From the Archives
“‘Were I to characterize the United States,’ said one British traveler who toured the country in the 1790s, ‘it should be by the appellation of the Land of Speculation.” –The Exchange Artist
Within a matter of months, COVID-19 has altered the trajectory and viability of many industries / businesses. While I am certainly not in the alarmist “nothing about life as we knew it will ever be the same” camp, and would side with Jerry Seinfeld over James Altucher in the debate over NYC’s future, there is no avoiding the fact that certain aspects of business and society will endure more permanent and long-term repercussions of COVID-19.
One of the most widely debated knock-on effects of COVID-19 is the prevalence of remote work post-pandemic. After non-essential businesses were forced into remote work as a result of the pandemic and government shelter-in-place policies were implemented, many companies realized the benefits of remote work and announced plans to institute a permanent work from home policy. Just this week, Okta joined other large companies like Facebook and Twitter in announcing their plans for letting employees work remote permanently.
This is where the focus of today’s Sunday Reads comes into play: Real Estate.
COVID-19 & Real Estate
History repeatedly demonstrates how difficult it is to predict the knock on effects of an exogenous shock. For example, it was the San Francisco earthquake of 1906 that led to a massive outflow of gold reserves in London, which led to tightened credit conditions as Britain raised rates, which helped spark the Panic of 1907, which ultimately resulted in the creation of the Federal Reserve as America’s leaders had finally had enough of the problems associated with gold flows and financial panics. Who could possibly predict that?
In the case of COVID-19, we do know that the remote work dynamic post-pandemic has serious implications for the real estate market, one way or another.
As traditional office buildings are being left vacant, and city dwellers begin to search for larger spaces after sheltering-in-place for months, some early signs of what the future could hold are starting to appear in the data. In New York City, for example, the Real Estate Board of New York published a report showing:
“[commercial] investment sales [in NYC] totaled $10.5 billion in the first half of 2020, down 54% from a year earlier and a record low since the Real Estate Board of New York began reporting the data in 2015.“
The pandemic is even starting to affect what buyers value when renting or purchasing in NYC. A recent Bloomberg article stated:
“In New York City, where early coronavirus lockdowns kept residents inside cramped apartments for months, apartments with terraces in Manhattan are selling for 5.4% more per square foot than those sold this year before the pandemic lockdown, according to data from appraiser Miller Samuel Inc. That’s compared with a 1.1% drop in price per square foot for co-ops and condos without terraces…
Even in a market partially paralyzed by the pandemic, places with outdoor space are getting more looks than those without. Searches for New York City rentals with outdoor space are up 270% since before the pandemic started…”
Outside of the city, new home sales in the United States rocketed to their highest levels since December 2006.
Similarly, housing permits are at the highest levels since 2005:
What’s also interesting is where and why new home sales are happening. Bloomberg wrote:
“Sales of new houses have taken off during the pandemic because borrowing costs have never been lower and listings for previously owned homes are in short supply. Shoppers want quarantine comforts, such as backyards and room for offices. And builders are shifting to lower-priced offerings, expanding the pool of potential buyers…
Three out of four major U.S. regions showed higher sales of new homes in July. Purchases surged 58.8% in the Midwest, climbed 13% in the South and 7.8% in the West. Sales fell 23.1% in the Northeast.“
The Next Frontier
Only time will tell if this is another instance where we get ahead of ourselves in overthinking how much everything is going to change, or whether COVID-19 will actually result in the structural shifts touched upon above. If remote work does serve a more prominent role even after the pandemic subsides, and people continue leaving cities like NYC and San Francisco, this will represent a new frontier of sorts for real estate.
I think that a great historical parallel for this is the birth of the automobile in the first quarter of the 19th century:
“The introduction of the automobile had a huge impact on the entire structure of America. The positive and negative effects of the automobile were felt throughout the country almost instantly. When the price on the Model-T dropped many common people were able to afford an automobile. This led to the development of suburbs since people could commute into the cities for work. The automobile also gave people the opportunity to spread out across rural areas because farmers no longer needed to be within carriage distance of a port or train tracks. These new environments created by the automobile changed how America lived and how people interacted with one another… New jobs opened up in factories, convenience stores, gas stations, state police, highway construction and many other fields.”
The automobile led to the rise of suburbs and retail malls in America as people were suddenly able to commute to work in cities and factories by car, and no longer had to live in the city or near the train station. This new freedom is similar to those facing Americans today that are increasingly less tied to their physical office location. If we no longer have to live near our offices, this freedom allows us to spread out across the country just as our predecessors did in the 1920s.
Who knows how this plays out, but it will be interesting to watch how everything unfolds.
Now let’s get to it!
While we are all familiar with the role that the Florida housing market played in 2008. However, the 1920s Florida land boom is a lesser known real estate bubble since it is often overshadowed by the 1929 stock market crash and ensuing Great Depression. This article provides an excellent overview of the 1920s land boom and compares it with the housing crisis of 2008.
