Skyrocketing land values are the main reason housing prices are at record levels, according to a new study.

Lot prices in places like Boston shot up at a compound annual growth rate of 18 percent between 1991 and 2001, while construction costs there have risen by just 2 percent, the joint research by two California real estate advisory firms found.

Other markets where the study found that land prices have far outpaced the cost of sticks, bricks and labor include such relatively inexpensive markets as Detroit, Miami-Ft. Lauderdale, Minneapolis and Albuquerque, all of which saw lot value increased by 10 percent or more annually over the last decade.

"Construction costs are not the reason house prices have gone up; it's land costs," said James Pugash, chairman of Hearthstone Advisor, a San Francisco-based firm which represents real estate investors from public and private pension funds, university endowments and Fortune 500 companies.

Based on a new measure called the "gross metropolitan product," the study found that lot values in some major markets haven't risen nearly as much as in other places.

While construction costs have gone up about 3 percent a year in Chicago over the 10-year study period, for example, lot values have risen only 2.9 percent annually.

And as a result, home prices in the Windy City rose by a relatively modest 3.6 percent a year.

On the other hand, land values in the Boston area have risen at a faster pace than anywhere else in the country, even San Francisco, the nation's most expensive housing market. And as a result, over the last 10 years, home prices here have increased 11.2 percent annually in that market.

But Pugash, a member of the Harvard Center for Housing Studies' policy advisory board, said the study shows that houses are not overpriced, at least not in relation to the supply of residential building lots.

He also said the research goes a long way toward refuting the notion that speculative house prices are akin to a bubble that's about to burst.

"If you take into account supply as well as demand, today's prices make sense," he maintained. "They may not be any more affordable, but at least they're more understandable." Pugash labeled most other analyses of housing costs "one dimensional and incomplete" because they talk about prices solely in relation to income. "Simply saying that housing is not affordable for the median income household tells us nothing about whether home prices are too high, too low or just right," he said.

To address that shortcoming, Hearthstone and the Rosen Consulting Group, a firm headed by noted housing economist Kenneth Rosen, developed the gross metropolitan product, or GPM, as a way to assess supply and demand at the same time.

They describe GPM as a "shorthand" measure for determining the balance between supply and demand. Though they concede the benchmark has some flaws, the researchers say it "goes a long way" toward explaining why housing prices are so high.

Although construction costs tend to be fairly stable from market to market, they concluded that home prices far exceed their replacement costs in a number of large metropolitan areas because the supply of residential building lots is so constrained that there simply aren't enough houses to go around.

Pugash said it would be "pushing it" to say there is no housing price bubble in most markets.

But, he added, "Even if the median income household cannot afford the median price home, there are enough higher income households in the market relative to the supply of available homes to support existing prices."

Published: November 6, 2002

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