“We Are Not as Wealthy as We Thought We Were”

I have a new paper up at the Mercatus Center: “We Are Not as Wealthy as We Thought We Were”: Elevated American Household Net Worth Reflects Poverty, Not Wealth

I don’t think it is particularly complicated. There aren’t 4 pages of equations and regressions in the paper. But, I think the point is clear and seemingly not commonly understood.

American residential real estate is currently valued at about $58 trillion. It is natural to view that as a form of wealth.

It is not. Only about half of that is true wealth, in the form of structures that provide shelter services. The other half is a measure of rent extraction that comes from blocking the construction of structures that provide shelter.

The official measures that are routinely cited of American net worth are incorrect. There is much more to write about, which I will do over the course of a series of posts. For now, here is the abstract:

From 1975 to 2023, the total value of residential real estate in the United States increased by 59 percent relative to incomes. It is tempting to equate this with increased wealth, but in fact, it signals regressive economic decline relative to the baseline. A series of three observations leads to this conclusion: (1) When aggregate real estate wealth grew because new and better homes were being constructed, it represented real wealth. For more than four decades, the construction of new homes has declined, and higher valuations are due to rent inflation on existing homes. Higher prices on unchanging assets do not represent real wealth. (2) Traditionally, as family incomes increased, aging homes filtered down to new tenants with lower incomes. The decline in new home construction has reversed that process. Today, successive tenants in existing homes frequently have higher incomes than the previous tenants. In other words, the typical American family today lives in worse housing compared to families in recent decades with the same real incomes but pays a larger portion of income for it. (3) In seven years, from 2015 to 2022, American real estate valuations increased by 20 percent relative to incomes. During that period, rising rents reduced household incomes, net of rent, in the lowest income quintile by 15 percent. Higher aggregate housing wealth is associated with regressively lower real incomes. The implication of these observations, as a group, is that the high measure of American real estate wealth is not the result of better housing and rising standards of living. It is the result of a regressive transfer of incomes from tenants and new homebuyers to existing real estate owners. The rate of new home construction has become so constrained that many families have been unable to reduce their consumption of housing at a fast enough pace to maintain historically normal nominal housing expenditures in the face of rising rents. Frequently that is because economizing for families with the lowest incomes requires displacement from their home neighborhoods or regions. The late-20th-century rise in reported household real estate wealth largely reflects families’ resistance against moving under economic duress in a housing-poor economy.

Here is a brief technical explanation of my point above, from the introduction, and a description of the contents of the paper:

This mismatch between measured wealth and living standards is a product of incomplete public accounting. The value of future rent inflation is capitalized in home prices and counted as an asset for homeowners. But the cost of future rents is undetermined for any family at any given time, so it is not counted as a liability. This accounting asymmetry would not create a distortion if rising home values reflected investment in structures that improve living conditions: newer, larger, safer, or more functional homes that would lead to an increase in real rents. The ownership of the home would reflect investment in better future living conditions. But the increase in real estate values relative to incomes has been inflationary. It has been entirely due to rising rents on old, depreciating homes that are not improving in quality or providing more real housing services. In this case, the value of the rising rents is a claim on future incomes of tenants, lowering their real spending potential.

In this paper I make observations about trends in American real estate values at three different levels—national, metropolitan, and local—to show how housing scarcity and rent inflation have inflated measured wealth without improving real living standards.

In section 1, I use national data to document that since the 1970s the stock of American homes has not been growing as quickly as real American incomes, but the rents and prices of homes have been inflated. The national aggregate value of residential real estate is inflated because the country has less housing, not because more has been built.

In section 2, I compare metropolitan areas cross-sectionally. Traditionally, new homes are mostly constructed for families with higher incomes. Older homes become more affordable, and their tenants, over time, have lower incomes than previous tenants had. When new homes are blocked, families must trade down into the aging, existing stock of homes. Rents on older homes become inflated, and their new tenants tend to have higher incomes than the tenants they replace. This is referred to as “filtering up” and is associated with declining housing conditions relative to incomes. Cities where homes are filtering up are responsible for the inflated national measures of real estate wealth.

Filtering does not affect families equally. In section 3, I look within metropolitan areas to further highlight the negative correlation between incomes and home values. I estimate the proportion of rising aggregate home values associated with the broadly shared changes in home prices versus price increases that have been negatively correlated with local incomes. I show that upward filtering leads to systematically regressive rent inflation at the local level, significantly lowering real income growth among families with incomes in the bottom quintile.

Finally, in section 4 I discuss specific examples in which a better understanding of the importance of supply versus demand trends in housing can clarify what policy choices will provide value and choice to American households, thereby contributing to equitable economic progress.