Larger Homes Were Not Due to an “Expenditure Cascade” But Were Rational

For home builders.

One of the problems I have with behavioral economics is that too often what is described as a cognitive or psychological glitch is actually very rational behavior as long as you correctly identify the underlying incentives. Robert Frank has an interesting article about how what he calls an “expenditure cascade“–the bidding up of prices by the wealthy, and which is exacerbated by income inequality–was a major reason for the housing bubble. I don’t disagree, since I’ve argued the same phenomenon is at work with college tuition. The rich don’t want to pay $50,000 per year for college, but they can and so they will if they want it badly enough. But then Frank asks this question, and his response is where he goes off the rails:

The important practical point is that when the rich build bigger, they shift the frame of reference that shapes the demands of the near rich, who travel in the same social circles. Perhaps it’s now the custom in those circles to host your daughter’s wedding reception at home rather than in a hotel or country club. So the near rich feel they too need a house with a ballroom. And when they build bigger, they shift the frame of reference for the group just below them, and so on, all the way down.

There’s no other way to explain why the median new house built in the United States in 2007 had more than 2,300 square feet, almost 50 percent more than its counterpart in 1980. Certainly, it’s not because the median earners are awash in cash. (The median real wage for American men was actually lower in 2007 than in 1980.)

Actually, there is a way to explain this: builders were trying to maximize their profits in a supply-limited market. First, as I’ve discussed before, school quality (however nebulously that is defined) is a huge factor in housing markets. Given the increasing importance of education for future income, parents will attempt to literally buy into a good school district. So supply is limited, as there are only so many good neighborhoods. Another factor is–and this is where the builders enter the picture–that most ‘good’ neighborhoods have density restrictions: only so many houses can be built per acre*. If you can’t increase the number of houses you can sell in a given area, then increase the size of the house you can sell. Since home buyers want to live in a limited number of locations, they will pay for ‘too much house’ in order to guarantee a good location.

Ladle on top of this the era of funny money and Big Shitpile, where anybody with a pulse could get a loan, and what you have is a series of very rational actors dragging us down into the abyss.

A house is the single largest investment that most people will ever make**: it would be insane if they weren’t behaving, for the most part anyway, rationally.

Still doesn’t explain the weddings though.

*If you look at pictures of the ur-suburb, Levittown, it’s remarkable how small the lots are compared to a modern suburb.

**And it’s a shitty investment too: leveraged, at best, 4-to-1, localized in exposure, and highly illiquid. The belief that housing and 401(k) should be the way Americans plan their retirements has led to a disastrous outcome. FREEDOM!

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1 Response to Larger Homes Were Not Due to an “Expenditure Cascade” But Were Rational

  1. Art says:

    From the builder’s side of things going bigger is always a winning proposition.

    You build what you can sell. The relative merits of this style versus that will always be debatable. The aesthetics of sight lines and a well placed mud room will always leave some people cold. The one thing that is easy to sell is a few hundred more square feet. All other things being equal a 2,400 sqft home is easier to sell than a 1,200 sqft home.

    Many Americans are entirely uninformed about architecture and quality building practices. The one thing they viscerally understand is size. Bigger is better. It may fall apart in twenty years, or break the bank in energy or maintenance costs, and 75% of the house may be completely unused and remain completely unsuitable for your lifestyle, but bigger sells.

    It also is cheaper, about 33% cheaper on average, for a builder to build one large home than two smaller ones even if the actual square footage is the same. Permitting costs are usually unrelated to size. Every house requires a central core of infrastructure that grows slowly as house size doubles.

    Building trades like big houses because it cuts travel time and administration in proportion to time on site working. This keeps profits higher. A small house keeps a crews working for a few days. Really big houses keep the same crew working for months.

    Builders like big because on a per square foot basis they are cheaper to build. Realtors like big because they impress and a re easier to sell. Customers, even outside home as investment, like big because they play into the fantasy of house as showplace, for dinner parties and family reunions. Parties and reunions that fail to materialize.

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