International Real Estate Review

Studies of the linkages between real estate prices and general economic conditions have an extensive history, beginning with tabulations suggesting the ways in which long swings in construction and price development were synchronized with long swings in aggregate economic activity (Gottlieb, 1976). Recent studies have explored the implications of alternative representations of investor expectations upon real estate construction and the cyclical behavior of housing prices and the rents for non-residential properties. These models trace through the effects upon supplier and demander behavior of differing price expectations in the real estate market. The earliest models tease out the dynamic paths of housing prices and commercial rents which arise from exogenous expectations about the future course of prices. More sophisticated models assume that households and firms have adaptive expectations about the future, assuming, for example, myopic behavior on the part of economic actors (in which they forecast that current conditions or current rates of change will continue into the future). In the most modern formulation of market dynamics, actors are assumed to have rational expectations. That is, in response to unanticipated shocks in the housing or property market, economic actors, on average, are able to predict the market response correctly and are able to act upon that knowledge. Models such as these are able to generate patterns of price change over time in response to varying conditions in economic fundamentals and in economic shocks. (See, for example, DiPasquale and Wheaton, 1992, and Case and Shiller, 1988). There has, however, been little or no research on the opposite line of causation -- the effect of changes in property markets upon subsequent economic conditions. The first part of this paper is focused on the former question –- the linkages between economic “fundamentals” and property prices. It reports on new research evaluating empirically the effect of economic conditions upon property prices. In particular, this research includes a detailed comparison of the importance of “fundamentals” upon housing prices relative to the importance of “history” in affecting outcomes. The second part of the paper focuses on the latter question -– the potential for a causal role between outcomes in the property market and the subsequent health of the overall economy. This discussion is largely speculative and suggestive –- and not based upon any tight theoretical or empirical model. The first part of the discussion is based upon a detailed body of data from the U.S. The second part of the discussion may be relevant to the economic conditions which have faced many Asian economies during the last three years. Specialists in Asian property markets will have far better access to data and hypotheses about these specific markets than I. However, I will raise a few questions that deserve more research in the analysis of the current fiscal crises in many Asian countries.