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Pragmatic Capitalism

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Dimensional analysis and housing

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There was a famous Chemical Physicist at UCSD, Kent Wilson, who made a fortune in currency trading and was largely able to self fund his cutting edge Chemical Physics group at UCSD. He once pointed out to a Chemical Physicist colleague of mine at a post-meeting dinner one night when my colleague was offering the opinion that housing in San Diego was over priced, that he was failing to take into account the dimensional analysis of housing near a coast. In a geographically non-constrained housing market, the travel distance to the economic center goes as the square root of the population. We don’t know the exact scaling of economic activity with population, but it is certainly higher than linear, but unlikely to be as high as the square of population. The point being that along a coast housing accessibility scales closer to linear than square root, but economic activity due to population growth goes at a higher power. Do you not think that a house is a depreciating asset, but the land appreciates due to geographic factors? Do you think it’s possible to evaluate housing using simple aggregate financial metrics?

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Posted by John Daschbach
Posted on 10/10/2016 9:52 PM
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Hi John,

Having lived in beachside San Diego towns for over 10 years I can tell you that there is 100% a uniqueness to the geography. Here’s what I’ve noticed basically. Real estate tends to be broadly correlated to wage growth. People pay for housing what they can afford to pay and since housing is the largest monthly expense it tends to be correlated to wage growth over long time periods. Okay, so housing usually grows at 2-3% nominal and 0% real. That’s consistent with Shiller’s national data over long periods.

But what about coastal areas? Who lives there? Well, it’s all rich people. And rich people’s incomes don’t grow at average rates. So, when you buy in a coastal area you’re buying a property that is likely to appreciate somewhat closer to the wage growth rate in higher income households. So, you might get 3,4 or 5% in coastal areas where there is high demand for housing.

That’s been my experience anyhow. It seems to jibe with the data I see and the experiences I’ve had, but I can’t say that I’ve done comprehensive research on it….

– Cullen

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Cullen Roche Posted by Cullen Roche
Answered on 10/12/2016 2:00 AM
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