This article refers mainly to developed economies. However, some of the author’s talking points are generic, of academic interest—and for those who are policymakers, home-buyers, and or in real estate business elsewhere–such as in an emerging economy, they are insightful, interesting, and a useful ‘we ought to know’ thing home & abroad–whether you are living in the Bering Strait zone or in the Tropic of Cancer region–as a desi or pardesi as a Pakistani or an overseas Pakistani, etc., the observations noted in the article are valuable. (Comment by Irshad Salim).
Tomas Pueyo at Uncharted Territories says: Over the last 75 years, demand for urban housing was driven by:
- Higher population growth
- More urbanization
- More homes per person
- Bigger homes
But supply ground to a halt horizontally and vertically:
- Cities grew as much as they could horizontally and the edge of our car suburbs hit the Marchetti constant.
- NIMBYs restricted building up, limiting supply
Now, we’re entering a world where all these trends are slowing down or reversing:
- In demand:
- The population is shrinking or soon will
- Urbanization has reached its limits
- We have all the homes we need per person. That growth is stopping.6
- Homes keep getting bigger, but that trend is slowing every year
- In supply:
- Remote work eliminates the need to live close to work, which means the entire world becomes potential housing land supply
- Building restrictions can’t get any tighter, and will likely be relaxed
According to Pueyo, “We’re moving from a world where people have only experienced growing housing prices, to one where they are likely to shrink”.
“Does that sound like a world where real estate will be as good an investment as it used to be? Not to me. That’s why I don’t invest in real estate,” he comments.
He adds: “Of course, there are more factors that influence real estate: housing vs commercial, certain cities vs others, interest rates, beach properties, income, immigration, home ownership, the timing of all of this, and more. I will cover these in this week’s premium article. I will also cover examples that illustrate all these trends already happening.”
Pueyo’s article at Uncharted Territories: Real estate has been a great investment for so long that people think it always will be. This is a mistake. I don’t think it will. Powerful forces have been raising housing prices for decades. But they are now petering out, even reversing. As time passes, housing prices might shrink. To understand this, we need a very simple rule: the law of supply and demand.
Have Housing Prices Always Gone Up? No. But you wouldn’t know that, because all your life, housing prices have grown. Our living memory of housing prices only goes back to the 1950s. In that time, real housing prices have quadrupled. But what happens if we look a bit farther back in time? Prices only started growing after 1950! Data from even farther back gets a bit spottier because few countries have good records, but the finding generally stands.
A. Demand
Housing prices used to be very stable. So why did they grow so dramatically in recent times
Simply because demand has outstripped supply. What drives the demand for housing? 1) More people. 2) Who want to live in the same place: cities. 3) Who generally want bigger houses. 4) And who also might want fewer people living in the same household.
Each one of these four trends has been growing incredibly in the past few decades, but is unlikely to keep growing and may even reverse.
Population Growth
The more people there are, the more housing we need to shelter them. It’s true that population has grown since we were hunter-gatherers, but it has exploded in recent times in ways we have a hard time fathoming:
More people meant more demand for housing. But will this trend continue? As you can probably surmise, it won’t. The populations of Japan, China, and Europe are already shrinking. The US is mainly growing because of immigration (which we’ll discuss later), but even there, the growth rate is going to be lower in the future than in the past. That is true for the entire world.
Of course, all of this is driven by the fertility rate, which is shrinking all over the world, is already below replacement rate in most countries, and will likely become the case in all of them. To be explicit: More people means higher housing prices. OK so one of the biggest drivers of real estate price increases was simply more people. But it’s not just that.
Urbanization
They also all wanted to live in the same places! More and more people want to live in cities, but that’s quite a recent phenomenon! In nearly all countries, by the middle of the 1800s, less than 20% of the population was urban!
When everyone began moving to cities, demand on urban housing increased, and prices with them: the denser the area, the higher the prices.
The urbanization rate can’t keep increasing forever. When it went from ~10% in 1800 to ~90% in 2020, that was a 9x increase. From there, at most it can reach 100%, which is only a 10% increase. Therefore, this huge driver of demand for urban land that has existed for 200 years is now dead in developed countries, and might even revert given remote work.
OK, so we used to have more people who wanted to live in the same place in the last 200 years, and especially in the last 75. But they also wanted to be less crowded!
