Entrepreneurship and Real Estate

Students in my senior research seminar in economics course are finishing a paper on residential real estate and government housing policy since 1934. It is a surprise to many people that homes used to be purchased with a 5-year balloon loan. That was when the homeownership rate was between 30 and 35 percent. In 1934 the government was determined to increase this rate. The government began its history of subsidizing home mortgages and partnered with banks to roll-out 20 and 30 year mortgages. By the 1960’s the rate had increased to 65 percent.

In this last housing boom, many people became familiar with “low-doc” and “no-doc” loans. Essentially you could borrow money for a home without proving all or any of your income. Another significant factor in the run-up in housing, and its weak foundation, was the moral hazard underlying the “originate and sell” model. Of course many banks would not have been willing to offer such mortgages without the government underwriting or the ability to sell the mortgages into a market rated by the government-approved ratings agencies.

My students focused on one particular aspect of the heavily subsidized real estate market, supply elasticity. Wheaton (2005) “Resort Real Estate: Does Supply Prevent Appreciation?” shows that real estate prices in Loon Mountain New Hampshire had little long-term nominal appreciation and no real long-term appreciation from 1980 through 2005. The explanation was extremely elastic supply relative to demand.

This extremely elastic supply can be viewed as an unintended consequence of government policies designed to increase the rate of homeownership. Easy credit not only increases buying power for potential homeowners in a real estate transaction; it also increases investors’ buying power. Furthermore, these investors are not necessarily all seasoned entrepreneurs. We are all likely familiar with HGTV’s “Flip this House” for example. We also probably know many people who profited handsomely by buying a lot or two in a resort or otherwise highly desirable area and selling it for double only a couple months later and sometimes even just weeks later. We also probably know many investors who were stuck with a few properties once the boom came to a halt. One can also see how the ranks of licensed real estate agents swelled throughout the housing boom, only to shrink after the collapse.

A phenomenon particularly unique to real estate investing is the ability of an investor to purchase more than one lot or home at a time, or at least over a short period of time, using leveraging with government subsidized financing instruments. It doesn’t take too much thought to see that eventually supply will outpace demand in a loose money boom environment, since the most stable fundamental underlying residential real estate is primary residential homeownership. Recreational homeownership adds a level of complexity to the dynamic, but the average person has little need for more than one home. Falling prices is the market adjustment to a high supply relative to demand. What was the extent of this market adjustment in many markets in the US? Horry County in Myrtle Beach currently has almost 18,000 vacant lots with infrastructure in place ready for building. Horry County only has approximately 265,000 people. Wake County (Raleigh), NC on the other hand has less than 16,000 such vacant lots for a population of approximately 900,000. Myrtle Beach is a tourist destination and its vacant lot to population rate is 3.8 times that of Raleigh’s. This year Realty Trac published the cities with the top 20 foreclosure rates in the country. All of the cities were in highly desirable, sunny places, except for #20 – Boise, ID, which is still a resort destination for its skiing and lower prices relative to Colorado. What does this say about supply? Many people became investors or “entrepreneurs” in these areas. Prices have plummeted in these areas because supply outpaced sustainable demand in the short-run. The “rules of the game” caused many people to become real estate investors and also influenced where their actions would take place geographically. The economic consequences have been dire for these regions and the nation, and the rate of homeownership has dropped. So much for good intentions.