Why Have Housing Prices Gone Up?

Why Have Housing Prices Gone Up?
Edward L. Glaeser and Joseph Gyourko

Since 1950, housing prices have risen regularly by almost two percent per year. Between 1950 and 1970, this increase reflects rising housing quality and construction costs. Since 1970, this increase reflects the increasing difficulty of obtaining regulatory approval for building new homes. In this paper, we present a simple model of regulatory approval that suggests a number of explanations for this change including changing judicial tastes, decreasing ability to bribe regulators, rising incomes and greater tastes for amenities, and improvements in the ability of homeowners to organize and influence local decisions. Our preliminary evidence suggests that there was a significant increase in the ability of local residents to block new projects and a change of cities from urban growth machines to homeowners’ cooperatives.

Too often, analysts attempt to understand housing prices only by attending to demand-side factors such as interest rates or per capita income, while ignoring the supply-side of the market. Rising prices require not only rising demand, but also limits on supply. The supply of housing includes three elements: land, a physical structure, and government approval to put the structure on the land. Thus, rising prices must reflect rising physical costs of construction, increasing land prices or regulatory barriers to new construction.

Even in booming markets, construction cost increases have been modest. Between 1970 and 2000, real construction costs in San Francisco and Boston rose by 4.6 percent and 6.6 percent, respectively. Over the same 30 years, real mean house prices rose by 270 percent in the San Francisco primary metropolitan statistical area (PMSA) and 127 percent in the Boston metropolitan area.



Rising structure costs still could explain the post-1970 growth in housing prices if structural size and quality were increasing rapidly. To assess the importance of housing quality, we can compare the overall rise in housing prices with the rise in prices measured by repeat-sales indices that hold housing structure constant. In the United States as a whole, the real median value of owner-occupied housing rose by 1.20 percent per year from 1980 to 2000. Over this same period, real appreciation of the repeat-sales index published by the Office of Federal Enterprise Housing Oversight (OFHEO) was 0.93 percent per year, which suggests that changes in the quality of housing account for no more than one quarter of the average increase in housing values. The same methodology in high-price areas shows that quality growth is even less important in those places.

It is only since 1980, and only in a relatively few metropolitan areas, that there has been a widening gap between price and construction cost. Almost all of the markets in which housing prices became substantially higher than physical production costs during the 1970s were part of the three big coastal metropolises in California—the Los Angeles-centered CMSA, the San Francisco-centered CMSA, and the San Diego MSA.

A decade later, gaps between prices and construction costs on the West Coast had grown and had spread to interior markets in California. For example, structure represented only 53 percent of average house value in Sacramento in 1990. High prices relative to construction costs had also spread to other West Coast markets such as Seattle. The non-structure component of house value also exceeded 40 percent across a swath of the east coast roughly approximated by Amtrak’s Northeast Corridor.

By the year 2000, there were 27 metropolitan areas in which structure could account for no more than 60 percent of total house value.

It is no longer the case that high prices relative to construction costs generally lead to a surge in new construction.

These results strongly suggest that restrictions on new supply have become increasingly important in preventing suppliers from responding to high prices by building additional units. But are these limits on new construction the result of a dwindling supply of land or other barriers to new construction?

Beyond physical structure, the cost of supplying a house includes both the cost of the land and the cost of the right to build. If the costs associated with the right to build were small, then the non-structure value of the property would include only the cost of the land. A completely free market for land would lead land to be worth the same amount on both the intensive and extensive margins. Stated differently, a quarter acre would be valued the same if it sits under one house or if it extends the lot of another house. Using this insight, Glaeser and Gyourko (2003) and Glaeser, Gyourko and Saks (2005) use hedonic price estimation to estimate the price of land when it extends the lot of an existing house. We find that such land is not all that valuable; generally a quarter acre is worth about ten times more if it sits under a house than if it extends the lot of another house. The fact that land is worth much more when it is bundled together with the right to build provides further evidence that the right to build is worth a great deal.

In sum, the evidence points toward a man-made scarcity of housing in the sense that the housing supply has been constrained by government regulation as opposed to fundamental geographic limitations.8 The growing dispersion of housing prices relative to construction costs suggests that these regulations have spread into a larger number of local markets over time. Moreover, they appear to have become particularly severe in the past 2-3 decades.

