An Exercise from Urban Economics
To his great credit, Mr. Leinberger does not fatigue readers with yet another worn-out tome about the mythical "bubble" in the housing market or the current mortgage credit crisis as being the cause of modern suburban housing blight; instead, he thoughtfully analyzes some of the many interesting innovations in housing development being realized as part of large and significant social, economic, and resource availability forces reshaping the landscape of America. Absent from his survey of important factors, however, is a quite basic and entirely ancient force that shapes and reshapes urban landscapes, and it is to the purpose of summarily explaining this essential and thoroughly natural phenomenon that this post is dedicated. The phenomenon is so well-known in real estate studies and urban economics that it even has a name: it is called "filtering of the housing stock," and it has been around ever since cities have existed.
As a first principle, no asset retains value of its own accord because assets, in general, do not have an accord of their own. ("Human capital" is a partialnot a complete, but a partialexception to this principle.) The essential phenomenon of decline in asset value is "economic depreciation"; in terms of accounting for this reality, some clerical system is used by which the erosion can be recognized in a mathematical or tabular way. Such a system is called "(accounting) depreciation," and several broad forms of it can exist even in tandem, as is the case with financial accounting depreciation and depreciation for tax reporting purposes, the latter often being more rapid and/or front-loaded to quickly realize tax shielding, the former being the method applied for public reporting.
Nevertheless, the underlying principle is not artifice: constructed assets (assets whose value is largely the result of improvements to raw resources) really do lose value through time, and the only way that can be prevented from occurring is through maintenance and improvements, both of which require capital. Absent the capitalfinancial, "sweat equity," or otherwisean asset becomes less valuable as it ages. More importantly, whether or not capital is invested to slow or reverse economic depreciation is entirely dependent upon whether or not the net present value of future expected cash flows from maintenance and improvements exceeds the current cost of the contemplated maintenance and/or improvements.
In urban areas, many were the housing divisions, apartment complexes, and businesses established in the heyday of urban life and activity. As that activity and the cash flows that go with it migrated outward from the city centers, usually along major arteries that led from the main parts of towns, the close-in housing stocks "filtered" down because there was insufficient incentive to maintain them, much less make improvements. Eventually, in some areas, "gentrification" occurred, and this was in part because tax incentives made re-investment in urban dwellings attractive, but it was also the result of the housing stocks having filtered so far down that "abandonment" values made re-investment attractive. It is not fanciful metaphor to describe gentrification as a value echo that returned to the point of origin once the valuation pressure differential had made the reflective path more attractive than the continued outward movement.
Whatever the particulars of the pace and pattern of filtering, it often follows pathssome quite linear, some much more complexout from the center of a city (what urban economists call the "central business district," or "CBD"). When filtering makes its way out to suburbs, an interesting phenomenon may occur: because the suburbs, themselves, are centers of community activity, both social and economic, they, too, can become the nodes from which filtering emanates. This means the suburbs have filtering from the major city sweep through; then the filtering from their own and proximate suburban central business districts sweeps through, thus creating a complicated and fascinating set of harmonics and interference patterns of devaluationsand sometimes even such devaluations that rehabilitation becomes economically attractivejust like waves from pebbles meeting and interacting on a pond cause multiple, standing depressions in the water right next to multitudes of standing crests.
It is these interacting patterns of filtering activity that economically devastate some housing divisions while leaving others completely unscathed. Although suburbanization intensifies the complexities of these economic winners and losers among housing stocks, the underlying phenomenon, itself, of filtering is enduring, pervasive, and fundamental, and it will remain so for as long as cities persist and for as long as avenues exist (be they streets, freeways, communication networks, or other modes of physical and information transport) by which economic value can articulate along paths of least financial resistance.
The Dark Wraith has once again demonstrated how fascinating theoretical economic analysis can be.