Secret #10 – The Economics of Houses are Different

Supply

• Location Good. Houses are a location good. 

  • A lot of the value of a house is its location and you can't change it. The price of 2 identical houses can vary a ton depending on their locations. Unlike most other goods, the location of a house can’t be changed which makes local supply even more difficult to increase. Unlike most other goods you can't import more houses from another country or even from another state.
    
    

• EXTREMELY Slow Growing. The total number of houses grows extremely slowly.

  • The total number of houses in the U.S. increases more slowly than the total stock of gold worldwide. (See #11.)

• Long Life. Houses have an extremely long life.

  • A well maintained house can last more than 100 years so the ratio of new builds to total supply is incredibly low, less than 1% a year. That changes the economics completely.

• Land Doesn’t Wear Out. 

  • Unlike man made products, land doesn’t wear out and lose value so landowners can often make money NOT building houses now and just riding any wave of land price appreciation.

• Extremely Price Inelastic. The total supply of houses is extremely price inelastic.

  • Because the number of new houses built is so low relative to total supply to begin with, and because it takes years from start to finish to build new developments, even if prices doubled overnight, the total supply of houses would increase extremely slowly.

Demand

• Investment Good. Houses are an investment good.

  • Houses are partially an investment good for live-in owners and are 100% an investment good for landlord-owners. Economically, investment good prices can act very differently than consumption good prices. Stock prices, for example, behave very differently than food prices.

• Most Expensive Purchase. Houses are the most expensive household purchase and asset by far. 

  • As their largest investment, changes in the price of houses affects household wealth like no other price.

• Extremely Price Inelastic. The total demand to own houses is extremely price inelastic. A given increase in demand leads to higher prices for houses compared to other goods because higher prices decrease the quantity demanded relatively slowly, despite being the most expensive household purchase.

  • Owning a house is more of a life goal than a normal consumption good that has lots of substitutes. 

  • Unlike normal consumption goods, higher prices can actually INCREASE demand for houses because houses are also partly an investment good. (See #12). In addition, higher prices can pull demand forward for first-home buyers who fear prices will continue to increase and price them out of ever owning a house if they don’t buy immediately.

• Largest Loan. Most borrowed money by far.

  • Changes in interest rates, lending standards, and loan design have far more impact on the demand for houses than on the demand for any other good.

• Slow Changes in Demand.

  • Population.

  • Income.

• Variable Changes in Demand.

  • Mortgage credit standards can change demand fast or slow depending on the change.

• Volatile Changes in Demand. 

  • Interest Rates. Interest rates have a huge impact on the demand for houses and interest rates can be volatile.

  • Investor Demand. Investors can jump into and out of the market for many reasons and have a big impact on prices.  

Overall, demand is FAR, FAR more volatile than supply which causes house prices to be unusually volatile when demand changes.

Takeaways

Most immovable – If you had to be standing in an orange orchard to eat oranges, it would change the economics of oranges entirely.

Most fixed supply – Supply grows more slowly than the supply of gold.

Most expensive – Extremely few sales relative to total number of homes.

Most money borrowed – Most sensitive to changes in interest rates and lending standards.