You Decide: How does the 'iron law of real estate' impact us
Almost 40 years ago my wife and I bought our first home. As a wet-behind-the-ears Ph.D. economist, I wanted to impress my wife with my knowledge of real estate by stating the “iron law of real estate”.
I confidently explained the “law” to her this way. “With a limited budget, people who value space - like square footage - over accessibility to work, shopping and other amenities buy a home farther out. Conversely, people who want to reduce their work commutes and easily reach stores, restaurants and entertainment settle for a smaller home closer in. Which do you prefer?
Her answer “I want a big house close to everything.”
To this day I don’t know if my wife was kidding or trying to put me in my place. I do know that in our subsequent home purchases she has been very aware of the tradeoff between space and location. In case you’re wondering, our first house was larger but far, far away from our daily travel destinations. We used to joke that, like the early pioneers, we’d hitch up the wagon and go into town a couple times a month for supplies!
Frustration with the iron law of real estate is frequently revealed when buyers say: “If only we could move this house closer in. It would be perfect.” TV real estate programs show real estate agents spending considerable time explaining the “you can’t have it all” choice to buyers. Incidentally, the same tradeoff between space and accessibility applies to renting.
The idea that we have to pay more for locations closer in makes logical sense. Most people value space (acreage, square footage) to accommodate their families, possessions and hobbies. At the same time people like proximity to work, shopping and other locational amenities because closeness reduces both travel time and travel costs, like gas.
Yet the unique characteristic of real estate was summed up by the 20th century humorist Will Rogers when he said, “Buy land. They ain’t (sic) making any more of the stuff.” At any location the amount of land is fixed. So if people want to live close to centers of work, shopping and entertainment, prices of these sites will be higher relative to locations farther away. With limited budgets, this means people who choose to live close in will only be able to afford less space.
Of course, not everyone puts a premium on living close in. People who have jobs in rural areas, small towns or people who don’t care about quick access to a variety of shopping, eating and entertainment options purposefully choose to live farther away from city centers. On the other side of the spectrum, not everyone values more living space. So they don’t mind living in a tiny house or apartment close to the action of the city center.
But enough people do like both living space and accessibility to make the iron law of real estate a reality. One way to easily see this is with tall buildings. In any region the tallest buildings will usually be in the center of economic activity (work, shopping, etc.). Building up is a way for developers to create more space at a particular location. However, because building up is more expensive than building out, prices per square foot in tall buildings will have to be higher. People who most value the accessibility provided by the big buildings pay the price.
In regions where there are multiple centers of economic activity – like Raleigh, Durham, and Chapel Hill in North Carolina or Dallas and Ft. Worth in Texas - it may be difficult to see the iron law of real estate at work, particularly on the boundaries of the centers. Also, there may be sites providing access to a very desirable feature – like an ocean, lake, or mountain ridge – that are very expensive even though they are not close to workplaces and shopping centers. Yet these are the exceptions – not the rule – to the iron law of real estate.
Could the iron law of real estate ever be repealed? Yes, and for two reasons. If economic centers lost their luster to the majority of households, then sites close to the centers would no longer be valuable. This could happen if technology changed the way we worked, shopped and relaxed. For example, if most people in the future worked remotely, bought products on-line and had them delivered by drones and were able to be entertained with on-demand streaming services and virtual reality, then big cities could lose much of their attraction.
Or, if cities were still valued but advanced transportation could easily and cheaply whisk people hundreds of miles in seconds (as in my wife’s favorite TV series, Star Trek), then the downside of more remote locations would quickly drop.
While these technological changes could happen, they’re not yet around the corner. So in the meantime, the iron law of real estate appears to be with us. Buyers of homes and renters of apartments can be ahead of the game in their search if they understand and use this long-established relationship between price and accessibility. Or, you may decide to be like my wife 40 years ago and say, “I want it all.” But economics – and finances – likely make that impossible!
Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook, and public policy.