Jessie Handbury, Assistant Professor of Real Estate, Wharton Real Estate Department explains why cities can be cost-effective places to live and how urban retail helps to explain the growing appeal of living downtown
Overview
Big,
top-tier cities are relatively inexpensive
places for high-income households to purchase goods because the
expensive items that high-income families tend to buy are plentiful
in such cities and households value the variety
Conversely,
big cities are relatively costly for low-income households because
cheap goods are expensive in such cities
The
synergies when retail options are tailored to residents' tastes
can yield higher rents and real estate prices as well as persistence
in the location's appeal
Executive Summary
Big,
top-tier cities, such as New York City or Los Angeles, seem expensive
because people spend a lot of money when they live there. But,
according to Jessie Handbury, Assistant Professor of Real Estate at
Wharton, such cities actually are relatively inexpensive
for many.
The
apparent paradox arises because people who tend to live in
high-priced cities have expensive tastes and hence are big spenders.
But if those big city dwellers moved elsewhere, they would be lucky
to obtain luxury items at all. Conversely, big cities are pricey for
low-income households because their preferred low-price goods, even
if available, are relatively costly to obtain there. In big cities,
expensive items are plentiful; but cheap items are expensive.
According
to Handbury, another benefit of living in a big city is that a wider
variety of goods is available. Such a plethora of options in big
cities means that residents can buy exactly what they want whereas in
smaller cities those residents would have to settle for something
else. Taking those factors into account, Professor Handbury finds
that a high-income household would find the cost of their preferred
bundle of goods to be 20 percent cheaper in a city like San Francisco
than in a city like New Orleans.
These
consumption benefits of living in big cities are so valuable, they
"go some way to explaining why high income households actually want
to live in these locations" despite high housing prices, Handbury
says.
It's
not just high-income households that can benefit from urban retail.
Anytime there is a concentration of people with similar tastes -- Millennials,
for instance -- living downtown, retail variety will arise to
satisfy the market. The attractiveness of those retail options will,
in turn, yield higher rents and real estate prices. This virtuous
cycle both creates value in the location and makes it persistent -- a dynamic real estate investors should keep in mind.
Transcript
Zell: We're here with Jessie Handbury, an Assistant Professor of Real Estate at the Wharton School. Thank you for joining us. Jessie, you have spent a number of years researching the cost of living across the U.S. It seems intuitive that there are big differences in the cost of living across cities. For example, New York City seems extremely expensive. Is that right?
Jessie Handbury: There are cities that are expensive, right, if you think of how much does it cost to buy things in that location. When we think of the cost of living that's the first place we tend to go. We think about how much a firm is charging for goods and services in that location, how expensive is housing and the like.
When you look at the data, households pay more for products, for the bundles of goods they're buying, in cities like New York than they pay in say, smaller cities like Des Moines. But those differences mask a lot of variation in what people are actually buying and also in what these different people's tastes are for these products.
If you look a bit deeper in the data, what you actually see is that the products households are buying in New York are generally at nicer stores and they're higher quality products. So, the fact that we're seeing households spend more say, on their groceries in the New York than in Des Moines, has a lot to do with what they're actually purchasing.
When you control for those differences [across cities] you find that the stores charge the same prices for the same product, controlling for the store quality. So, Whole Foods charges pretty much the same amount for an apple in New York as they do in Des Moines. It's just that a lot more households in New York shop at higher end stores like Whole Foods and buy higher end products in those stores, making it look like those households have a higher cost of living.
Zell: So, it's not that things are more expensive, but that people in "expensive" cities are just buying more expensive stuff?
Jessie Handbury: Yeah, it's not that individual products are more expensive.
Zell: Okay.
Jessie Handbury: The fact that households in more "expensive" cities buy more expensive stuff tends to indicate that perhaps there's more expensive stuff available there than in these smaller cities. And that these households have different tastes for products: they want more expensive products.
So, the cost of living differences actually derive not from the prices of identical products being different but the fact that cities like New York supply a much greater variety of products in general. New York has, for example, four times the variety of products available than a city like Des Moines. This ends up making New York, for the average household, about 10 percent cheaper if we're thinking about say, grocery prices than a smaller city like Des Moines. So, the expensive cities actually are cheaper once you think about what you can purchase there.
Zell: Well, suppose I'm someone who really just does not like organic food. And I'm in New York. How does it look for me?
Jessie Handbury: Well, certainly part of the reason that New Yorkers are buying these more expensive products has to do with the fact that they are more available [in New York], but it's also that they want these products. So, a Bouley Bakery brioche roll might be completely irrelevant to a lower income household. That's not going to impact the relative cost [for that household] of Des Moines versus New York.
But for a high income household who depends on that brioche roll every morning, it might have a very large impact on their cost of living. In fact, they can't get that roll in Des Moines whereas they can get it in New York. So, when we're thinking about the cost of living, we really want to think not just about accounting for prices and variety but how much do different households value that variety. It's really in the eye of the beholder.
Zell: So, if you were to take someone with gentrified tastes and put them in Des Moines, is Des Moines a cheap place for them? Is Des Moines an expensive place? Is Des Moines cheap but they're unhappy?
Jessie Handbury: When we say cheap versus expensive I'm really thinking about how much happiness costs. So, for someone with gentrified tastes, a city that doesn't offer the products that they want to purchase, the cost of utility, the cost of happiness, for them is going to be higher in that location. Either they're going to be less happy or they're going to be spending a lot of money to try to substitute away from the products that they can't access there.