“Although long obscured by the Great Depression, the nationwide ‘bubble’ that appeared in the early 1920s and burst in 1926 was similar in magnitude to the recent real estate boom and bust. Fundamentals, including a post-war construction catch-up, low interest rates and a ‘Greenspan put,’ helped to ignite the boom in the twenties, but alternative monetary policies would have only dampened not eliminated it. Both booms were accompanied by securitization, a reduction in lending standards, and weaker supervision. Yet, the bust in the twenties, which drove up foreclosures, did not induce a collapse of the banking system. The elements absent in the 1920s were federal deposit insurance, the ‘Too Big To Fail’ doctrine, and federal policies to increase mortgages to higher risk homeowners. This comparison suggests that these factors combined to induce increased risk-taking that was crucial to the eruption of the recent and worst financial crisis since the Great Depression.“
If you are looking to learn even more about this episode of American history, I would highly recommend this book: Bubble in the Sun
Lessons from the 1920s
“What was absent in the 1920s and what, by comparison, seems to have been central to today’s far greater disaster, were policies that induced banks to take increased risks. In the twenties, there was no federal intervention in mortgage markets. Far more households rented; and the boom only increased homeownership from approximately to 50 percent of households, while the early twenty-first century boom drove up homeownership from 65 to 69 percent. Because it provided new mortgages to homeowners with significantly lower incomes and wealth, many features of the recent boom were more extreme even if these are not easily quantifiable. While contemporaries in the 1920s may have decried buildings and loan associations’ innovations that permitted mortgagors effective down payments of only 20 percent, it seems like very conservative lending compared to zero down payment loans that characterized some mortgages in the 2000s. Similarly, while securitized mortgages in the twenties obscured some of the risk present in a pool of mortgages, there was more risk to be hidden in subprime loans and hence the greater degree of complexity of more recent securitized products. This higher level of risk is apparent in the aggregate foreclosure rates of recent stable economic times that often exceeded the foreclosure rates of the post-1926 bust and the Great Depression.
Furthermore, in the twenties, bankers were not tempted by moral hazard from deposit insurance or the “Too Big to Fail” policy to take more risk on or off their balance sheets. In fact, the general imposition of double liability on bank stock may have induced bank managers, subjected to greater monitoring by shareholders, to reduce risk-taking. However, this is not to say that the regulations governing the banking system of the 1920s made it particularly resilient to shocks. The dominance of small undiversified single office banks translated shocks from the post-World War I collapse in agricultural prices and the Great Depression into waves of bank failures.
Yet, faced with incentives set by the market and policy, banks and other financial institutions in the 1920s remained prudent, modestly lowering lending standards and increasing their holdings of mortgages. When the bust came, large losses did not accrue to them; and the most risky securitized mortgages were held by investors, not leveraged financial institutions. Banks and other intermediaries survived until the Great Depression unexpectedly hammered the banking system and homeowners, causing the great housing boom and bust of the twenties to fade from memory.”
When one talks about backtests, it doesn’t get much further back then housing data since 1290…! Note the drop off in British real estate around the Black Death in 14th century Europe.
“Global Financial Data has put together a data series covering seven centuries of real estate prices. The series covers real estate costs in Great Britain from 1290 to the current day… How did we do this? Unfortunately, there was no Ye Olde Zillow Real Estate Co. that had stayed in business for seven centuries and allowed us to analyze their records, but instead we spliced together several long-term series to create this index. The data from 1290 to 1894 is actually based upon the rental costs of housing rather than actual housing prices since rental data was the only information that was available. The data from 1895 to date is based upon actual housing costs using series put together by the Bank of England and the Nationwide Building Society.”
“How do pandemics affect urban housing markets? This paper studies historical outbreaks of the plague in 17th-century Amsterdam and cholera in 19th-century Paris to answer this question. Based on micro-level transaction data, we show outbreaks resulted in large declines in house prices, and smaller declines in rent prices. We find particularly large reductions in house prices during the first six months of an epidemic, and in heavily-affected areas. However, these price shocks were only transitory, and both cities quickly reverted to their initial price paths. Our findings suggest these two cities were very resilient to major shocks originating from epidemics.”
If you’re curious about how previous pandemics and epidemics have impacted the housing market, look no further. This fascinating article assesses the impact of pandemics on urban housing markets through case studies on 19th century Paris and 16th/17th century Amsterdam.
The results show that during an epidemic, housing prices fall roughly 5.5% a year, and then fall a further 4.1% after the epidemic. However, the positive news is that these declines are short-lived, with both Amsterdam and Paris displaying quick bounce-backs following their respective epidemics. The authors state that ‘real house prices and rents grew in the decades around the epidemic by almost one percent per year – significantly above their historical average.’
As the chart below demonstrates, Amsterdam was no stranger to the plague during the 16th and 17th centuries. The most severe plague in this period killed a staggering 10% of the city’s population, and it’s possible that the real figure is even higher due to under reported data.
