The Principle of Comparative Statics in Housing Markets: Post-COVID Shifts in Urban Real Estate

The Principle of Comparative Statics examines the effects on a market due to a change in some exogenous (external) factor. Comparative statics compares the equilibrium points before and after the exogenous factor occurs. The exogenous factor could shift the market demand, market supply (or both). COVID-19 was a major exogenous event in 2020, affecting most markets, and the effects are being felt to this day. So, what can comparative statics tell us about the post-COVID shifts in urban real estate? COVID has certainly had a major, long-lasting effect on property markets, and in particular, house prices, across much of the world.

In this post, we examine the analysis of Arpit Gupta et al in Pandemic-Induced Revaluation of Urban Real Estate and Nina Biljanovska and Giovanni Dell'Ariccia in Pandemic-Induced Shifts in US and European Housing Markets.

Exogenous vs Endogenous Factors

It’s important to distinguish between exogenous and endogenous factors when analysing comparative statics. Exogenous factors are events that occur outside the model, whereas endogenous factors are explained within our analysis.

When looking at a supply and demand model of a marketplace, price and quantity are endogenous variables – they are inherently part of the model. External changes, such as shocks caused by the COVID-19 pandemic, are exogenous factors.

Urban Real Estate Markets Before and During COVID

In the decade before COVID, there was an increasing demand for urban real estate in many city centres. This led to widespread concerns about housing affordability, particularly in popular cities. Central city housing in many areas has an inelastic supply, and whenever there is a change in some exogenous demand factor (for example, increased population) both housing prices (and rents in the rental market) rise relatively quickly. As a result, existing property owners (and landlords) of inner-city housing benefited from a boom during the 2010s.

Traditionally, house prices and rents in the central city are considerably higher than in the suburbs in most cities.  This recognizes that living in the city gives ready access to more facilities and activities than further afield. In many cities, there are increased employment opportunities in the city compared to the suburbs. In most cases, land is comparatively fixed in the city centre, but there is room for expansion in the suburbs.

COVID-19 gave a significant shock to the housing market in 2020. Many residents fled from city centres to escape urban density. This had a particularly notable effect on places like New York which has a high percentage of renters. Alongside this, there was a massive drop in demand for office space, with many people opting (or being forcibly required) to work from home. Office usage was still below 25% of the norm in most large markets by the end of 2020; less than 10% in New York. House prices and rents rose faster for suburban properties than for urban properties in 2020.

The bid-rent function, (the land price gradient) relates house prices and rents to the distance from the city centre.  The bid-rent function traditionally has a negative slope. Gupta et al calculated this data for the 30 largest US cities and compared the figures between December 2019 and December 2020. They found that the elasticity of price to distance changed from -0.127 pre-pandemic to -0.115 during that year for house prices, and an even more noticeable -0.04 to -0.004 for rents. This meant that house prices 50km away from the city centre grew 5.7% more than those close in. The difference in rents was 9.9%.

The researchers found that increased working from home was a major driver in the pattern of house prices and rents during (and soon after) COVID-19.

Results from a More Recent Post-Covid Study

Biljanovska and Dell'Ariccia made their study two years after Gupta et al and widened their research to include a variety of European countries, as well as the USA. They found that price gradients across the top 30 US Metropolitan Statistical Areas continued to increase over 2021 and 2022, and house prices in the outer regions of these cities continued to outpace their inner counterparts in the second half of 2022.

However, they found that relative house prices in cities in Denmark, the UK, and France did not follow the same trajectory seen in the US. Here, it appears that household relative preferences for suburban versus downtown living remained roughly constant during the COVID era. The study’s authors hypothesized that this was because of a difference in demographics between the US and Europe: US suburbs tend to have larger houses and be favoured by middle-class families, but European suburbs have more varied home sizes and cater for people on a wider range of incomes.

These researchers believe that the change in pricing gradients was primarily driven by demand shifts by higher-income households with the means and the opportunity to move to the suburbs. Areas that exhibited greater mobility of high-income individuals saw more pronounced suburban house price increases.

How Government Policies Can Affect the Housing and Rental Markets

We now have a new government in the USA that is considerably more interventionist than other recent governments. One of President Trump’s first executive orders in his second term was to “take all necessary steps to terminate remote work arrangements and require employees to return to work in-person”.

This should have the effect of reversing the housing demand shifts that occurred during the heart of the COVID epidemic. Of course, all of the other shocks caused by government policies, such as the current DOGE lay-offs occurring, could have another major effect, greatly reducing demand for housing in inner-city suburbs by former government employees.

Other government policies can affect either the demand or supply curves for housing, generally distorting the marketplace. This applies equally to owner-occupied and rental housing. For example, a government may think that it is helping tenants when it imposes a rent freeze. The problem is that if they set this below the equilibrium rent level, the quantity of rental properties demanded at the rent control price will greatly exceed the number of properties that landlords are prepared to offer at that price, causing a rental housing shortage.