NY Times on Housing Prices

In a New York Times column last month, Robert Shiller painted a scenario in which home prices might fall for years (and even decades) to come. However, this view ignores some critical differences between real estate and other more purely “financial” assets. This oversight often leads to an exclusive focus on demand fundamentals, expectations, and other factors that both create asset price bubbles and their collapse. What is missing from this analysis is the supply side of the market. Real estate is a physical asset and not just a claim on a hypothetical income flow.

As housing is a physical asset, its price must eventually equal or exceed the full cost building or rebuilding it – that is, as long as the market requires the construction of additional housing. So the real questions in the current crisis are a) when and how much future housing will the US need to construct, and b) are prices today so much higher than the cost of construction that they could still fall significantly and have development remain economically viable?