As it turns out, the citizens of Amsterdam had a very similar experience to what we’re living through right now in terms of social distancing. The best example is found in the ‘Plague Law of 1558’, which forbid the population from ‘visiting markets, inns, and churches during epidemics, as well as any other place where many people gathered.’
Additionally, many industries were shut down by the government in efforts to prevent spreading the disease. The description below sounds exactly like the problems facing hotel chains, restaurants, airlines, and other affected industries today:
‘After the 1617 epidemic, owners of inns complained that they lost most of their income because travelers avoided the city due to the epidemic. In the 1635 epidemic, Amsterdam merchants halted all orders from the textile industry in Leiden because they were afraid of the spread of the plague. In Hoorn, a town nearby Amsterdam, a chronicler wrote in 1656 that all businesses and artisans have shut down by now, and people have not much else to do than to help the sick.”
However, a positive takeaway from the city’s unfortunate battle with an epidemic is that the economic impact was short-lived, and did not stunt Amsterdam’s long-term growth .
‘The frequent plague outbreaks do not seem to have prevented Amsterdam’s growth over the longer term. Between the late 16th century and the late 1660s, the period of the most severe epidemics, Amsterdam rose to prominence and established itself as the merchant capital of the world. Its population rose from about 30,000 in the 1580s to over 200,000 in the 1660s, and in their landmark work on the Dutch economy, De Vries and Van der Woude classified this period as the first round of modern economic growth.” So while plague outbreaks vaged the city over the shorter-term, migration towards Amsterdam stayed very high, resulting in significant population growth over time.
The first outbreak of cholera in Paris occurred in March 1832, and killed more than 11,500 people in the first month alone. Eventually, the outbreak killed roughly 2.5% of the city’s population. In 1849, cholera returned and claimed the lives of another 1.5% of Paris’ population. In some areas of the city with higher population density, cholera killed up to 6% of the neighborhood’s community. The exhibit below shows the death rate per 1000 inhabitants by sections of Paris:
If there was a silver lining, however, it was that the worst hit areas of Paris (which were essentially slums) were cleared away and rebuilt to higher sanitary standards following the first cholera outbreak in 1832.
‘When Count de Rambuteau came to power in Paris in 1833, he proclaimed that his mission was to provide “air, water and shadow” to all citizens in Paris, and started clearing unhealthy housing in the worst-affected central areas of the city, as well as introducing public urinals to improve sanitation…
The epidemic in 1849 confirmed the validity of Rambuteau’s approach: mortality levels were still much higher in the working-class areas in the cities on the left bank but had gone down in the historical city center, where much of the slum housing had been cleared . This confirmation paved the way for massive renovations: the Hausmann renovations that took place in the late 1850s and 1860s destroyed a large part of the unhealthy medieval Paris and gave Paris the image it still has today.’
As far as the outbreaks’ impact on housing prices, for the 1832 outbreak:
‘Between 1832 and 1836, high-mortality areas fall significantly in prices relative to low-mortality areas, with a relative price drop of 7.3%. Reassuringly, this drop is more significant in areas profoundly affected by cholera in 1832 compared to 1849. Until the mid-1840s, house prices between high and low mortality areas remain at relatively stable levels, except for a slight but insignificant jump in 1840.’
“The great housing convulsion that buffeted America between 2000 and 2010 has historical precedents, from the frontier land boom of the 1790s to the skyscraper craze of the 1920s. But this time was different. There was far less real uncertainty about fundamental economic and geographic trends, making the convulsion even more puzzling. During historic and recent booms, sensible models could justify high prices on the basis of seemingly reasonable projections about stable or growing prices. The recurring error appears to be a failure to anticipate the impact that elastic supply will eventually have on prices, whether for cotton in Alabama in 1820 or land in Las Vegas in 2006. Buyers don’t appear to be irrational but rather cognitively limited investors who work with simple heuristic models, instead of a comprehensive general equilibrium framework. Low interest rates rarely seem to drive price growth; under-priced default options are a more common contributor to high prices. The primary cost of booms has not typically been overbuilding, but rather the financial chaos that accompanies housing downturns.”
“How have house prices evolved in the long-run? This paper presents annual house price indices for 14 advanced economies since 1870. Based on extensive data collection, we are able to show for the first time that house prices in most industrial economies stayed constant in real terms from the 19th to the mid-20th century, but rose sharply in recent decades. Land prices, not construction costs, hold the key to understanding the trajectory of house prices in the long-run. Residential land prices have surged in the second half of the 20th century, but did not increase meaningfully before. We argue that before World War II dramatic reductions in transport costs expanded the supply of land and suppressed land prices. Since the mid-20th century, comparably large land-augmenting reductions in transport costs no longer occurred. Increased regulations on land use further inhibited the utilization of additional land, while rising expenditure shares for housing services increased demand.”
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