Upside Down CAPM and Home and Land Prices

As I touched on in the previous USDCAPM post (Upside Down Capital Asset Pricing Model), there are two primary forms of excess housing price inflation.

One form is cyclical inflation that follows the classic bubble formula - inelastic short-term supply and elastic long-term supply. This is basically fast moving market mechanisms versus slow moving market mechanisms.

Home prices, household formation and migration can change quickly. Rents and home construction are a bit sticky. So demand for purchasing homes can get ahead of supply of homes in ways that will somewhat predictably reverse. When that happens, prices across the entire metro area increase while rents remain relatively stable.

The other form is secular supply obstruction. When that happens, rents increase regressively, and they drive prices higher, especially in low tier neighborhoods. This price inflation does not reverse itself. It requires more construction or a regional economic depression.

You could say that the cyclical home price inflation is from impatient households and secular home price inflation is from obstinate households. In the first case, they don’t want to wait out the market to get a lower price. In the second case, they are forced to pay ransom to their landlords in order to avoid being displaced from their homes.

In the past 25 years, Phoenix has shades of both types of price inflation and also briefly was an example of a market where housing costs declined in spite of supply constraints because of regional economic depression.

Figure 1 shows Phoenix home prices and rents. In 2005 and 2006, there was a substantial bubble - prices increased but rents didn’t. (Actually, they did a little. More on that below.) It reversed, and then some. Then, prices and rents increased together after the Great Recession when the mortgage crackdown reduced construction activity. Then, after Covid, there was a small divergence between prices and rents.

Figure 1

In Figure 2 you can see the difference between high tier and low tier prices. In the pre-2008 bubble, they moved together. In the post-2008 construction depression, the low tier rose more than the high tier.

That is because every lot in Phoenix now has a “Phoenix scarcity premium” attached to it. “The bribe you must pay to the land to buy the house.” That proportionately pushes up the cost of a $150,000 house more than it pushes up the cost of a $300,000 house. And it is unbounded. Well, it is eventually bounded by the inability of poorer residents to pay the “bribe”, so eventually a lack of supply triggers outmigration more than rent inflation.

Figure 2

Figure 3 uses the Erdmann Housing Tracking model to take snapshots of these various phases of Phoenix housing. Figure 3 and the rest of the post is below the paywall.