And we see pretty big differences in the cost of utility across locations. If we're thinking about gentrified tastes versus non-gentrified tastes, let's take a city like San Francisco that's pretty high income and a city like New Orleans that's lower income but where you have some high income households. Even though San Francisco might have higher prices because products are more expensive there, the high income household with gentrified tastes actually faces a lower cost of happiness or cost of living in San Francisco relative to New Orleans. It's actually 20 percent lower relative to a low income household, who finds San Francisco to be 20 percent more expensive.
So, those are pretty big differentials.
Zell: When people with gentrified tastes are looking for what city to live in, how big a deal is it to their happiness to be able to choose a place with lots of restaurants and great stores and boutique shops like New York or San Francisco versus a place that has fewer or lower end retail options?
Jessie Handbury: These amenities are somewhat hard to measure in the sense that we don't have a lot of data on what stores are available in different locations and the prices and products they're offering. But for the subset of products that we have been able to look at — generally, grocery products, things you can buy at Walmart or Kmart — we see pretty big differentials on the order of 10 or 20 percent of living costs. That [difference] is smaller than differences in housing costs across locations, but it's still significant, particularly when you consider the fact that the two might not be correlated.
So, New York might have very high housing prices, but for high income households New York has lower costs of goods and services because they have these boutiques, restaurants. And it goes some way to explaining why high income households actually want to live in these locations.
Zell: So, I might choose to live in an expensive housing market because I can get to go to the restaurants I want to go to and I can shop at the stores I want to go to.
Jessie Handbury: Exactly. You're buying these amenities.
Zell: When we think about this from the perspective of an investor in commercial real estate, what implications do these differences across cities in retail variety and cost of living have for that kind of investor?
Jessie Handbury: Well, I think the first implication is something that real estate investors are already paying attention to, which is what are the demographics in a given market and what types of properties might you want to develop in order to suit the demand of those demographics. So, if you have a very high income neighborhood, perhaps in that neighborhood it might make more sense to a develop a high end retail location rather than a lower end retail location. Similarly when you're thinking about housing, you want to pair the housing and the quality of the housing that you're developing with the demographics and the demand in the market.
Something that perhaps is a little bit less intuitive or straightforward is the fact that when households are choosing where to live, particularly high income households, and they're thinking about moving into a gentrifying neighborhood, they might be looking for certain retail opportunities to already exist in that neighborhood.
But firms are also making a decision — retail firms — as to whether to enter these gentrifying neighborhoods. There's a coordination problem that we're faced with where there's not demand yet in the neighborhood but there's also not the supply of stores in these neighborhoods, or these amenities, to suit the tastes of the high income households. And you might need both to enter at the same time.
There is an opportunity for real estate developers by developing high end mixed use properties in neighborhoods that perhaps they think have the potential to be gentrified in order to solve the coordination issue and to essentially bring both the amenities and the higher income households at the same time.
Zell: Okay, so a mixed used development would bootstrap the provision of the boutique food or the Whole Foods or the Trader Joe's or whatever with the clientele that wants to be in those shops?
Jessie Handbury: Yeah, exactly. You're overcoming the issue of the fact that firms want, before they enter, to already have demand for their product there and households, before they move to a location, want to see those amenities. If you provide the space for both at the same time, then you're encouraging a joint entry.
Zell: Is the implication of the work in your field that such an initial start tends to snowball?
Jessie Handbury: Yes. Once there is a demand in a location, we generally think that firm entry is going to happen endogenously. Once there's a minimum level of demand for a certain product, firms can support the distribution of that product in a location. Similarly, once there's entry of base products obviously we'll have lower costs of living for higher income households and those locations will become more attractive to them and they'll continue to move in which will encourage the entry of more products.
Zell: I see. If I'm an investor in residential real estate in one of those steam rolling markets — because it's cheaper for the kind of people who want to live there, there's more variety of things that they want to buy and they're less expensive — they'd be willing to pay more, I guess, in rent in order to be there?
Jessie Handbury: Yes. A lot of work's actually been done already thinking about how amenities like schooling capitalize into house prices. But less work's been done — and we're starting to look at this now — on how the retail environment and these consumption amenities capitalize into house prices or into rents. I think that given the fact that it's going to cost say a higher income person less to buy their goods and services in that neighborhood that they'll be willing to pay more for those opportunities in terms of their housing.
Zell: I see. Pay more for a better fit?
Jessie Handbury: Exactly.
Zell: One of the largest groups that we think is turning to urban living is Millennials. How does that all play into this "good fit of a market to the consumer" story?
Jessie Handbury: One of the things that we still don't understand just yet is why Millennials are moving downtown. We're seeing it happen in the larger markets. And when we're talking about Millennials we're really saying it happened amongst the 25 to 45 year old age group and the college educated 25 to 45 year olds.
In thinking about why they're moving downtown, there are a range of reasons. It could be that their taste for suburban living is changing because there's some change in delaying child bearing or household formation. It could have something to do with credit constraints — they're not moving to the suburbs because they can't actually get a mortgage and get credit to buy a house.
An alternative explanation is that in these downtown locations, firms have entered and so have consumption amenities. There's been some sorting where firms have entered to satisfy the tastes of these young Millennial college-educated households and that has lowered the cost of living in these locations.
Regardless of why these households are living downtown in the first place — perhaps there was a short term shock to their credit availability so they couldn't buy houses — if firms have started entering to satisfy their demand and satisfy their tastes, then [the firms] might act as a magnet to keep these young college educated households downtown and we might see some long term implications.
Zell: I see. So, even if the original impetus for Millennials to be in a downtown location was short-lived, what you're saying is that it becomes sticky because [downtown] develops into a better fit and a nicer place for [the Millenials]?
Jessie Handbury: Yeah.
Zell: Jessie, thank you very much for taking the time to talk to us.
Jessie Handbury: It was my pleasure. Thanks for having me.