Asymmetrical Information - Megan McArdle

09.28.12

What Is Going On in The DC Housing Market?

Looking a little bubbly, are we?

A couple of years ago, when we bought our house, I was convinced that we had probably already lost money.  We put in our offer immediately after the expiration of the first-time homebuyer's tax credit, which in DC had triggered bidding wars that upped prices by far more than the $8,000 the tax credit was worth.  

We weren't particularly worried about this, mind you; we planned on being in the house for long enough that we expected it simply wouldn't matter.  But we didn't have any illusions that the huose would be, say, part of our retirement savings.

So far, I have been proven spectacularly wrong in this assessment.  Renovated homes on our block are selling for more than 150% of what we paid for our (less renovated home); even wrecks are going at a substantial premium.  We're glad to think that our house is worth more, of course, but we're also mystified.  It seems to me that there remains a distinctly bubbly mentality in the city, which you can a bit of in this comment thread on a local blog.  People seem to have a hidden assumption that every house in the District will eventually be crowding $1 million in value.  

This doesn't seem possible to me.  Ultimately, home prices have to have some relationship to incomes.  And at a traditional salary-to-value ration of two or three times income, I don't see where the money would come from to push everyone's house into the $800,000 range.  (Nor, needless to say, would it be a good thing for soceity if this happened).  

There are two possible ways to justify this.  First, you can say that you think DC incomes will rise very fast--as they have been doing, at least relative to the rest of the country, for the last decade.  Perhaps.  But the last ten years saw a vast expansion of our defense operations, much of which went through private contractors in the DC area.  That will not be replicated again, and the stuff that America will be spending money on in the text ten years--entitlements--isn't so concentrated here.  

A more plausible argument is that incomes won't rise all that much, but the relative desirability of real estate in the District will.  This is essentially the argument made in Alan Ehrenhalt's The Great Inversion, which I highly recommend to you.  The traditional arrangement of cities, says Ehrenhalt, is poorer people on the periphery, richer people in the center.  During the 1950's, this pattern reversed.  You can argue about why--public policy that encouraged automobile use, scurrilous practices by realtors--the fact that school bussing didn't cross the county line--but in most places it happened, cemented by the riots of the 1960s.  But ultimately it doesn't matter.  Ehrenhalt argues that it the old pattern is more natural, and is now reasserting itself.  Ultimately, the centers of the cities will once again be the most affluent zones, as is already true for Manhattan.  

I basically buy this thesis.  And yet, I can't help but think that people in DC, who have not suffered through the bubble the way others did, are still somewhat caught in bubble mentality.  People are buying houses for $650,000 on the assumption that they'll soon be worth $850,00--because that's what happened on U Street.  But there are still income limits, and the future appreciation is priced in.  Maybe more than priced in.