Elements of Real Asset Pricing: A Theoretical Analysis with Special Reference to Urban Land Prices

Abstract

The rapidly rising general inflation rates of the early 1970s were, in many cases, dramatically outpaced by increases in real asset prices. Land, housing, art, and gold were among the assets affected. In Canada, for example, a recent Task Force [Report 1978] has demonstrated that a land and housing price boom occurred in virtually all areas from Ontario to the West Coast during 1972-75. The average real increase in the price of building lots during this threeyear period was 53%7, with the average nominal increase reaching 103 %o. In the pressure of the moment, a number of hastily conceived theories were offered to explain these asset revaluations. Several theories of the Canadian land and housing price boom, for example, assumed from the beginning that local restrictions on the supply of new lots were the cause. Some analysts claimed that the land development industry was highly concentrated, and colluded to restrict supply. Others blamed the government for an ever-growing amount of red tape which was interfering with the flow of land onto the market. Elsewhere [Markusen and Scheffman 1977, 1978a] my colleague and I have argued that restrictions in new supply could not have caused such large price increases. Production of new housing in most cities amounts to no more than 3%7 of the existing stock and thus a 50% cut in this flow supply would amount to a cut of only 1.5% in stock supply in the first year. We suggested that the large price increases were probably due to significant increases in demand, generated largely by rising real incomes, falling real mortgage rates, a rising rate of general inflation, and the introduction of high-ratio mortgages. Land as an asset was revalued as both buyers and sellers revised their expectations concerning current and future incomes and interest rates. My reaction to this debate is that a number of important gaps still exist in