Edward Conard

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AI Summary. Housing price appreciation in "superstar" cities has exceeded that of other regions by up to 60 basis points annually over 150 years, but higher rental yields outside these cities—about 160 basis points more per year—leave superstar cities with a negative total return premium of roughly 100 basis points annually.

Francisco Amaral Federal Reserve Bank of New York
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According to @FederalReserveBank of New York, superstar cities have seen higher housing price appreciation over 150 years, but total returns are lower due to higher rent returns in non-superstar cities.

Do superstar cities deliver lower total housing returns than other regions?

Core argument: Housing in "superstar" cities has delivered a negative total return premium of roughly 100 basis points per year over the past 150 years, as a price-appreciation edge of up to 60 basis points annually is outweighed by rent returns about 160 basis points lower.

Over the past 150 years, housing price appreciation in "superstar" cities has been higher, with an average annual difference of up to 60 basis points compared to other regions. However, total returns in non-superstar cities have surpassed those in superstar cities due to significantly higher rent returns, estimated at 160 basis points more per annum. This results in a negative return premium of approximately 100 basis points annually for superstar cities. The higher returns outside superstar cities are seen as compensation for greater risk, as these areas exhibit higher covariance with income growth and lower liquidity. Despite the allure of rapid price appreciation, the long-term total returns in superstar cities are lower, with investments in these areas earning only about half the cumulative return compared to national portfolios over the past 70 years. Rent returns, representing about 67% of total housing returns, have been the main driver of this trend.

Takeaways by Macro Roundup® AI

  1. Housing in "superstar" cities has delivered a negative total return premium of roughly 100 basis points per year over the past 150 years, as a price-appreciation edge of up to 60 basis points annually is outweighed by rent returns about 160 basis points lower.
  2. Rent returns account for about 67% of total housing returns, and investments in superstar cities earned only about half the cumulative return of national portfolios over the past 70 years.
  3. The higher returns outside superstar cities are interpreted as compensation for greater risk, as those areas show higher covariance with income growth and lower liquidity.

FRBNY research suggests "Superstar" real estate is safe, "...We study long-term returns on residential real estate in twenty-seven “superstar” cities in fifteen countries over 150 years. We find that total returns in superstar cities are close to 100 basis points lower per year than in the rest of the country. House prices tend to grow faster in the superstars, but rent returns are substantially greater outside the big agglomerations, resulting in higher long-run total returns.The excess returns outside the superstars can be rationalized as a compensation for risk, especially for higher covariance with income growth and lower liquidity. Superstar real estate is comparatively safe...."

Core finding, ".... Our central finding is that, over the long-run, superstar cities have witnessed lower total returns on residential real estate than other parts of the same country. With 5.75 log points per year, average total returns have been smaller compared to the national average of 6.68 log points. In other words, an investment in superstar cities comes with a negative return premium of approximately 90 basis points annually relative to national returns (including the superstars) and about 100 basis points lower than the rest of the country (excluding the superstars).These return differences are a robust feature of the data across countries and time periods, and statistically highly significant. A negative return premium of around 1 percentage point accumulates to substantial return differences in the long run. For instance, an investment in the superstar portfolio earned only about half the cumulative return than the national portfolio over the past 70 years..... We confirm that house price appreciation tends to be higher in superstar cities than in the rest of the country. Over the long run, we estimate an average annual difference of up to 60 basis points annually between our 27 superstars and other parts of the country (albeit with mixed statistical significance).At the same time, rent returns are considerably higher outside the large cities. Our point estimate puts the mean rent return differential at 160 basis points per annum. The differences in rent-price ratios exceed the differences in capital gains in the long run and lead to lower total housing returns…”

Why would this be the case, "...Why are housing returns persistently lower in large cities when compared to the rest of the economy?Our key finding can be rationalized in a standard asset pricing framework where excess returns are a compensation for risk. Observable long-run return differences between different assets must be attributable to differences in risk, or to violations of standard assumptions (such as persistent behavioral biases in expectations). Suppose that everything that makes a national superstar city - its diversified economy, its large market, its amenities, the international demand - also makes it a safer place as an investment. A consequence would be that the present value of future housing services will be subject to less risk so that buyers are willing to pay a higher price and accept a lower return for housing investments in large agglomerations. In turn, higher returns outside the superstars would be a compensation for higher risk. For remote locations to attract capital, they have to offer higher returns..."
Evidence

"... The left-hand panel of Figure 4 shows average log housing returns for the full time period and the right-hand panel for the period post 1950. City-level total housing returns have been in the four to six log point range per year, with some differences across the cities in our sample. Toronto, Amsterdam, Gothenburg, Tokyo and Sydney are the cities with the highest long-run returns. The panel on the right shows that housing returns have been higher in the post 1950 period and reached about 6 log points...."

