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More on gas prices and home prices.

June 16, 2008
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I’ve tried to evaluate the impact of gas prices on home prices before.  Richard Green, a GWU real estate/finance/economics professor, comes to a completely different conclusion:

Let’s say the average household makes five one-way trips per day–for work, shopping, entertainment, etc. Let’s also say that the average car gets 20 mpg in city driving. Each mile of distance to work, shopping, etc. is therefore now 50 cents per day per household more expensive than before. A household living immediately adjascent to work and shopping should then be willing to pay $5 per day more in rent than a household 10 miles away compared with six years ago, all else being equal. This becomes $150 per month, or $1800 per year. Assuming a five percent cap rate for owner occupied housing, this translates to $36,000 in relative change in value. Given that the median house price in the US is about $220k, this is kind of a big deal.

The assumptions here are pretty crude (particulalry the ceteris paribus assumption), but if gas remains at its current real price, we will see the shape of US cities change.

Green is using the standard monocentric model.  Under that model, all employment and city amenities are assumed to be concentrated in the CBD.  With that assumption (Ok, and a few others), the model predicts that land rents are completely determined by commuting  costs.  That is, property values (which depend directly on rents) will decline to offset any increase in gasoline costs.

I am skeptical that home prices will completely offset the rise in gas prices (and, to be fair, Green acknowledges he is making a bunch of assumptions for the sake of simplicity).

First, homeowners can cut their gas bills by switching to more efficient vehicles, combining errands, taking public transit, etc.  This means they won’t necessarily respond to higher gas prices by bidding up rents dollar for dollar.

Second, cities aren’t really monocentric.  They are polycentric.  Think of Houston, which has its downtown, the Galleria, the Med Center, Greenway Plaza, the Energy Corridor, etc.  A home nine miles from downtown Houston may become less attractive to downtown commuters, but if it is only three miles from the Galleria, it may become relatively more attractive to Galleria commuters.  The push and pull of the different employment centers will snarl the simple rent gradient predicted by the monocentric model.

Ultimately it’s an empirical question.  It will be interesting to see what really happens to home prices.  Will (have) home prices in Houston react(ed) differently than home prices in a relatively more monocentric city such as Boston?

I think Green definitely overstates things, though,  when he says “we will see the shape of U.S. cities change.”  Even if one assumes that home prices will completely absorb the rise in gas prices, our urban form won’t change much, at least not quickly.  Rising gas prices theoretically could drop the value of suburban land below its value as farmland, but it still won’t be worth anyone’s while to plow under all those houses.  The markets simply will clear at very low prices.  The low land prices may discourage the construction of new suburban housing, but this assumes that central city zoning will allow the density necessary to accommodate the suburban refugees (which it certainly should).  Even then, adding a robust 1-2% per year to existing central city housing stock won’t have a dramatic effect on the city’s urban form.  For example, if a city starts with 70% of its housing as detached single-family homes, it will take a very long time before most of its housing is made up of condos and apartments. 

In other words, Atlanta won’t turn into Berlin during our lifetimes, regardless of what gas prices do.

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