Many real estate markets are affected by an aspect of consumer behavior — and sometimes supplier behavior — that involves people making rapid, often unexpected, responses to situations they want to avoid. I call this the elastic adjustment factor. It affects what people do in housing and office markets.
The most common elastic adjustment occurs in rental housing markets during economic slowdowns. Many renters living alone during prosperity can no longer afford to do so when economic adversity strikes — so they double up, or return to their parents' homes. This causes a bigger drop in demand for total rental units during recessions than may be justified by demographic factors or the shrinkage of available jobs alone.
Poor households immigrating to the United States into high-cost housing also make similar adjustments. California has the highest housing costs in the nation, yet it receives more poor immigrants than any other state. How can they afford to live in California's expensive units? They double up, with multiple families living in a unit designed — and legally limited to — one family.
That is why Southern California has more illegally overcrowded units than any other place in the nation. Such behavior also occurs in large cities that received many poor immigrants in the 1990s.
The arrival of such newcomers has stimulated housing markets in cities ranging from New York to Chicago to Fresno, Calif. But housing demand often does not rise nearly as much as the number of new immigrant households because so many are sharing accommodations. In addition, many poor immigrants from abroad are now moving directly into older suburbs, as in Arlington County, Va.
Elastic adjustment also is prevalent in the office sector, where tenants are marketing excess space that they no longer need or can afford. Some industry observers estimate that nearly 15% of all office space on the market today is sublease space. When the market softened, experts' difficulty in projecting just how large an elastic adjustment would take place in the office sector led many of them to underestimate the real vacancy rate by considering only unrented space.
One result of elastic adjustments is that economic forecasts regarding housing and office occupancy or behavior are often mistaken because they do not allow for such adjustments.
For example, many believe that high housing prices have led to a housing price bubble that will soon burst and be followed by plunging housing values because we are now in a period of economic weakness.
But this forecast does not take into account the ability of existing homeowners to elastically adjust to declines in market demand. Faced with the prospect of selling their homes at reduced pricing levels in a sluggish economy, most homeowners will likely wait until market conditions improve before putting their house on the block. This ability of homeowners to hold out for their desired price keeps home values from plunging even during periods of dwindling demand.
Another housing manifestation of elastic adjustment occurs on the supply side of high-cost housing markets. Owners of existing units start adding accessory apartments to their homes or garages — often illegally — because the demand for lower-rent housing is so acute in places such as Honolulu and Nassau County, N.Y. Local authorities often look the other way because they know low-income households need accommodations that are not otherwise available.
Thus, before making key investment decisions in any property market, it is essential to take into account what elastic adjustments either consumers or suppliers may make that will not show up in economic models or direct measurements of demand.
Anthony Downs is a senior fellow at the Brookings Institution in Washington, D.C.