Superstar Returns: Extended Excerpt Image 1


"... Figure 5 plots the distribution of annual log real housing returns for the pre- and post-1950 period. While housing returns were on average lower in the pre-1950 period, they also displayed a higher standard deviation than in the post-1950 period, apparent in a thicker left-tail in the pre-1950 period. This does not come as a surprise, considering that this period featured two World Wars, the Great Depression and large variations in housing policies. Post-1950 superstar returns were close to 2 percentage points higher with a lower standard deviation..."

Superstar Returns: Extended Excerpt Image 2


"...Panel (a) of Figure 6 plots 10-year lagged moving averages of log real housing returns averaged over the 27 national superstars over time. Housing returns dropped sharply around the World Wars as house prices dropped. The effect is particularly pronounced after World War I, as many governments introduced rent freezes in high inflation environments as discussed by Pooley (1992) and White, Snowden, and Fishback (2014)...Higher mean annual total returns in the post-1950 period are driven by substantially higher capital gains. While mean annual capital gains were, on average, 2.95 log points higher in the post-1950 period when compared to the pre-1950 period, mean annual rent returns were, on average, 1.22 log points lower. Panel (b) ofFigure 6 shows the difference in means between the post- and pre-1950 period by city.Across the majority of cities in our sample, mean capital gains were substantially higher in the post-1950 period, while mean rent returns were lower. The increase in mean capital gains is mostly driven by the largely negative capital gains during the war periods. Kuvshinov and Zimmermann (2020) discuss that the fall in rent returns mirrors the secular decline in the yield component of stock returns over the same period. Rent returns represent approximately 67% of total housing returns over the last 150 years. Panel (a) of Figure 7 shows that, although the relative share of rent returns has been quite volatile over time, it has remained by and large the main contributor to total housing returns. In fact, for all cities in our sample, with the exception of Milan, rent returns represent more than 50% of total housing returns in the long-run. This result is in line with the findings in Jord`a et al. (2019) and Demers and Eisfeldt (2021)...."

Francisco Amaral, Martin Dohmen, Sebastian Kohl, and Moritz Schularick, "Superstar Returns," Federal Reserve Bank Of New York, December 2021, https://www.newyorkfed.org/research/staff_reports/sr999

Superstar Returns: Extended Excerpt Image 3

Superstar Returns: Extended Excerpt Image 4


"...To guide the reader through the results, we start with an example of an undisputed national superstar city for which we have high quality data: Paris. Our data show that an investor who bought an apartment in Paris in 1950 realized an average yearly capital gain of 4.85 log points over the period until 2018. The annual rent return in Paris was 3.66 log points on average, resulting in a healthy total annual return of 8.33 log points. This means, for instance, that investments in Parisian residential real estate beat investments in the French equity market by a substantial margin, even on an unleveraged basis. How does this investment return compare to the rest of France? According to Jord`a et al. (2019), an investment in the French national housing portfolio over the same 70-year period saw annual capital appreciation of 4.48 log points, somewhat lower than Paris. As Paris is a substantial part of the French national portfolio, the difference must be driven by other regions in France, in which house prices have risen about half a percentage point less per year than in Paris. However, the picture changes when we bring in rent returns, which were substantially higher in the rest of the country (5.06 vs. 3.66) and more than offset Paris’ advantage with respect to capital gains. Total housing returns were 9.15 per annum for the rest of France and thus about 85 basis points per year higher than in Paris. Despite higher capital appreciation, the superstar city Paris underperformed the rest of France with respect to total returns on housing investment...."

Superstar Returns: Extended Excerpt Image 5


"... Figure 9 shows that the city-level portfolio increased much faster in value than the national one, because house prices in the superstar cities appreciated more, namely by a factor of 6.2 compared to 4.7 for the national portfolio.11 Once again, the picture changes when rent returns are added in the right panel of Figure 9. Assuming reinvestment of rent returns, the national portfolio outperforms the city-level portfolio by a large margin. From 1950 to 2018, the cumulative return on a national housing portfolio has been twice as high as the returns in the superstars...."

Superstar Returns: Extended Excerpt Image 6

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