Endless Light

The gravity-defying dynamics of high-end real estate in the world's top cities contradicts the famously gloomy vision of chief property Cassandra Robert Shiller. The Yale economist made his reputation seven years ago, when he correctly predicted the stock-market collapse in his book "Irrational Exuberance." In the second edition of that book, he applied the same analysis to the overheated housing market in the United States, blaming much of the staggering rise in prices on illogical herd mentality. Shiller is sticking by predictions of a 40 percent drop in housing prices in real terms over the next 20 years, and continues to warn that the bursting of the real-estate bubble will likely induce a major recession. "There's a lot of faith in glamour cities, but these cities have been around for hundreds of years, going up—and down," says Shiller. I don't see any reason why this [upward] trend should continue this time."

But others aren't so sure. In the new edition of "Irrational Exuberance," Shiller drew heavily on the pioneering research work of Piet Eichholtz, a Dutch professor of real-estate finance who charted housing prices in a fashionable residential district of Amsterdam from 1628 to 1973. Eichholtz concluded that real housing prices grew by a mere 0.2 percent annually over the span of nearly 350 years, and Shiller cited those figures to support his general thesis that real-estate values rise very modestly over the long term. But Eichholtz himself does not foresee a collapse in housing prices in many of the world's hot cities, including Amsterdam and Paris, for the next five to 10 years, because increasing urbanization and the growth of global wealth has more people chasing a limited number of city-center properties. "I'm not saying this process will continue forever," he notes. "But for now, my prediction is growth."

Further evidence that top cities may be less vulnerable to the usual boom-and-bust cycle comes from a lengthy working paper written by three economists from the Wharton School of Business and Columbia University for the non-profit National Bureau of Economic Research. The researchers identified several American cities like San Francisco, Los Angeles, Seattle and Boston that attract ever-larger numbers of high-income people willing to pay a premium to live there. The rise of such cities is rooted in the unprecedented proliferation of very affluent families in the United States that occurred in the second half of the 20th century. While the total number of families living in U.S. metropolitan areas doubled during that period, the number making more than $140,000 annually in constant 2000 dollars grew by eightfold.

Though the study focused on America, one of its authors sees a parallel process underway in some foreign capitals. "You need a combination of two things: a growing number of high-income folks who want to be together in a certain market and an unwillingness or inability to provide substantially larger numbers of new housing," says real-estate and finance professor Joseph Gyourko of the Wharton School. "Certainly London fits the mold and so does Paris, where you have a growing economy, a skewing of income distribution and very limited supply in the areas that are much in demand."

Of course, not all major world cities are enjoying a rebound in housing prices. Hong Kong has experienced a genuine collapse in its residential-property market, where prices fell by 2.6 percent in the third quarter of last year after soaring by more than 20 percent in the same period of 2005. In Australia, housing price increases in once thriving Sydney are lagging behind the national average. In both cases, rising interest rates were to blame.

The bigger worry is, what (if anything) could bring high-end real-estate markets to their knees en masse? Certainly a sustained depression in the world economy would induce a plunge in housing prices, no matter how tony the address might be. If the past is any guide, central bankers would play a big part in such a debacle. "The lesson we learn from history," says Milan Katri, chief economist of Britain's Royal Institute of Chartered Surveyors, "is that policy errors are almost always at fault when it comes to housing busts." Consider the 1990s, when policymakers in Tokyo failed to cut interest rates fast enough to cushion a steep fall in the economy. Huge numbers of homeowners defaulted on their mortgages, and banks stopped issuing new loans. Britain experienced a similar disaster over the same time period, when a too-steep rise in rates (they doubled in less than a year) caused a housing crash.