San Francisco, Boston, and Other 'Superstar Cities'

Posted by: Peter Coy on August 4, 2006

Economists have twisted themselves in knots trying to explain why housing prices in cities like San Francisco and Boston are so high. One theory says that the cities have better amenities. Another says that moving to these cities makes workers more productive (presumably because of the higher quality of their colleagues) so people will pay more to live there.san francisco.jpg

Lately, though, three economists from Philadelphia and New York have been pushing a completely different argument, which is a version of the old riddle about what happens when an irresistible force meets an immovable object.

The irresistible force, in their telling, is rapidly rising incomes in the top tier of the U.S. population. Their immovable object is the supply of buildable land in "superstar cities," which are mainly along the coasts where there isn't much room to grow.

Simply put, a certain percentage of rich Americans would like to live for whatever reason in, say, San Francisco. But at some point, there's no more room to build there. So the arrivistes have to pay a premium to move in. Prices go up. The number of rich Americans keeps going up and the number of houses in San Francisco doesn't. So the rich newcomers are pushed out by even richer newer-comers. And before you know it, people are paying millions of dollars for houses that would go for $150,000 in Rochester. (Pictured is a house you won't find in Rochester. It's a Spanish-style home in San Francisco on the cliffs above China Beach, going for $23.5 million, offered by Alain Pinel, Realtors.)

What goes for San Francisco goes for other superstar cities such as Los Angeles, Boston, New York, and Seattle, say the authors: Joseph Gyourko and Todd Sinai of the University of Pennsylvania's Wharton School and Christopher Mayer of Columbia University's Graduate School of Business.

The authors sum it up this way: "Living in a superstar city is like owning a scarce luxury good."

Their theory implies that the price gap between superstar cities and the rest could get even bigger in coming years if incomes of rich Americans continue to rise and the supply of houses in the cities remains fixed. The U.S. population will simply re-sort itself again, with the richest supplanting the slightly less rich from their homes along Superstar Boulevard.

Reader Comments

Frank

August 4, 2006 7:28 PM

Basically your scenario is correct that:
"the price gap between superstar cities and the rest could get even bigger in coming years if incomes of rich Americans continue to rise and the supply of houses in the cities remains fixed. The U.S. population will simply re-sort itself again, with the richest supplanting the slightly less rich from their homes along Superstar Boulevard.

More explanation about the supply problems in places like San Franxisco can be found at http://www.nber.org/digest/sep05/w11129.html

Michael

August 7, 2006 7:07 PM

The "superstar city" trend is just another polite way to describe the growing economic segregation of America and inability of the middle class to keep up with the cost of living in the great cities that were built by the middle class. Here in NYC, there is increasingly a 2-class system; one for Wall Streeters and other superstars who make at least $100k a year, and another for the low wage service workers and immigrants who provide services to the first group, e.g. drive their Town Cars, nanny their children, clean their apartments etc. This is what the future of America looks like, and it's similar to what is common in the 3rd world.

jim

August 7, 2006 7:53 PM

Solid argument.

However, I have read almost nothing about the coming long term downtrend which will surely ensue as Boomers retire/die and want out of the city life. The US will be removing a substantial number of households over the next 20 years. Simple assertion but very logical.

The past 5 years has been an ingenious trick. If we are short on Social Security, trick the young into financing the retirement of the old.

SUCKERS!

superstarexcess

August 7, 2006 10:26 PM

The truth is people drive up prices because they can - its pure supply and demand. Often, its investors who buy property and hold it until some wealthy non-investor comes along to buy it. Because the supply is so limited - the demand (price) goes through the roof. Just like Jimmy Choo shoes. I still can't figure out who these people are and what they do for a living that allows for all of this opulence.

tx broker

August 8, 2006 7:08 PM

I think it is without a question that the big 'superstar cities' will be even moreso of symbol of wealth and power 5-10 years down the road. The blue collar workers will be forced to commute 1hr+ to work while the white collar workers will be living in urbanized areas.

I do realize I'm generalizing and yes there will be those exceptions...

Nathan

August 11, 2006 1:43 PM

I actually read the study, and it was quite interesting and provides a statistical foundation for some of the trends I have been noticing. For instance, if you look at the rate of change of particular income groups in the SF Bay Area, you will notice something remarkable (the authors have a graph for San Francisco itself in the study), the richest cohort (150k+)is also the fastest growing. The superstar cities, are also built out by choice. In general, some of the top 5 cities, SF, Oakland, Portland in particular, all imposed urban limit lines, which limit the land available for housing.
TX Broker noted the decline in "blue collar" jobs and 1 hr+ commutes. Interestingly enough, those are the jobs that are leaving those areas, because their workforce has been leaving too. So, the rate of job growth slows overall. Population growth also declines as the "superstar" cities are generally not family friendly because of their cost and the lifestyle needed to live there.