Given these assumptions, there is a unique amount of development that will maximize the average discounted lifetime utility of all current residents of the town. In order to achieve this social optimum, it is necessary to allow for the possibility of sidepayments between developers (who gain from additional residential construction) and homeowners (who lose from additional development through lower future housing values). It is straightforward to show that a higher fraction of homeowners will lead to less development. Moreover, because a shorter lifespan makes the resale value of homes more salient to homeowners, shorter life spans also curtail the optimal amount of development.

There are two reasons why the level of development that maximizes the welfare of current residents will not be socially optimal. First, higher population density has a negative impact on the utility of future residents of the town and of the reservation locale that current residents will not internalize. Second, current homeowners have an incentive to increase the value of their homes, and do not internalize the impact that higher housing prices have on non-homeowners who would like to live in the town.

The second comparative static suggests that the explanation lies in the rise of homeownership and the success of community organization. Increases in both the share of homeowners and the political organization of homeowners’ groups should lead to less development. In the past 40 years, the fraction of homeownership has risen from about 59 to 68% (Federal Reserve Board, 1964 and Aizcorbe et. al., 2003). Moreover, political participation of homeowners groups has been rising (Nelson, 2004, Freund, 1974). Not only should this trend restrict residential development, but Altshuler and Luberoff (2002) suggest that these groups have been increasingly able to restrict large-scale nonresidential development projects as well.


In 1977, Robert Ellickson noted that “suburban governments are becoming ever more adventuresome in their efforts to control housing development.” (p. 388). Ellickson does not explain this change, but points to judicial decisions such as Nectow v. City of Cambridge which have made it difficult for landowners to stop municipalities from restricting new construction on their land. Fischel (2004) points to the ideology of judges: “Courts, whose judges share the same environmental attitudes as middle class homeowners (just as 1920s judges shared the ideology of hearth and home), were more sympathetic to claims that the local decision had failed to account for environmental impacts than they had been to seemingly selfish claims that neighbors’ home values were at risk.” (pp. 332-333) Other cases such as Mt. Laurel that demanded low income housing have simultaneously allowed growth controls: "once a community has satisfied its fair share obligation [a fraction of the region’s low-income housing], the Mount Laurel Doctrine will not restrict other measures, including large-lot and open area zoning, that would maintain its beauty and communal character"(Mount Laurel II, 456 A.2d at 421 cited in Fischel (2004), p. 331).

While the influence of developers may or may not have declined, many observers have noted a sizable increase in the organization and political impact of local residents. Altshuler and Luberoff (2002) examine the history of large scale government projects (“Mega Projects”) and describe changes that began in the 1960s, when citizens became better able to challenge large scale projects that would impact their neighborhood. One early and striking example was Jane Jacobs’ leadership of the Greenwich Village movement that stopped Robert Moses’ West Side highway project in New York. Through increasingly sophisticated use of the media, local groups learned how turn mega-projects into public relations disasters.

Another way to think about the effect of income is to consider the zoning environment of very rich places in 1960. If the income hypothesis is correct, then permitting in these places should have been as restrictive in 1960 as the entire metropolitan areas of Boston or New York in more recent years. However, places like New Rochelle, NY, San Mateo, CA and West Orange, NJ, each allowed at least 10 times as much development in the 1950s as metropolitan areas with comparable incomes today. Again, this analysis suggests that the complete story goes well beyond the explanation that homeowners became richer.


A final hypothesis is that the impact of new construction on housing prices has changed over time. In the 1950s, housing costs were low, lower incomes made people less concerned about environmental amenities, and an absence of construction in previous decades may have meant that the quality of new housing was significantly higher than older units. For these reasons, new construction may not have led to major reductions in housing prices for existing units and as such, homeowners had much weaker incentives to fight new construction. In 2004, however, homeowners appear to believe that new construction will significantly reduce housing prices. Certainly, the evidence in this paper linking rising housing prices to reductions in construction suggests that they are right. As in the case of the previous theories, we have little evidence on the relevance of this theory and we look to further research to examine this hypothesis more thoroughly.