In the late 1980s and early 1990s, residents of Boston lamented the loss of the city’s computer industry. For more than a decade, the Boston metropolitan area had been a center for manufacturing minicomputers — word processors built by the likes of Wang and DEC — which vanished when the market turned in favor of personal computers.
Many people thought Boston wouldn’t recover. Instead, a new wave of businesses came to the city, including many financial services firms and biotech software companies. These businesses chose Boston because it already had a highly skilled workforce. “Oddly enough, it wasn’t industry that drove the growth,” says Professor Chris Mayer, who worked at the Boston Fed during this time of transition. “It was the people who attracted the industries.”
Boston is what Mayer calls a “superstar city.” A superstar city, by Mayer’s definition, has two key qualities: it is in high demand as a place to live, and its housing is supply constrained. These factors push its housing prices higher than in the rest of the country, and at a far faster pace. New York, Los Angeles and Seattle are superstars; the sprawling metropolises of Houston and Dallas are not. As more people move to Atlanta, one of the fastest-expanding metropolitan areas in the nation, developers simply build more apartment complexes and McMansions.
Most superstar cities are on the coasts, where supply is most limited. The prototypical example is San Francisco, where zoning laws since the 1980s have restricted new construction. As building slowed in the city, its housing prices soared, but the city remained extremely attractive to high-income, high-skilled workers, who bid up housing prices.
In contrast is Las Vegas, a city that experienced remarkable growth but could seemingly expand to the desert horizon. The percentage of rich, poor and middle-class families who lived in the city remained relatively stable even as it grew. “If there’s only a small number of projects that can be built, builders will cater to the highest end of the market,” Mayer explains. “But if builders can satisfy demand at the high end of the market, they will produce ever more affordable housing.”
Mayer traces the superstar city phenomenon to population growth and the skewing of the income distribution. In recent years, many economists have noted that high-skill workers are earning higher and higher wages, relative to the typical worker in the U.S. population. Some argue that the middle class is going the way of Wang minicomputers as the incomes of the wealthy continue to climb. Mayer, working with Joseph Gyourko and Todd Sinai of Wharton, researched what this socioeconomic shift means for the housing market.
The researchers studied the differences in housing prices and income growth from 1950 to 2000. The surge in wealthy households and their desire to live in a small number of attractive cities has driven up prices at a relatively fast pace. And as more people are priced out of these attractive cities, high-income households have accounted for an increasingly greater share of their populations. “Over the years, a smaller and smaller percentage of the population can afford to live in superstar cities,” Mayer says.
This can quickly restyle the character of a city, Mayer notes. He cites changes in New York as an example. “It means luxury restaurants and shops, rather than neighborhood diners and dollar stores,” he says. “The Yankees used to be a blue-collar baseball team. Blue-collar workers can’t afford to go to Yankees games on a regular basis now.”
When Michael Bloomberg ran for mayor in 2001, he called living in Manhattan a luxury, a description Mayer sees as apt. “The idea that living in New York is the equivalent to driving a luxury car instead of a Ford or a Chrysler is hard for people to think about, because they’re used to thinking they can live wherever they want,” Mayer says. “You can also choose to buy whatever car you want, but there’s a price to pay. In that sense, living in New York is like driving a Lexus, and it’s moving into the Rolls Royce range.”
Some superstar cities appear at risk of pricing out everyone but the very rich. As prior studies by economists have shown, the rise in high-income salaries in cities tends to lift middle-class salaries over time. Hospitals need not just doctors but nurses. Firefighters and teachers need to be paid enough so that they can afford to live in superstar cities. In New York, the wages of people who provide support services to Wall Street bankers have climbed as bankers’ salaries rocketed higher, although obviously not to the same extent.
However, the slight lift in the salaries of nurses and Wall Street administrative assistants doesn’t entirely compensate for the jump in housing prices. “People end up commuting farther,” Mayer says. “It becomes very difficult to live without two wage earners in a household. People who want to live in superstar cities are willing to live in small apartments and forgo other things they might want. That’s the tradeoff that superstar cities force people to make.”
There is a natural limit, Mayer says, to how far housing costs in superstar cities can climb, and that is determined by the wages and productivity of the people who choose to live there. As long as there is demand, housing prices in superstar cities will continue to rise. In New York, a penthouse apartment at the Hotel Pierre was listed for a record $70 million in December, just a few months after a mansion on East 75th Street sold for $53 million.
“It seems like there should be a limit to what even the wealthiest will pay, but we still might not be there yet in the highest-priced places,” Mayer says. “If high-skill workers keep earning more and more money, it’s conceivable that the run-up in prices in superstar cities could continue to go on for a long time to come.”
Chris Mayer is the Paul Milstein Professor of Real Estate and director of the Paul Milstein Center for Real Estate at Columbia Business School.
Professor Mayer is Paul Milstein Professor of Real Estate and Finance and Economics at Columbia Business School. His research explores a variety of topics in real estate and financial markets, including housing cycles, mortgage markets, debt securitization, and commercial real estate valuation. Dr. Mayer is also a principal at Longbridge Financial, a new and innovative company focused on developing and delivering reverse mortgage products...
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Christopher Mayer, Todd Sinai, Joseph Gyourko