geographic mobility
  • Growing preference for walkable, mixed-use neighborhoods
  • Rising importance of environmental factors and climate risk

These shifts are creating new spatial equilibrium patterns that may diverge from historical city-centric models.

Density Equilibrium: How Tall We Build

The vertical dimension of housing markets—how tall buildings are constructed—is governed by density equilibrium, which balances land costs against construction costs.

The Economics of Building Height

Building density reaches equilibrium based on a simple economic calculation:

  1. Land Value vs. Construction Costs: As land values increase, developers are incentivized to build taller to spread land costs across more units. However, construction costs increase non-linearly with height.
  2. The Marginal Unit Decision: Developers continue adding floors until the marginal revenue from an additional floor equals its marginal cost. This point determines optimal building height.
  3. Regulatory Constraints: Zoning regulations, floor area ratios (FARs), height restrictions, and other regulatory tools often artificially constrain density below what market forces would otherwise produce.

The Height Gradient

In an unconstrained market, building heights follow a pattern similar to the bid-rent curve:

  • Tallest buildings in city centers where land is most expensive
  • Progressively shorter buildings as distance increases from centers
  • Single-family homes at the periphery where land values are lowest

This pattern emerges naturally as the economic calculation for optimal height shifts with land values.

Construction Technology and Density

Advances in construction technology have significantly influenced density equilibrium:

  • Steel frame construction enabling skyscrapers
  • Elevator technology making tall buildings practical
  • Concrete innovations allowing taller, stronger structures
  • Modern HVAC systems making deep floor plates functional

These technological advances have shifted the cost curves that determine optimal building height, enabling denser development.

Absorption Rate Equilibrium: What Determines Housing Development Speed

The pace at which new housing is built and absorbed into the market represents another crucial equilibrium mechanism in housing markets.

Understanding Absorption Rates

Absorption rate equilibrium determines how quickly developers build and sell or lease new housing units. This equilibrium depends on:

  1. Market Depth: The number of qualified buyers or renters able to absorb new units at prevailing prices.
  2. Developer Risk Calculations: Developers pace construction to minimize financial exposure and maximize returns, balancing carrying costs against potential price appreciation.
  3. Financing Constraints: Construction and development loans impose timelines and phasing requirements that influence development pace.

The Development Pipeline

Development proceeds through a pipeline that includes:

  • Land acquisition
  • Entitlement and permitting
  • Site preparation
  • Construction
  • Marketing and sales/leasing

Each stage has its own timeline and risk profile that affects overall absorption rates.

Equilibrium Dynamics

Several factors determine absorption rate equilibrium:

  1. Price Elasticity: Developers can increase absorption by lowering prices, but this reduces profit margins.
  2. Supply Coordination: Developers monitor competitor activity to avoid flooding markets simultaneously.
  3. Cyclical Patterns: Absorption rates fluctuate with economic cycles, typically accelerating during expansions and slowing during contractions.
  4. Local Market Conditions: Population growth, job creation, and household formation rates directly influence sustainable absorption rates.

Policy Implications

The absorption rate equilibrium has important policy implications:

  • Housing shortages can persist despite high prices if absorption constraints limit supply response
  • Streamlined permitting can accelerate absorption rates
  • Infrastructure investments can enable higher absorption by expanding developable areas
  • Anti-speculation measures can stabilize absorption by reducing investor-driven demand volatility

Understanding this equilibrium helps policymakers design more effective housing policies that address supply constraints.

Conclusion: The Interconnected Housing Equilibriums

These five equilibrium mechanisms—asset price, rental, spatial, density, and absorption rate—do not operate in isolation. Rather, they form an interconnected system where changes in one equilibrium affect the others:

  • Rising asset prices can push rents higher as investors seek returns on expensive properties
  • Spatial patterns influence density decisions as central locations justify taller buildings
  • Absorption rates affect asset prices through supply dynamics
  • Rental returns influence development decisions and building heights
  • Density restrictions impact spatial patterns and price gradients

Understanding these interconnections provides valuable insights for various stakeholders:

For Homebuyers and Renters:

  • Recognizing how location premiums translate to housing costs
  • Understanding how income growth affects affordability
  • Anticipating how interest rate changes might impact prices

For Investors and Developers:

  • Identifying markets where equilibriums suggest untapped potential
  • Optimizing development density based on land costs
  • Timing development phases to match absorption capacity

For Policymakers:

  • Designing interventions that work with rather than against market forces
  • Addressing regulatory constraints that distort natural equilibriums
  • Creating balanced approaches to housing affordability

By respecting these fundamental equilibrium mechanisms, stakeholders can make more informed decisions that lead to more efficient, equitable, and sustainable housing markets.

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