Economics of Housing
Similarly, efforts to increase homeownership or bolster the supply of rental housing have met with both success and failure. Inventive modes of housing finance do not always succeed. Clearly, the learning curve in developing well-functioning real estate markets has been quite steep. Again, real estate as an asset class is associated with financial crises.
The character of housing is multidimensional, an important factor to consider when seeking financial solutions. A home can be viewed as a shelter, an investment, or simply a product—the ultimate consumer durable.
From their earliest beginnings, homes have been the largest investment most individuals and their families make. Until the recent price collapse in the United States and other countries, they were also the most passive of investments.
Economic theory suggests several factors driving housing demand:
- Physical characteristics of housing (rooms, facilities, water and sewage, location, construction, and so on)
- Prices for residential services (such as the value-to-rent ratio of owning versus renting)
- Investment components (capital gains in real income)
- Current and permanent income characteristics6
Even after the recent housing crisis, real estate is one of the largest businesses in the world. Buying, selling, and renting properties and the related benefits to owner-occupiers accounts for 15% of the gross domestic product (GDP) of developed countries and two-thirds of the tangible stock of most economies.7
The importance of housing wealth cannot be understated. In Europe and Australia, housing accounts for 40% to 60% of total household wealth, while in America, it is about 30%.8 Changes in such wealth can have significant effects on consumer spending and, therefore, overall economic activity. In particular, financial and real losses can be magnified when property prices fall from historic highs.9
Of the components of GDP, residential investment is always an early warning sign of recessions. As Robert Shiller has noted, “Residential construction as a percentage of gross domestic product has had a prominent peak before almost every recession since 1950.”10