Why Falling Home Prices Could Be a Good Thing

The solution: Americans, together and all at once, would have to stop thinking about their homes as an investment.

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People might expect home prices to go down instead of up. Homebuilders would probably spend more time talking about technology and design than financing options. Politicians might start talking about their plans to lower home prices further, as they often do with fuel prices.

In this thought experiment, housing prices would probably adjust. They would be somewhat cheaper in most places, where population is growing slowly. But they would be profoundly cheaper in places like super-expensive San Francisco.

That was the conclusion of a recent paper by the economists Ed Glaeser of Harvard and Joe Gyourko at the Wharton School of the University of Pennsylvania. The paper uses construction industry data to determine how much a house should cost to build if land-use regulation were drastically cut back. Since the cost of erecting a home varies little from state to state -- land is the main variable in housing costs -- their measure is the closest thing we have to a national home price.

According to them, a standard American home should cost around $200,000, a figure that includes the cost of construction, what land would cost in a lightly regulated market, and a modest profit for developers. In many places, that's what the prices roughly are. But for a few metropolitan areas like San Francisco and Boston, homes are wildly overpriced, leading to distortions in the economy and labor market.

... prices would still vary from place to place, based on demand and geography. It's easier to build in Phoenix (plenty of flat land), and harder in San Francisco (lots of hills and nearby water). But while building in the San Francisco metro area is more expensive than in other places, it's not that expensive. By the paper's calculations, a home in the San Francisco area should cost around $281,000.

The actual price for a standard home in the area is more like $800,000 (using 2013 data). The paper argues that most of that difference is caused by regulatory hurdles like design and environmental reviews that can add years to a project's timeline and suppress the overall housing supply. The result is overpayment on a grand scale for the few homes that do get built.

People are sure to quibble with the economists' calculations, but their general conclusion -- that an abundance of new homes would result in lower prices -- is not remotely controversial