I found the study quite fascinating, and thanks for noting it. The ironic part is that these "superstar" cities all have "affordable" housing mandates to retain lower level service workers, when as the first commenter noted in the NBER study, it is really their attitude toward development that drives up the cost of housing.

Bubba

August 12, 2006 7:32 PM

I have two comments/questions. First, this all sounds a bit like a big ponzi scheme. The really rich onload their houses on the somewhat rich to shift up to bigger/better places, in the process pushing up the prices of the new class of houses as they look to improve their lot. To move up to the homes previously owned by the really rich, the somewhat rich unload the houses on the somewhat less rich. And so on. Housing prices keep pushing up in all of these segments as each group keeps shifting up one class. Problem is that this could unravel at some point. In some sense, someone near the bottom has to be willing/able to allow the second lowest group to shift up. But once this lowest group gets priced out (basically, no one else can afford to move to San Fran, and those already there can't trade up and don't see much point in swapping homes), does everything fall apart (like a big ponzi scheme)?

Second, where does the Japanese case fit into all of this? Japan has lots of characteristics, similar to those of San Fran, etc., that would seem to make it the ultimate "luxury" market - they sure aren't building new land on those islands and in the late 80s, there were lots of wealthy people there (or at least wealthy on paper until the stock and real estate markets crashed). But Japan then went kablooey in spectacular fashion for 15 years. Does this example have any relevance for this analysis? I suspect so.

Realist

August 17, 2006 4:53 PM

There seem to be some intelligent responses to this story, so I'm wondering why so many people can not see the effect that creative financing has had in all of this.

I remember WAY back in 2001 when they reported on the "affordability index" in the nightly news. It went from 25% to 15% and quickly well under 10% here in San Diego. This was supposed to be a measure of the percentage of average wage earners in an area who could "afford" a median priced home. Well the index got to be so ridiculous, that they simply stopped reporting on it.

Everyone wondered who these people were that were buying if nobody could "afford" a home. The answer was simple... the Federal Reserve and a slew of new (and not-so-new, but never actively marketed) loan products.

After the recession of 2001 was headed off pre-maturely by the Fed and their rate-reducing Chairman, interest rates went way down and the party started with great low-rate fixed loans. But, nobody wanted to party to end, so instead of telling people to lock in long term low rates, they started pushing Interest Only ARM's and finally, the surest suicide loan of all, the Option-ARM.

To make a long story a little longer, easy credit and uninformed buyers trying to reach a little (sometimes a lot) higher than they should have is what accounts for the latest run-up in prices. It has nothing to do with the rich and all their cash buying every home in sight. I'm not sure exactly how many "rich" people you all believe are out there in pure numbers. Plus, if you think making $100k in San Francisco is "rich" then you're crazy.

The fact is that these "Superstar Cities" have been "Superstar's" for many, many years. What so spectacular has happened in the last 5 years to make things any different? House prices have ALWAYS been high in these cities (relatively speaking), but what has happened since 2001 is completely outside of "normal" supply and demand.

Just because someone "wants" to buy in an area, doesn't mean they can or will at any cost. The person with the mention of the "Ponzi Scheme" is right. The bottom will fall out (it already is in many places) unless either wages make a big jump across the board, or the whole thing comes undone and we revert to more sustainable price/earnings ratios. For those waiting for the wages to jump significantly, I believe time is not on your side.

Scott

September 10, 2006 5:52 PM

Most of these responses are variations on the same
theme, in different guises. We have two tracks
of income and net worth, rapidly seperating from
each other. The middle chases the upper middle,
the UM chases the rich, and the bottom fades into
the distance, all under the umbrella of Housing.
The middle-to-bottom goes into debt chasing the
tail of the well-off, pawning their future net worth for a pile of bricks, and other assorted
baubles. The rich watch the chase with amusement,
and collect with glee all the bucks they can,
as we come closer to a Brazilian and Mexican rich/poor divide. In this game, the middle and poor never catch up, build no net worth, and essentially sell their future to mortgage the
aforementioned piles of bricks and baubles.....

Shawn

October 2, 2006 6:37 AM

Note also that superstar cities are attracting rich buyers from all over the world, at the same time that some Chinese and Indians citizens are amassing huge fortunes in their respective burgeoning economies. I suspect that some of this wealth is being spent on buying up property in the SF Bay Area. Recent census counts show Chinese and Indian populations here have increased significantly here in the last five years, and I've watched the streets of Mountain View turn almost completely Chinese in the last two years. The Chinese, as the world's new rich, are moving in and forcing native-born Americans out of one of the best regions of our country.

liz

April 30, 2007 12:25 PM

i live here and just because i am the richest person on my street, and robin williams is my next door neighbor, and i just bought five 1,000 dollar bags does not mean i'm asian!

Gwen

November 7, 2007 8:41 PM

Hi I am from Singapore. By going against the current market sentiment would this now actually be a good ime to buy property in San Francisco ?

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About

BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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