Household Size
The number of people per household has shrunk dramatically over the last couple of centuries. But this decade will likely be the first in at least 160 years in which American households have more people:
If you zoom in on the most recent years, you’ll see that this trend has stopped too, or even reverted. The drive to live in homes with fewer family members grew housing demand until the 1990s, but has barely contributed since. The same is true in Europe, where household size (as in people per household) is even lower.
Will we get to a world with one person per household? 0.5, if each person owns more than one home? Maybe. But based on the trend of the last few decades, it looks like this trend is now dead. Why? Because its main driver is family size:
And families can’t get much smaller than a couple and half a child. They do want bigger houses though.
Bigger houses
As family sizes shrunk, house size grew.
This is how we arrived at houses with one room per child, coming from a world where we packed many people in one room.
This trend seems to be true in other rich countries also. But the more they grow, the less valuable each new square foot is. Yes, each person can have a room and an office, but at some point they have enough empty rooms and don’t want more. This trend will stop. And until then, it will decelerate.
Growth rate of new homes’ average size
In other words: Over the last few decades, there have been: 1) More people. 2) Moving to cities. 3) Who increasingly want to live alone. 4) In bigger houses.
These trends meant there has been a huge increase in demand for housing land since 1950. But now all these trends are stopping or reversing. While demand grew, supply didn’t keep up.
B. Supply
One inconvenient thing about houses is that they occupy volume. As a result, you can only grow your supply of housing by growing horizontally or vertically.
Horizontal Supply and the Marchetti Constant
In How Transportation Technologies Shape Cities, I explained how the main driver of city size is transportation technologies. It’s easy to understand why: People don’t like commuting more than 30 minutes—the Marchetti Constant. When new transportation technologies speed up the commute, city footprints can increase.
As such, city size was limited for thousands of years. Until the train arrived, and then streetcars, bikes, and eventually cars. When your average commute speed goes from 5 km/h walking to 50 km/h by car, you can travel 10x farther in 30 minutes, and the edge of a city is pushed 10x farther. But the land available increases by the square of that, making the city 100x bigger!
The result is that the car increased the supply of land for housing by 10-100x compared to walking! But that is only useful if you own a car. Car ownership has increased dramatically in the last 70 years.
In the US, we’ve reached saturation: There are about two cars per household, and that number hasn’t grown since the late 1980s (Source). This means nearly every household can have a car, nearly everybody can drive to work, and car ownership doesn’t limit city size. Consequently, over the last few decades, cities stopped growing horizontally: They had grown dramatically in the 1950s-2000s along with car ownership, until it wasn’t a limiting factor anymore. The edges of cities was the limiting factor. You can probably get a sense of that in your daily life. When did your city suburbs grow the most? Probably in the 1950s-2000s. After that, new suburbs were ever farther from the city center, less compelling. This limited housing supply, which drove prices up. But this trend is now ending, because remote work has reduced commute time to zero, so cities’ potential size is infinite.
Remote Work
If the car can allow people to live dozens of kilometers away from downtown because they can travel at 30-50 km per hour, what happens when they can travel at 300,000 km per second? That’s the speed of light, which is basically the speed of your video call. When you work remotely, you are no longer limited by the Marchetti constant. At most, you’re limited by the timezone.
People couldn’t work remotely until very recently. Now, they can get electricity and Internet from virtually anywhere. Many people will go to live in rural and semi-urban areas, where prices are lower, and safety and quality of life are higher. The entire world is now potential housing supply. What do you think that will do to housing prices in the long run?
Vertical Supply and Sky Highways
At the very same time that transportation technology was increasing supply horizontally, another type of technology was increasing the supply vertically: construction and elevators. Until the 1800s, buildings were at most six floors tall because taller ones would crumble under their own weight. But steel framing and reinforced concrete changed that, technically allowing buildings to grow taller. It’s one thing to make them possible, another thing to make them enjoyable. In the past, higher floors were for poor people because nobody wanted to climb six flights of stairs. The elevator, invented at the end of the 1900s, changed that. It allowed people to reach any floor easily.
Coupled with the advent of electricity and things like water pumps for water access in high floors, elevators didn’t just make higher floors possible; they made them better. Now you’d rather have the penthouse than the ground floor. This is only 100 years old.
As skyscrapers filled the skyline, people’s dwellings ascended into the heights, and this new supply kept prices controlled in the first half of the 20th century. Then, we stopped building up.
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